Pro forma in real estate and how to calculate

Pro forma is both a method of analysis and the resulting financial statement. A pro forma statement lists actual income and expenses in one column and estimated income and expenses in another column. 

• Business. A pro forma financial statement, like a budget or balance sheet, calculates projected financial results, which can help business owners evaluate a company’s outlook and make informed business decisions about the future.

• Real estate. Pro forma in real estate can help investors determine the property's potential. Much like how a company uses pro forma to make predictions about the business, a real estate investor can determine if the initial investment—and efforts if they decide to manage the property themselves—are worth the long term profit.

One important thing to note about pro forma is that it typically focuses on consistent cash flow and costs, excluding one-time or out-of-the-ordinary costs. But by looking at estimated income and expenses, you can predict how a business or investment will perform over time. 

In real estate, pro forma is a document that helps investors evaluate a property’s potential profit. It combines real-world information about a property (such as past or current rental income) and projections (such as how much repairs might cost and how often you’ll need to make them) to provide an assessment of the property’s potential future financials (see below for more calculation specifics). 

A real estate pro forma report details a property’s projected net operating income (NOI) and cash flow projections using its current and potential rental income and operating expenses. It will forecast how a property would perform with certain fluctuations in mind—for example, if you raised rents, shrunk the vacancy rate, made improvements, or hired a property manager and incurred property management fees.

The first step in calculating pro forma is to estimate the following line items:

• Projected gross rental income (GRI). This is the income the property would bring in if it was completely filled all the time at market rent.

• Vacancy rate. Takes into account how many vacant units your property would have at any given time, and how often vacancies might occur.

• Repair expenses. An estimate of how much repairs to the property would cost over a year. It is best to set aside a portion of the monthly gross income for potential repairs.

• Property management fees. This includes what you’ll pay to a property manager, property management company, or a  building super.

• Mortgage payment. If you have a mortgage, how much will it cost you per month?

• Other expenses. This includes tax fees, insurance costs, leasing costs, and legal fees.

Once you’ve made the estimations above, total your expenses and use the equation to calculate pro forma: 

Pro Forma NOI = GRI – Vacancy expenses (Vacancy rate x GRI) – All other expenses

Remember, the pro forma calculation is an estimate based on assumptions and projections that are calculated using market research, history, and financial know-how. It’s a vital piece of real estate investment decisions best used alongside other projection tools to paint the fullest picture of risk and return.

A thorough pro forma document will include other calculations that are helpful in making investment decisions.

Cap rate

In real estate, the capitalization rate, or cap rate, is used to show the expected rate of return on an investment property. It is expressed as a percentage of the initial purchase price and indicates its net gain or loss over a one-year time frame. To calculate:

Capitalization rate = Net operating income / Current market value x 100% 

Return on investment (ROI)

ROI tells you how much profit you can expect to make in rental income over the long term. It’s expressed as a percentage of the cost of the investment, and you can figure it out by using a fairly straightforward formula. To calculate:

ROI = (Gain on investment - Cost of investment) / Cost of investment 

Cash-on-cash return

Cash-on-cash return, sometimes abbreviated as CoC return and also referred to as cash yield or the equity dividend rate, is an annual measure of a real estate investor’s earnings on a property compared to the amount the investor initially spent to purchase it and make it operational. To calculate: 

Cash-on-cash return = Annual cash flow (pre-tax) / Total cash

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