A Proforma Income Statement is a projection—typically over a period of ten years—of an investment property’s income and expenses. It is used for real estate investing analysis because it gives the investor an idea of the property’s cash flow, and in some proformas, the investor’s tax benefit (or loss) and sales proceeds in the event of a future sale.

ProAPOD real estate investment software provides essentially two kinds of proforma income statements. Whereas Premium 10.0 includes depreciation, amortized loan points, mortgage interest, investor tax benefit, cash flow before and after tax, and sales proceeds after tax, Basic 6.0 does not include the elements of tax shelter, and provides only before tax cash flows.

Some would argue that a proforma should be a twenty-year income statement. The problem most see with this, however, is that since it is a projection, the numbers being estimated out over so many years would be too unreliable for concise analysis. For that reason, most opt for a ten-year proforma, as does ProAPOD real estate investment software.

Creating a Proforma Income Statement is not difficult, especially with a spreadsheet program like Excel, but it can be time consuming. Here is a typical layout for a proforma income statement:

Gross Scheduled Income (GSI)
Less: Vacancy
Equals: Effective Gross Income (EGI)
Plus: Other Income (i.e., laundry, etc)
Equals: Gross Operating Income (GOI)
Less: Operating Expenses
Equals: Net Operating Income (NOI)
Less: Debt Service
Equals: Cash Flow Before Tax (CFBT)
Less: Tax Liability or (Savings)
Equals: Cash Flow After Tax (CFAT)

In this case, all numbers are annualized.

ProAPOD Real Estate Investment Software provides a proforma similar to that above in both the Premium 10.0 and Investor 4.0 editions. Basic 6.0 does not include the tax liability or CFAT computations.

To see a sample (in PDF format) go to our real estate investment software reports page.

Successful real estate investing requires that operating decisions be made on a timely basis. Some involve day-to-day operations while others involve long-run strategies based upon the investor’s portfolio considerations.

As a result, real estate investors make use of a pro forma operating statement with anticipated and forecast levels of cash flow for management plan decisions regarding investment property performance. A number of useful ratios, multipliers, and other analytical formulas have been developed to make better use of that information.

Here are some of those formulas, though it should be noted that the results of these calculations are only useful if they can be compared to similar information gleaned from comparable properties.

1. Economic Value is a measure of value from the standpoint of the real estate investor and may be more or less the market value of the property. It is determined by the investment property’s NOI and a capitalization rate that a real estate investor requires to attract that specific investor’s capital to the project.

Formula: Economic Value = Net Operating Income (specific property) / Capitalization Rate (individual investor)

2. Operating Expense Ratio provides an indication of what percentage of the gross operating income (GOI) is being consumed by operating expenses. If the investment property varies substantially from the operating expense ratios of similar competing property, the differences might be attributed either to better management of expenses or to the discovery that all expenses may not have been ascertained.

Formula: Operating Expense Ratio = Operating Expenses / Gross Operating Income

3. Break-even Ratio (BER; also called default ratio) provides the investor with the percentage that operating expenses and debt service will consume of gross operating income. Its purpose is to estimate how vulnerable an income property is to defaulting on its debt in cases where rental income should decline, and is often a benchmark ratio used by lenders when underwriting commercial mortgages.

Formula: Break-even Ratio = [Operating Expenses + Debt Service] / Gross Operating Income

4. Debt Coverage Ratio (DCR) provides information on the extent to which the net operating income covers debt service. A ratio in excess of 1.1 indicates that there should be net income remaining after servicing the mortgage, though lenders typically like to see an NOI cushion and therefore require a DCR of 1.15 or greater on their investment property loans.

Formula: Debt Coverage Ratio = Net Operating Income / Debt Service

I am generally opposed to the “get-rich-quick” methods of real estate investment because they often assume self-management while ignoring your opportunity cost of time and the risks of high leverage. Besides, logic suggests, that when you uncover a goldmine you do not publish a map.

In real life, there is no secret way to attain real estate investing success. It requires hard work with good research and systematic analysis.

Here are some things about real estate investing that you may, or may not, know that may help you.

Real Estate Investment Does Provide Opportunities to Make Money
There are various ways to add value to real estate investment property, and thus real estate investing a profitable business.

• Real estate acquisition
• Development
• Financing
• Site analysis
• Controlling operating costs
• Innovative marketing
• Innovative property management

Business Goals You Might Consider

• Maximize long term wealth
• Short term financial goals like cash flow
• Develop or own only the highest quality properties in prestige locations
• Own the largest market share of a certain type of income property in a local market

Short Term Financial Goals You Might Consider

• Satisfy the requirements of the lender in terms of pre-leasing or debt coverage cash flows
• Satisfy the minimum required first year cash on cash returns required of investors
• Project minimum internal rates of return for the entire holding period of some minimum percentage
• Maintain occupancy levels above 95% in all portfolio properties

Popular Financial Analysis Decision Models

• Cash on Cash Return (CoC)
• Gross Rent Multiplier (GRM)
• Capitalization “Cap” Rate
• Internal Rate of Return (IRR)

Cash on Cash Return
Cash on cash measures the initial profitability of a rental property. The higher the better, and typically a first-year cash on cash return ranges from about 4% to 10%.

Formula: Cash on Cash = Before Tax Cash Flow / Cash Equity (Initial Investment)

Gross Rent Multiplier
Gross rent multiplier measures the ratio between annual gross rental income and sale price. Think of it as an indication of the number of years it takes the annual rental income to equal the price, so the lower the better. It is good for simple comparisons to other rental property opportunities but insufficient as a stand-alone number.

Formula: Gross Rent Multiplier = Purchase Price / Gross Rent

Capitalization Rate
“Cap Rate” is essentially a return on asset indicator of how much debt an income property can carry. The higher the return rate, the more debt a property can support, and hence the better the investment opportunity for the real estate investor. Sellers of income property, of course, prefer to sell at lower cap rates. Local markets dictate capitalization rate (there is no one-size-fits-all) but they typically run from about 5% to 12%

Formula: Capitalization Rate = Net Operating Income / Purchase Price or Value

Internal Rate of Return
The IRR model essentially calculates the average discount rate that equates all future returns over the projected holding period back to the present value of the initial equity investment.

It is the most frequently used measurement of projected holding period overall returns because IRR delivers in one number an investment return that integrates rental growth rates and property value appreciation.

RR should be used as a comparison to the real estate investor’s required rate of return for making capital allocation and initial investment decisions. An IRR can be before or after tax using before or after tax cash flows.

Software
Although you can make the calculations yourself on some hand-held calculators or in Excel, both your time and money would be better spent if you invest in good real estate investment software that can quickly make the calculations for you.