If you’re looking to get started with commercial real estate in Chicago, it’s important to familiarize yourself with interpreting and creating pro forma financial statements. These statements can help you understand whether or not a property is the right investment for you.
What is a Real Estate Pro Forma?
‘Pro forma’ is a Latin term used in real estate investing to describe the formal report drawn up to collect financial information about a certain property. At its most basic, this financial report typically includes the current or estimated income and expense information. The pro forma is used to make short and long-term projections about the investment, such as the potential ROI, the cap rate, and cash-on-cash return.
Beware the Seller’s Pro Forma Financials
One common mistake made by new commercial real estate investors is to rely exclusively on a seller’s financial reports when making a decision to buy. When it comes to what information to include in a pro forma, the seller’s and buyer’s interests are not always aligned. It’s important that the investor creates their own pro forma (or enlists the help of a third party consultant) in order to have an unbiased reference.
A seller could be inclined to emphasize the cash flow of their property and mislead potential investors by leaving out key information. For example, a report that includes things like purchase price, annual rent, and appreciation—without any mention of costs—provides a limited and misleading snapshot of the investment property.
What Totals Should Be Considered?
- Rent income. Estimate the amount you are likely to receive from the building’s tenants as an owner, bearing in mind that rent prices can fluctuate ±5%.
- Vacancy loss. Adjust your income estimation to include time the unit(s) will spend vacant between tenants. Often, this is the highest cost on a pro forma.
- Repairs. How much will be needed to repair and maintain your building? Most property owners should set aside at least 5% of their rental fees for repairs and maintenance.
- Property management fees. PM costs can equate to 8-10% of a company’s cash flow and need to be included in your pro forma. Owners who decide to manage the property themselves need to assess their own compensation for their time and related expenses.
- Property taxes and insurance. Projected taxes and insurance rates for a property can be difficult to nail down as there are many factors at play. Researching to determine potential ranges, and then using the higher end, can help investors avoid unhappy surprises.
- Other miscellaneous costs. Depending on the investor’s strategy, legal costs, advertising costs, or staging fees may be necessary parts to include on a pro forma balance sheet.
Commercial Real Estate in Chicago
Are you looking to buy or sell commercial real estate in Chicago? Let the Frontline Real Estate Partners help make your experience in the marketplace as positive as possible. Contact us today to set up an appointment with a member of our real estate team.