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Royal LePage
Royal LePage

How to Read a Proforma

A proforma provides a detailed financial projection of a property’s potential performance, helping you make informed investment decisions. Understanding how to read a proforma effectively allows you to evaluate real estate opportunities thoroughly.

Proforma Sections:

1. Income Projections

  • This section details the expected revenue from the property, including:
    • Rental income
    • Parking fees
    • Other sources of income

Tip: Verify income assumptions by comparing them with local market data and consulting with local experts to ensure they are realistic.

2. Vacancy and Credit Loss

  • This accounts for potential income losses due to:
    • Vacant units
    • Tenants failing to pay rent

Tip: Use conservative estimates based on average vacancy rates for similar properties in the area to get a realistic view of potential cash flow.

3. Operating Expenses

  • Operating expenses include:
    • Property management fees
    • Utilities
    • Maintenance
    • Insurance
    • Property taxes

Tip: Break down operating expenses into fixed and variable costs to better understand how they may change over time.

4. Net Operating Income (NOI)

  • NOI is calculated by subtracting operating expenses from total income.
    • It represents the property’s profitability before financing and tax considerations.
    • NOI is a key indicator of the property’s financial health and potential return on investment.

Tip: Look for opportunities to improve NOI through cost-effective management and maximizing rental income.

5. Debt Service

  • Debt service refers to total loan payments (principal + interest) for the property.
    • It significantly affects cash flow and the overall financial health of the investment.

Tip: Check the debt service coverage ratio (DSCR), which compares NOI to debt service and indicates whether a property can comfortably manage its financing costs. A DSCR of 1.5 means the property produces 1.5 times the income needed to pay its loans.

6. Cash Flow Before Taxes (CFBT)

  • CFBT is calculated by subtracting debt service from NOI.
    • It represents the cash generated by the property before taxes.

Tip: Ensure the cash flow is positive and sufficient to cover unexpected expenses and provide a financial buffer.

What’s the difference between DSCR and CFBT?

  • DSCR provides a relative measure of the property’s ability to cover its debt.
  • CFBT shows the actual cash available after covering expenses and debt service.

7. Capitalization Rate (Cap Rate)

  • The Cap Rate measures the property’s return on investment, calculated by dividing NOI by the purchase price.
    • It helps compare the profitability of different investment opportunities.

Tip: Use the Cap Rate to benchmark the property against similar investments.

8. Internal Rate of Return (IRR)

  • IRR calculates the expected annualized rate of return on the investment, considering both the property’s income and its eventual sale.
    • It provides a comprehensive view of the investment’s long-term profitability.

By understanding each section of the proforma, you can better assess a property’s financial viability and potential returns, helping you make smarter investment decisions.