Pro Forma Financial Analyses
When working with our clients on real estate development projects, one question they frequently ask is, “How can I be sure this project will be successful financially?” This is an important consideration, as municipalities, developers, local businesses, brokers, and others in the community commit significant time and resources to bringing a project to fruition. A pro forma financial analysis by CERC can help answer this question.
A pro forma, in its simplest form, is a tool used to estimate a company’s or project’s financial performance, using a specific set of criteria. For example, a company may want to understand what their operations would look like after a transaction such as a merger or acquisition, or what the prior year’s performance would have been without certain non-recurring items, such as large disposition.
In real estate, a pro forma is typically prepared in advance of a transaction, such as the purchase, sale, or redevelopment of a site. The pro forma models the expected financial performance of the transaction, and typically includes several components. These components include revenues, such as income from the rental or sale of the space to be developed, as well as ancillary revenues such as parking, tenant fees, and signage, among others; and estimates of revenue deductions such as vacancy or collection loss. On the expense side, line items typically include real estate taxes, insurance, repair and maintenance, and administrative categories. The difference between these categories is the net operating income (or loss, if expenses are greater than revenues).
From there, the a pro forma can further delineate the non-operating cash flows, including expected tenant improvements, leasing commissions, and capital expenses; reserves; financing payments; and/or cash flows to investors, depending on which portion of the transaction is being evaluated. The analysis may also include property-specific adjustments, such energy efficiency credits, tax abatements or other incentives, and the like.
A real estate pro forma is a valuable tool used by a number of parties. For example, buyers would want to understand the anticipated performance of the property to calculate the return on their investment or estimate their annual cash flow. Investors, likewise, use a pro forma to calculate their expected return or understand the cash waterfall, while lenders want to ensure that the project will have sufficient cash flow to repay the loan. Other interested parties, such as those awarding loans or grants for a specific purpose, such as rehabilitation of a strategic parcel in a downtown or commercial area, may want to see that “but for” their financial assistance, the project could not move forward. Similarly, public officials or government agencies considering tax abatements or other incentives may use a pro forma to determine the amount of support needed for the project, or simply to ensure that the project has sufficient financial resources to be completed.
While some larger developers have financial analysis capabilities in-house, many of CERC’s clients, including smaller firms, brokers, or municipalities either do not have expertise in this area, or lack available staff time to complete such analysis. In other cases, even for firms who do have the in-house expertise, an analysis by a neutral third party can lend credibility to the findings when being presented to a third party for review. If a pro forma financial analysis would help with the decision-making process for your next real estate project, CERC can help.