The Proforma Income Statement | How to Project Rental Property Cash Flows And Performance

Real estate investors commonly depend on a proforma income statement whenever performing a real estate analysis so that you can evaluate the long term cash flow performance of rental properties out over a number of years.

The concept of the proforma income statement is straightforward. As a result of examining the financial performance of the rental property the year before and then making use of a variable to generate projections into the future, the real estate investor has the ability to project the cash flows he or she might expect to receive on a year-to-year basis over time based on those projections in the proforma.

Here's the way it works.

Assume that a property presently generates $30,000 gross operating income and has operating expenses of $12,000, consequently providing a net operating of $18,000 (i.e., income - expenses = net operating income). In this case you could ascertain the subsequent year's net operating income based upon an educated guess for next year's income and expenses.

As an example, say that you project the gross operating income of $30,000 will increase yearly at 5% and the operating expenses of $12,000 at 4%. Then it follows that the net operating income at the conclusion of the coming year will increase to $19,020.

Revenue (next year) = $30,000 + (30,000 x .05) = $31,500
Expense (next year) = $12,000 + (12,000 x .04) = $12,480
Net Operating Income (next year) = $31,500 - 12,480 = $19,020

This is basically the procedure used for every subsequent year extending out for any specified amount of years until the rental income proforma is populated for that number of years (e.g., 10 years).

Why are these property performance forecasts important? Because, as anyone engaged in real estate investing understands, real estate is not regarded as liquid. So it is prudent that a property's performance must be considered over the long term. The proforma accomplishes this for real estate investors during their real estate analysis and for that reason explains why real estate investors regularly depend on it when making an investment opportunity decision.

How do I create a pro forma income statement?

If you have the free time and some working knowledge about the MS Excel spreadsheet program, you certainly can create one on your own. Otherwise, you might want to consider making an investment in a good real estate investment software solution. You will discover that many investment software solutions include a proforma (though with slight variances). For example, not all software solutions might include computations for tax shelter or the time value of money in their proforma income statement.

Whatever method you choose however, whether real estate investment software or a spreadsheet, here are a few important considerations to keep in mind.

1. Understand what you want to accomplish with the proforma. You want to analyze the cash flow and other performance data that result from changes to income, vacancy allowance, operating expenses, and property value over future years.

2. The pro forma is 100% assumptive (a guess). Do not rely solely upon a proforma income statement to make your investment decision.

3. Though a proforma can be constructed to project any number of future years, because a proforma is speculative, you might not want to go out further then ten years. I personally would not feel comfortable going out any further.

4. You must be sure to use realistic numbers to make your projections. Don't, for instance, increase the income 10% annually when 2-3% has been normal or operating expenses 1% annually if a 2-3% annual inflation is more probable.

Okay, but that’s what you must do when creating a proforma income statement under any circumstances. It must be a reasonable (albeit, speculative) projection of a rental property’s financial performance based upon realistic data. Fair enough.

But having serviced income property myself for over thirty years as a real estate broker, I cannot emphasize enough the benefit you will receive by shelving the idea of trying to create a proforma income statement yourself and instead making the investment to purchase a good real estate investing software solution. You'll get a professional-quality report and get a ton of other real estate analysis features that will benefit you as well. Plus, you can hit the road running.