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The Operating Pro Forma

Pro Forma

  • “For the sake of form”
  • Signifies Pro Forma Operating Statement
  • Predicted budget based on changes to structure, revenues, profits, expenses
  • Provides overview of annual operating costs
    • Details daily operating expenses
      • Utilities
      • Insurance
      • Property
      • Repairs & maintenance
    • Expenses increase during a real estate downturn
  • Helps lenders and investors determine their position
  • One of the first documents in a deal package
  • All numbers must be supported and well-cited
  • Size of Operating Expense and Loan Size considered more in income property than interest rates.


Fundamentals of Apartment Pro Forma

  • Gross Scheduled Rents
    • Use current rent roll
    • Exception: rent increase letters have already been sent. If so:
      • Include previously sent letters as sample
      • New rent should typically not exceed 90 days
  • Vacancy Factor
    • Typically use 5% regardless of actual percentage
  • Operating Expenses
    • Simplest way of obtaining expense number is if an appraisal arrives with the income package
    • If appraisal fails, estimate
      • In general, borrowers do not keep current records
        • If you are able to obtain exact expenses, insert footnote:
          • Actual operating expenses for the last 12 months
        • If you are unable to obtain up-to-date expenses, use actual expenses for the last calendar and insert footnote
  • Reserves for Replacements
    • Money put back into property to maintain and leasable (i.e. renovations on parking lots, roofs, ovens, refrigerators, etc.)
    • Separate from Repairs & Maintenance
    • *Not included in multi-family property Pro Formas, but considered into Repairs (6-10% of Effective Gross Income)


Fundamentals of Commercial/Industrial Pro Forma:

  • Similar to Apartment Pro Forma
  • Differences
    • Net Leases: Tenant is responsible for some expenses
    • Full Service Leases: the owner is responsible for preparing the Pro Forma
  • Vacancy Factor
    • Office Buildings: 7-12% (Depends on market)
  • Off-Site Management
    • 3-5% of Effective Gross Income


Calculating Other Estimates

  • Real Estate Taxes
    • 1.25% of original purchase price
  • Insurance Premium
    • $5.50 per thousand dollars of coverage
  • Repairs & Maintenance
    • 6-10% of EGI (Dependent upon quality and property of tenants)

Sample Financial Analysis


Financial analysis is crucial to real estate investing. Without performing the proper due diligence, you will never truly know the strength of an investment. The principles used in this analysis are mainly used for smaller residential properties, but also apply to various analyses for all real estate investment vehicles.



Suppose we have been searching for deals and have stumbled across a multi-family home in Montclair, New Jersey.

  • Type: Multi-Family Residential
  • Number of Units: 4
  • Price: $1,000,000
  • Cap Rate: 8%
  • Year Built: 1975
  • Lot Size: 5,000 Square Feet
  • Pro-Form Financial Summary
  • Gross Income
  • Expense Taxes
  • Insurance
  • Maintenance
  • Advertising
  • Utilities
  • Net Operating Income
  • Unit Breakdown
  • # of Units
    Unit Type
  • 2
    2BR + 2BA
  • 2
    2BR + 1BA

Financing- Suppose we have agreed with a lender on the following loan terms:

  • Purchase Price: $1,000,000
  • Renovations: $45,000
  • Down Payment: 25%
  • Interest Rate: 6%
  • Closing Costs: 1.5% of Purchase Price
  • Cost Assumptions
  • Loan Size
  • Downpayment
  • Renovations
  • Closing Costs
  • Total Cost
  • Total Cash
  • Financing Assumptions
  • Downpayment
  • Financing Amount
  • Downpayment Amount
  • Interest Rate
  • Term of Mortgage
    25 Tears
  • Mortgage Payment

After securing agreeable financing details, it’s time to examine feasibility.


Net Operating Income

Calculating the net operating income (NOI) is necessary for a proper financial analysis of a rental property. NOI is the property’s total generated income a property generates calculated by revenues less expenses excluding loan/debt costs. The formula to calculate it is below:

Net Operating Income = Income – Expenses (not including loan/debt costs)

We must find both income and expenses of the property.


Property Income

Income mainly composed of tenant rent, but can also include a food mart, parking garage, or printing labs. In this case, our only income is rent; let’s calculate the monthly gross income from the four units on our potential property.

  • Property Income
  • Unit #
    Unit Type
  • 1
    2BR + 2BA
  • 2
    2BR + 2BA
  • 3
    2BR + 1BA
  • 4
    2BR + 1BA

The monthly gross income is $8,000. To find the total gross annual income, we multiply the monthly income by 12 to arrive at $96,000. Now, let’s find expenses.


Property Expenses

Let's specify and calculate the prices.

  • Expenses
  • Taxes
  • Insurance
  • Maintenance
  • Advertising
  • Utilities
  • Total Cost

These are the expected monthly expenses. To find annual expense, multiply $1,333 by 12 to get $16,000.

Now that we have calculated our annual income and expenses, we can finally calculate our net operating income.

NOI = Income – Expenses

NOI = $96,000 - $16,000

NOI = $80,000

Our property generates an estimated $80,000 per year. We use NOI to examine the more detailed financials of this property.


Cash Flow

Now that we have our NOI, we can move onto finding out cash flow, which is the total profit per year. If you recall, we noted that NOI is calculated by taking your income less expenses, excluding your debt service costs (loans). We calculated this NOI without debt service costs to show the income a property can generate, unaffected by different financing. The financing changes from owner to owner, so NOI is used to evaluate only the property. We now consider debt costs to arrive at our annual net profit, or cash flow.

The formula for cash flow is very simple: the NOI less debt costs.

Cash Flow = NOI – Debt Service Costs

Our annual NOI came out to $80,000 and our monthly mortgage we agreed upon with our lender came out to be $5,154.41. In order to get our annual cash flow, we need to annualize the mortgage by multiplying it by 12, arriving at the annual debt service cost of $61,852.92. Now by entering these numbers into the formula, we can arrive at our annual net profit generated by this property.

Cash Flow = $80,000 - $61,852.92

Cash Flow = $18,147.08

At the end of the year, we have a net estimated $18,147.08 earned!


Return on Investment – Capitalization Rate

Now we are going to calculate and interpret different rates that can show us whether or not our investment is worth pursuing. The first rate we will discuss is Capitalization Rate. The Capitalization Rate or Cap Rate is NOI divided by the price of the property.

Cap Rate = NOI/Property Value

The cap rate is especially important when doing a financial analysis of rental properties because it shows the income a property can generate without taking into account financing assumptions. For our property, we calculate the cap rate of the property by plugging our NOI and property value into the formula.

Cap Rate = $80,000/$1,000,000

Cap Rate = 8.00%

Cap rate can be used to compare a potential investment to others in the area to gauge the profitability of the investment. However, with cap rate, the full price of the property is implied as the cost, when in reality most people will obtain some sort of financing. This is where our next return comes in – Cash on Cash.



The Cash-on-Cash (COC) rate is different than the cap rate and useful in its own way because it is dependent on the financing that an investor obtains, so this rate changes from buyer to buyer. It is calculated by dividing the cash flow by your investment basis (the amount your investment costs). Let’s calculate the COC for our property in order to see exactly how COC works.

Cash-on-Cash = Cash Flow/Investment Basis

Cash-on-Cash = $18,147.08/$260,000

Cash-on-Cash = 7.0%

The cash flow was calculated earlier by taking your NOI and subtracting your annual debt service costs, and the investment basis of $260,000 came from the sum of our downpayment, renovation costs, and closing costs.


Total ROI

The last return we are going to discuss is the Total ROI. When investing in real estate, benefits besides your cash flow and your cash-on-cash rate of return exist. The Total ROI is calculated by dividing your Total Return by your Investment Basis.

Total ROI = Total Return/Investment Basis

The reason we also calculate the Total ROI is to factor in the other benefits and returns that real estate investing generates. These include equity accrual, appreciation, and tax benefits.

For our property, let’s make some assumptions in order to calculate a Total ROI. To get our total return, we will add a 4% appreciation on our property, $12,984 in equity accrual, and we will assume that there are no tax breaks for this property.

Total Return = $18,147.08 + $40,000 + $12,984 + 0 = $71,131.08

Total ROI = $71,131.08/$260,000

Total ROI = 27.4%

All things considered, a 27.4% total return on investment is very attractive.

Although this analysis makes a lot of assumptions and simplifications, the ideas and calculations used can be applied to other analyses to help make sense of all the numbers that need to be accounted for in the world of real estate investing.