Pro Forma Cash Flow Statement | Pro Forma Real Estate Investment Analysis
The Pro Forma Cash Flow Statement is a real estate cash flow analysis that projects an investment property's cash flows in a cash flow proforma format. The pro forma cash flow projection is similar to a cash flow statement, except it follows the conventions and terminology of the commercial real estate industry.
The proforma cash flow is used to estimate a rental property's market value and project a rental property's continued financial performance. The Net Operating Income and Pre-tax Cash Flow that are part of the real estate pro forma, are used in capitalizing income and calculating the cash on cash return.
The pro forma cash flow analysis may use market estimated variables such as rents and vacancy rates and other assumptions to project future cash flows. The format and calculations of the pro forma cash flow analysis are explained below.
Proforma Cash Flow Statement
The Proforma Cash Flow Statement provides us with SGI and NOI upon which an estimate of market value is based.
The basic formula and format for the Pro Forma Cash Flow statement follows below:
Scheduled Gross Income (Potential Gross Income)
-Vacancy
= Effective Gross Income (Gross Operating Income)
-Operating Expenses
= Net Operating Income (NOI)
-Loan Payments
= Pre-tax Cash Flow
1) Scheduled Gross Income
The Scheduled Gross Income represents the total potential revenue a property could produce. This includes the total rent generated as if the property was 100% occupied plus all other sources of revenue. Other sources of revenue may include parking, laundry, vending machine revenue, expense reimbursements or other services provided. This top line item is also referred to as Potential Gross Income or Potential Gross Revenue.
2) Vacancy
Vacancy is a deduction from Scheduled Gross Income to account for the fact that the property will not always be, if ever, fully rented. There will be tenant turnover to consider as well as other demand factors such as rent levels and seasonal demand that affect vacancy. The vacancy rate can be calculated as a percentage of Scheduled Gross Income when the only source of income considered is rental income. The vacancy rate used is determined by comparing the vacancy rates of similar properties within a given market.
3) Effective Gross Income
Effective Gross Income is the effective operating revenue for a property. It is calculated by subtracting the Vacancy Allowance from the Scheduled Gross Income (the total potential revenues of a property). It represents the maximum stabilized estimate of the revenues a property can generate under the given market conditions. This line item termed Gross Operating Income.
Effective Gross Income = Scheduled Gross Income - Vacancy Allowance
4) Operating Expenses
The Operating Expenses are the financial charges incurred due to the operations of a property. These charges include property management, utilities, maintenance, insurance, and property taxes. However, since this is a cash flow analysis, these charges do NOT include depreciation expenses.
5) Net Operating Income
Net Operating Income (NOI) is calculated by subtracting operating expenses from Effective Gross Income. The NOI is the basis of the Capitalization approach and the Discounted Cash Flow approach to determining a property's value.
Net Operating Income = Effective Gross Income - Operating Expenses
6) Loan Payment
The Loan Payment line item is the sum of the periodic payments made to service the debts on the property for the year. Since the Cash Flow Pro Forma encompasses the period of one year, the "Loan Payment" line item is equivalent to the Annualized Debt Service.
7) Pre-tax cash flow
The Pre-tax Cash Flow is the cash that remains once the Loan Payments are deducted from the Net Operating Income. Since this is a Cash Flow analysis, we deduct the loan payments for the period at this point, because we are interested in the cash flows of the property. The Pre-tax Cash Flow is used to calculate the Cash On Cash Return.