What Is a Proforma Income Statement And Why Do Real Estate Investors Use It?

Published: 06th June 2011
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A report known as the proforma income statement (or proforma) can be described as a investment real estate report that real estate investors and analysts normally incorporate when it comes to predicting the revenues an income real estate asset might produce for a prospective owner over time. Here's the idea.

By projecting out across a certain period of time the revenues that the investment property could very well spawn, investors and analysts are able to carry out a profitability analysis which will help them to determine the potential future capabilities of a property. Thus lending support to their investing decision-making process.

There are no constraints regarding the quantity of years a person would like the proforma income statement to process. I have encountered proformas (as an example) that create statements ranging from ten to twenty years; several software companies in fact boast that their package provide you with thirty-year forecasts. Nevertheless, I honestly feel that many of these much longer range projections can end up being too unfounded to possibly be assigned very much weight. There exists just too many aspects that could amend any cash flow estimate (especially for that many years). So if you are using a real estate investment analysis software solution that produces a ten-year proforma income statement to conduct your rental property evaluations you'll do just fine.

By the same token, a proforma is not limited by the assortment of fiscal details it unveils. A first-rate statement will need to (at the very least) project annual (end of the year) results for revenue flows, rates of return, and the funds that result from a sale (known as reversion). But the significantly better ones additionally include the aspects of tax shelter; thereby enabling real estate analysts to also consider the property's returns "after taxes". This is important. Taxation greatly impacts whether or not the property is a profitable investment opportunity. So it makes good sense for the proforma to make forecasts with full consideration for income taxes.

Fair enough. But having said all of that, there are two important issues you must consider.

1) That the proforma mirrors your own personal real estate investment analysis goal and in turn offers the particulars you require for you to conduct your own investment property evaluation.

2) That the particular projections you intend to create are based on sound information. No proforma income statement is good for anything other than lining the birdcage if the data is faulty. When making your projections, for instance, if you believe that rental cash flow can reasonably increase two percent each year than drive back the temptation to bloat that percentage to three or four percent simply because you pray so. You may even want to think about staggering the amount of increase merely to be safe. Perhaps three percent appreciation in year two, two percent in year three, and zero percent for the remaining years.

How do you go about obtaining a proforma income statement? Naturally, you can create your own with an Excel spreadsheet and some surplus time. In fact, a whole lot of surplus time. Or, as an alternative, you can consider just investing in a good real estate software application that generates the statement for you automatically. Regardless, whether you make it yourself or invest in software, you certainly don't want to be without a proforma the next time you get around to purchasing investment real estate.

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