Today I thought I would give you an idea of what a comprehensive pro-forma should look like as well as giving you some information on where to find a free pro-forma tool that you can use to analyze
So You Want To Buy Rentals
I was browsing the internet last week and stumbled onto an acquaintance's facebook page. He is part of a small real estate team who have apparently upgraded their photography. They have some really nice black and white stillls and some black & white videos. As I watched one of the videos, I was a little surprised to hear my colleague telling everyone on the internet that as a real estate investor, "you are really just buying paper..." WAIT-WHAT?! That's some expensive paper-a few sheets for potentially a few hundred thousand dollars. Yikes! Are they 14 karat gold?
Okay seriously, he was actually on the right track he just kind of oversimplified the concept. What I think he really meant was that real estate investing is much more than buying the brick and mortar or the real property and appurtenances. An investor is really buying a series of leases or contracts that are attached to a particular piece of property, hopefully as well as an opportunity. The opportunity may be to decrease the vacancy rate or improve the property and hence increase revenues, or maybe the investor sees a way to reduce annual expenses, which may not have been realized by the current owner but will increase net revenue. The opportunity may just be a tax shelter in the form of expenses and depreciation. Or the opportunity may be to add units or square footage to be leased at a decent rate of return. The point here is that finding the property can be a challenge but the real challenge is to find a property that has potential. I believe it is always important to fully analyze an investment property before even setting foot in it. That usually helps take the emotions out of it because it's harder to love a property, no matter how cute it is, if it is going to cost you money every month you own it.
Most investors use proformas to analyze property. A proforma is a document that helps you put the cash flow, expenses and tax benefits into perspective. It helps determine advantages and disadvantages of a particular property using readily available information. I usually create a series of proformas- one based on the current situation/the information disclosed in the listing documents. If it looks promising I set about re-running proformas with all reasonable scenarios imaginable. These proformas contain estimated costs of any improvements, estimated increases in rent, and resulting Return On Investment (ROI) for both the downpayment and monies subsequently invested to improve the property. My hunch is that these pro-formas are the "paper" to which my colleague makes reference, suggesting they are what you are really buying.
He's close- I would never suggest buying an investment property without running a pro-forma or two or three, so they are a part but only a part of the investment process. As far as I am concerned they can be pure gold- forget 14karat - but there are additional things you may want to consider and there is an opportunity to get creative... Next time I post I will start to cover what's on the Golden paper as well as why creativity counts.
Until then -
Broker Owner of Cygnus Great Lakes....