The real estate investor, purchasing a commercial real estate investment relies heavily on the pro-forma given to them by the seller or real estate broker.
There are many ways it can become too optimistic or negative if the basic assumptions of real expectations of monthly activities or conditions of the income properties are not being represented.
These Pro-Forma Assumptions Can Make the Difference Between Failure and Success
Examples of these line item pro forma assumptions are:
- Capital reserve numbers and how they were calculated,
- Vacancy related to the type of property and tenants the income property represents,
- The estimated cap rate expected when sold to arrive at a true internal rate of return for the investor, and
- The possible increase of rents or appreciation inflation percentage utilized to determine ending valuations after a determined time period.
When estimating capital reserve numbers, a real estate broker or owner must use the normal life span of the typical HVAC units for that location such as Florida verses S. Dakota. Weather makes a huge difference in lasting performance, shorter or longer, less or more use. Roof, the type of and the area the roof is subject to for extreme weather conditions.
Vacancies, the type of property and where it is with what amenities it offers and geared to what type of tenant ,all play huge roles in estimating vacancies for the investment property. There are stats that are published in commercial real estate magazines and other directories that can predict more accurate vacancies for various types of income property for most areas in the USA. The net income or cash on cash returns can wildly differ if the numbers projected are inaccurate.
Expected cap rates when selling are simply guesswork based on today’s interest rates and future interest rates that all intelligent investors understand can swing in a very high or low manner yearly depending on world events. The Federal Reserve can make the present investment property great or poor in a few short years if sold or refinanced.
Increase or decrease of rents are based on:
- economic conditions of the area,
- the increase or decrease of population or
- business in the area or the over supply or under supply of the property similar to the investor’s described.
Proper inflation or deflation for the property can determine the overall appreciation, if any, of the commercial real estate investment property in question.