Pro Forma Income Statement – Forecasting Rental Property Performance

james kobzeffThe pro forma income statement is a commonly-used cash flow forecasting report used by real estate investors to evaluate the future financial performance of real estate investment property.

More robust than most other real estate analysis reports like an APOD, which is perhaps the most popular report used by analysts but only gives a “snapshot” of the property’s performance for the first first year, a pro forma income statement projects the investment property’s financial data over a given time period into the future that exceeds the first twelve months of ownership.

So the proforma provides real estate investors a concise way to anticipate what he or she can expect in the way of profitability, rates of return, tax benefits, and sales proceeds from a rental property over time.


proforma income statement

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As stated, a proforma income statement is a financial report that projects a rental property’s performance and profitability over a given period of years into the future (e.g. 2-10 years into the future).

The objective is straightforward.

The investor wants to see how changes in the property’s performance over time might impact the bottom line (i.e., cash flow and rates of return). After all, the property’s financials are rarely static and will likely change as the months roll by.

Rents, for instance, are likely to increase sometime in the future. Perhaps not immediately nor even all at once for each of the units, but rents do change. As a result, so does the cash flow, rate of return, and profitability.

Operating expenses are also likely to increase. These are the expenses associated with the property that keep it in service such as property taxes, insurance, water and sewer, utilities, and maintenance and repairs. In some cases these additional expenses could easily negate any appreciable income benefit due to rent increases, and maybe even worse, they can severely impact the financials and reduce cash flows and rates of return.

Then, of course, there’s the property’s potential future sale price. Sale proceeds play a major role in the investor’s bottom line and ultimate profitability. So prudent investors will want to account for it with some amount of forecasting.

You get the idea.

The Pro Forma Income Statement provides real estate investors a way to make those forecasts and with a series of projections help to highlight the pros and cons of an investment real estate opportunity.

Of course, it would be unwise to make a buying or selling decision based solely upon the results of a Proforma alone. It is, after all, simply a projection with speculative numbers. But when used cautiously with conservative rather than overly aggressive numbers, a Pro Forma Income Statement can be a worthy real estate analysis tool.

So You Know

ProAPOD Real Estate Investment Software solutions do automatically create a Pro Forma Income Statement.


Understanding the Depreciation Recapture Tax

If you’re about to sell a rental income property that you’ve owned for more than one year then prepare to pay the Feds a depreciation recapture tax to spare yourself an unpleasant surprise at tax time. Because most real estate investors will have to deal with it once they sell their investment.

It seemed needful, therefore, to discuss depreciation recapture for those of you who are new to real estate investing and might not be aware of how the Internal Revenue Service will impose this tax upon you following a sale. We’ll consider the meaning, method and rationale used by the IRS to impose it.

What It Is

Depreciation recapture is the procedure used by the IRS to “recapture” income tax on a gain realized by a real estate investor when he or she disposes of a rental property that had previously provided an offset to his or her ordinary income through depreciation.

In other words, it’s a tax associated with the “depreciation allowance” write-off that you’ve been enjoying at tax time for each of the years that you’ve owned the property.

How it Works

When you sell an income property you’ve owned longer than one year and have a recognized gain, the feds will tax you for the accumulated depreciation deductions you’ve taken during the years you owned the property.

Their contention being that since you were able to realize a capital gain by reducing your tax liability with allowable depreciation deductions while you were holding the investment, the Feds expect you to pay some of it back now that you’re disposing of the investment.

Their rationale is fairly straightforward.

The IRS does not want to allow you to simply pay the generally more favorable (15-20%) capital gains tax rate on your entire gain, but instead, also wants to collect the currently higher recapture tax of 25% on a portion.

Let’s do some math to show how this could impact your tax obligation.

Let’s say, for example, that you sell your rental property after owning it for five years and realize a gain of $1,959,420 of which $609,860 is attributable to the depreciation you’ve taken during that holding period.

sale with depreciation recapture

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Okay, now let’s assume a depreciation recapture tax rate of 25% and a capital gains tax rate of (say) 20%.

1. If your entire $1,959,420 gain were merely taxed at the capital gains rate you would owe the Feds (1,959,420 x .20), or $391,884 .

2. Because of recapture, however, your accumulated depreciation of $609,860 gets taxed at the higher 25% rate and only your adjusted capital gains of $1,349,560 (1,959,420 – 609,860) gets taxed at the lower 20% rate. In this case you owe the Feds $422,377.

In other words, thanks to the depreciation recapture tax you wind up owing the IRS $30,493 more in taxes than you would have had the tax not been imposed.

So You Know

ProAPOD Real Estate Investing Software automatically calculates depreciation, recapture tax, capital gains tax, and tax obligation.


The Loan-to-Interest Table


loan-to-interestA loan-to-interest table is a very useful report for real estate investors or brokers doing a real estate analysis because it concisely shows various combination’s of monthly payment based on a range of loan amounts and rates of interest.

In just one sitting you can precisely know what your monthly payment will be depending on your loan and the interest rate you have to pay to obtain that loan.

A loan-to-interest table is a spreadsheet with columns and rows that intersect. The column headers show differing interest rates and the utter-most left column rows of differing loan amounts and the appropriate monthly payment is shown inside the cells where they intersect.


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In the table illustrated to the right, for example, the table is constructed with the loan amount running up and down in the left column  and interest rates running left and right along the top row.

In this case my investor was considering the acquisition of a rental income property with a fully amortized thirty-year loan of $350,000 at 6.0% annual interest rate and a monthly payment of 2,098.43.

We decided to create the loan-to-interest table because the he was interested in seeing how the monthly payment would be affected with perhaps more or less down payment and at various interest rate options.

So we based our scenario upon a range of loan amounts at 5,000 intervals and various interest rates at 0.125% intervals.


The real estate investor was quickly able to determine the monthly mortgage payments for loan amounts ranging from $230,000 to 470,000 at interest rates ranging from 5.750% to 6.25%.


You can use Excel if you’re interested in constructing this table. It will require some knowledge of Excel and loan amortization formulas, but you can do it if you have the time.

Here’s a quick and dirty list of what to consider.

  • Number of rows and columns to include for payment variations
  • Allowable loan amount “steps”
  • Allowable interest rate “steps”
  • Reference to a starting loan amount and interest rate

You will also want to consider including a “form interface” that enables you an easy way to “step” the loan amount and interest rate. Here’s how I did it for my real estate investing software solutions to give you the idea.

form interface example

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You certainly don’t have to get as fancy as I did for your own interface. But if you’re serious about using a loan-to-interest table for your real estate analysis, you definitely want to include some way to quickly and easily create the scenarios.

Bottom Line

A loan-to-interest table is a concise way for you or your customer to decide which combination of loan amounts and interest rates provide an acceptable (or desired) monthly loan payment for any investment real estate under consideration. I strongly recommend it for anyone engaged in real estate investing business. You will find it a real benefit.