A proforma income statement is a report investors and analysts who are engaged in real estate investing commonly use for the purpose of forecasting the cash flows generated by a rental property. The concept is simple. By projecting out over some number of years the income that a rental property might likely generate, investors and analysts are able to conduct a cash flow analysis that will help them evaluate the future performance of a property during the real estate investing decision-making process.
There are no restrictions on the number of years you want the proforma income statement to project. I’ve seen real estate investment software, for instance, that create statements ranging from ten to twenty years; a few even boast that their software provides for thirty-year forecasts. However, I personally feel that these longer range projections can become too misleading to be given much weight. There are just too many factors that can alter any cash flow forecast, especially for that many years. My own real estate investment software creates a proforma income statement that allows you to measure the financials for ten years, and I consider that adequate for any investment property cash flow analysis.
Likewise, a proforma is not limited to the type of financial data that it reveals. A good statement should include cash flows, rates of return, and proceeds resulting from a sale (known as reversion) at the very least. But the better ones also include calculations for the elements of tax shelter, so that cash flows, rate of return and proceeds resulting from a sale “after taxes” is revealed as well. I believe that prudent real estate investing decisions should include projections for cash flows and returns after taxes, so my real estate software provides both.
The bottom line, of course, it that you are seeking to evaluate how well a rental property might perform in future years. So whether you prefer to forecast a property’s financials out ten or twenty years, with or without taxes, is up to you. The most important thing is that the proforma reflects your own real estate investing objective, and in turn provides the data you require to conduct your investment property cash flow analysis.
Of course, no proforma income statement is worth the paper it’s printed on unless the projections you want to make are based upon sound data. For example, if you feel that rental income can realistically appreciate two percent per year, than use that percentage for your forecast, and fight off the temptation to bloat that percentage to three or four percent just because you hope so. You might even consider staggering the percentage of growth just to be safe. Perhaps two percent for the first two years, zero percent for years three and four, and one percent for each year thereafter. My real estate investment software will allow you to do this.
If you are engaged in real estate investing, and choose to create your own proforma income statement, please feel free to refer to mine as a guidepost. You can preview several samples on my website at www.proapod.com under reports for my three solutions. All you will need is a spreadsheet program like Excel, and some extra time. Well, maybe a lot of extra time, but it’s worth the effort because you certainly don’t want to exclude having a cash flow analysis the next time you invest in real estate.