Evaluating a Deal with a Property Pro Forma

Talk to any real estate investor and you’ll get a variety of opinions and advice on how to evaluate a real estate deal. That’s the thing about real estate, because many use it as an investment vehicle to help them achieve their dreams, different returns satisfy different people. Because of this, we can’t tell you one way is right or wrong. All we can do is explain how we present our properties, so you have clarity around what you’re seeing in our Pro Forma, and you can adjust as needed to fit your criteria. We will advise you that it’s important to use the SAME criteria for every deal you look at, though. Otherwise, you’re comparing apples to oranges when you want to be comparing apples to apples.

What's shown on Bridge's Pro Forma?

The top of our proforma includes all of the big picture information you want to know when assessing a property: purchase price, estimated monthly rent, square footage, beds/baths, photos, location. 

Note: Many people tell you that if a property doesn’t hit the 1% Rule of rental rate to purchase price, you should rule it out. We have a slightly different take on that, which you can read more about here!

Top of Property Pro Forma
Underneath the “big picture” information are the financial assumptions. In our pro forma, each aspect of the financial assumptions is represented on a slider, which can be moved to adjust the numbers. If you don’t like the slider and want to input a specific number, you can also click directly on the number and edit it.

Rental Rate: This reflects the same rental rate at the top. You could adjust to see how your numbers will change with regular rent increases over time.

Down Payment: This is set to default at 20%. If you’re planning to put down more, you’ll see your monthly cash-flow and cash-on-cash return change. Cap Rate is not impacted one way or the other because it is calculated off of Net Operating Income, which does not include financing costs. If you’re ready to pay with cash, you can adjust this slider to 100%.

Property Tax / mo: This number defaults to the previous year’s property tax (as pulled from public records) divided by 12, so it’s expressed as the monthly value.  You can expect property taxes to increase some every two years in Kansas City, so if you’re wanting to adjust for the future, you can move the slider higher.

Interest Rate: The interest rate in our proforma defaults to 4.5%. We highly recommend that you look into what current rates are and adjust as needed. Remember, interest rates on loans for investment properties are generally a little higher than one you’d get on a home you’d live in. If you want to, you’ll also have the opportunity to buy down your interest rate, too, which can be a great option if you want to pay a little more up front, but save in the long-term.

Property Management: In our pro forma, the property management fee defaults to 8% because this is what our property management partners charge our clients. The 8% is a percentage of the monthly rent rate. 

Expense Ratio: This is the term we use in our proforma to categorize unplanned expenses that could occur at your property. We display them as a percentage of the Gross Income (what you bring in from 12 months of rent). The 15% is made up of an estimated 5% for vacancy, 5% for maintenance, and 5% for CapX. Again, this is an estimated cost as it’s meant to cover you in the event of unforeseen or tenant-caused issues. Some years it won’t be that high and some years it’ll be higher. It all depends. 

**NOTE: Insurance costs are not included in our expense ratio. We do this because they vary so much based on the client’s risk tolerance and coverage choices. If you want to roughly estimate, you could increase the expense ratio by another 5% in order to account for some insurance costs.

The big white box highlights the data points most investors prioritize when evaluating a deal.

Cap Rate: The ratio of Net Operating Income to total property value based on purchase price. Investors use this data point to measure a property’s yield in a one-year time frame. This way they can easily compare one property’s cash flow to another – without taking into account any debt on the asset. Basically, it provides the property’s natural, un-levered rate of return. 

Monthly Cash Flow: This number represents the income generated monthly from a property once all expenses are factored in. Remember, because expenses fluctuate from month to month, this number will likely change monthly for you, once you own the property.

Cash on Cash Return: This is the ratio of annual before-tax cash flow to total amount of cash invested, expressed as a percentage. As you increase your down payment, you’ll see this percentage go down. Alternatively, as you increase your rental rate (income), you’ll see it go up.

Operating Income: This is your annual income calculated based on your rental rate. Increase your monthly rent, and you’ll see your operating income go up.

Operating Expenses: These are your annual expenses for the property. We’ve added your annual property taxes plus your annual property management fee plus your annual expense ratio together. This should give you a sense for the cost to operate your property over the course of a year. Remember, again, insurance is not included here unless you’ve adjusted the Expense Ratio to include your expected monthly insurance premium. 

Net Operating Income: If you take your Operating Income and subtract your Operating Expenses, you should get this number. If all goes according to the numbers in the proforma, this is what you would bring home off this property in a year.

In addition to the numbers of the deal, Bridge’s property pro forma also includes a link to that property’s Due Diligence folder. The folder includes the following:

  • Scope of work: a list of everything Bridge completed during the renovation
  • Comparative Market Analysis: a list of the comparative properties in the area that have sold on the MLS and the prices for which they’ve sold. This will help investors see how we came to our price point
  • Rentometer Report: a report of all of the properties for rent in the same area as the property you are evaluating. This report shows the size of the home, beds / baths, and rental rate, so you can see how we came to our rental rate. Remember that Bridge properties are fully-renovated and often the nicest property in the area, so we generally expect to be able to get rents on the higher end of the range you see in the report.

In addition to checking the deal on our website, we always encourage investors to use their own pro formas, as well. If you don’t have one, there are excellent options available on websites like BiggerPockets! And, as always, if you have ANY questions, don’t hesitate to reach out to our team!

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