Lies, Damn Lies and Proforma’s

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“There are three kinds of lies: lies, damned lies, and statistics”
– Benjamin Disraeli

The 50% rule is a great start for back of the envelope analysis for apartment investing, but what if you are seeking development capital for a project or private money? Will a wave of the hand and “oh the 50% rule says x” for your pro-forma suffice?

Pro-Forma’s Can Be a Dangerous Thing.

A recent horror story I heard is a prime example:

Allegedly, a group of doctors fresh from a famous apartment guru boot camp rushed right out to buy a property. As it turns out they relied on the pro-forma’s provided by the seller side. The actuals only supported a shocking 1% cap rate based on what was paid. OUCH! The end result is new buyer is ending up with a steal-of- a-deal based on their pain.

When dealing with the seller side in commercial and you need a friend: better to get a dog.

That being said, for a developer – I believe pro-forma’s are more dangerous. We are telling our own story. For me I am very concerned about “deal junky” syndrome. Are we lying to ourselves’ to justify our passion to build? Field of Dreams is a great movie but the SEC won’t let you off the hook based on that defense. Okay maybe if you did a séance and brought Johnny Cochrane…”the pro-forma didn’t fit so you must acquit”?

Are enforcement actions and civil litigation a pretty solid deterrent to the Field of Dream’s effect for you too?

To seek a reliable truth others have innovated a great data source. Two organizations that I have found infinite return from are Institute for Real Estate Management (IREM) and the (ULI) Urban Land Institute. The IREM is a great professional organization that focuses on continuing education for property managers and the ULI is the similar to the bar association for real estate developers.

Both organizations offer tremendous “cost to operate” surveys that can work to substantiate your expense pro-forma’s. The beauty of these reports is that they serve both in acquisition and development.

What’s This All Mean?

Imagine you are buying your first 20 Unit apartment. Your financial diligence can be checked against the cost survey from IREM or ULI. Perhaps you can get a great feel for whether the property has an inherent flaw or the management is incompetent? Opportunity and danger can be identified down to a line item to help you make a better decision on the expense side.

The crunchers in data crunching have tremendous choice over the quality of the research. GIGO (garbage in garbage out) is a chief concern.  Cost-effective resources are available that go along way toward finding the truth.

Photo Credit: Mario Inoportuno

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About Author

Douglas Dowell J.D. is a commercial and multifamily investor. His blog will focus on legally raising private money, risk mitigation with due diligence and management science. He is also an avid student of success principles with a focus on modeling success factors.

10 Comments

  1. Ronald Reagan followed this mantra: “Trust … but verify.”

    He was dealing with nuclear arms but the same applies to buying real estate for commercial purposes.

  2. Proformas, forecasts, projections – they’re all fiction, and it’s hard to believe anyone would rely solely on them. Clearly these doctors either didn’t analyze the actual financials they were provided for the building, or they didn’t understand them, in which case, they should have hired an expert to review (especially being their first apartment building purchase). Some people are their own worst enemies – they pay a guru who knows how much for his/her course, but then cheap out when it comes to due diligence.

    • Douglas Dowell on

      I have to agree Sharon,

      One of the huge benefits of BP in my mind. Such a great network of people with experience to draw on. Recently just dawned on me as entrepreneurs and we are the smartest person in the room then we doing our selves an injustice.

    • Agree!!
      Sad part about it is you have to rely on trusted information when going into any project. Doctors are looking for a return. They entrust the real estate professional who is representing them. 1% Cap rate is sad. The unfortunate part about all of this is that it scares investor capital away. leaving a bad taste in their mouths.

      • Douglas Dowell on

        I think that was the big problem Gerald,

        The went in without representation as I understand it. They even went so far as to fire the management company and self managed as well as I understand this cautionary tale.

    • Douglas Dowell on

      Thanks Kyle,

      I have been really been striving to be rigorous as possible within cost justified means. I am so thankful for ULI and BP.

      Have a prosperous new year my friend!

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