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Lies, Damn Lies and Proforma’s

by Douglas Dowell on January 3, 2014 · 10 comments

  
Damn Lies and Proforma's

“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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{ 10 comments… read them below or add one }

Kevin Yeats January 3, 2014 at 8:39 am

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.

Reply

Douglas Dowell January 4, 2014 at 11:07 am

Great quote Kevin,

Nuclear fallout can be avoided if we head it.

Reply

Sharon Tzib January 3, 2014 at 2:01 pm

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.

Reply

Douglas Dowell January 4, 2014 at 11:11 am

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.

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Kyle Zaylor January 3, 2014 at 5:25 pm

1% Cap rate?…ouch indeed!

Great points about development due diligence–especially “garbage in, garbage out”.

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Gerald Harris January 3, 2014 at 7:03 pm

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.

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Douglas Dowell January 4, 2014 at 11:16 am

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.

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Douglas Dowell January 4, 2014 at 11:13 am

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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Shaun January 5, 2014 at 5:58 pm

One of the best titles ever!
I always say Proforma is Latin for “total bullsh*t”. :)

Reply

Douglas Dowell January 6, 2014 at 7:19 pm

Bovine excrement for sure! haha

Reply

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