Building a Pro Forma: an Essential Skill for Real Estate Investors
Pro formas are the business plans of the real estate development world.
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They give you a snap shot into the future given the data available and your sense of the current and future market.
When evaluating a potential development opportunity, you can’t get anywhere without making a sound case for your development to potential lenders, partners, and internally.
That sound case starts with and gets honed through building and understanding your pro forma.
Like any skill set, becoming proficient at modeling a pro forma takes time, trial and error, and patience (and plenty of frustration too). The larger a deal gets, typically the more detailed the pro forma gets. However, many times the mechanics and foundation of your pro forma will stay the same regardless of the deal size (i.e. money goes into a project, that money creates/improves something, money comes out).
Building and using a pro forma is certainly a skill set that’s important in the real estate game. Like any skill set, baby steps can grow into walking, walking can turn into running, running can turn into sprinting. At the same time, skill sets can be softened, forgotten, or even lost. So starting, maintaining, and/or improving one’s modeling skill set is always encouraged in my book.
There are many strategies and techniques one can adopt to quickly improve and/or learn. Here are a few I think are the most effective:
Build from Scratch on a Real Deal
I’m a huge fan of not reinventing any wheel you can. Yet building a pro forma from scratch can be a valuable undertaking that could pay dividends in the future.
Motivation tends to be lower for fictitious projects. So pick out a project that could turn into a real deal. Maybe it's a vacant lot down the street that you've always wanted to develop. Maybe there's an underperforming multifamily property close by that could use a facelift.
Regardless of the property or deal, the point is to sit down and start.
It is scary to sit down with a blank spreadsheet and have to plan out how to build a fully functioning pro forma. Like any epic saga one is about to embark on, a sense of nervousness always surrounds this stage because of the anticipation of changes, adjustments, and dead-ends likely to occur. Yet for the time invested, I believe it’s worth it to try.
There are plenty of great books out there on structuring real estate deals. While not always as enthralling as a great novel, a little bedtime reading on the subject could go a long way to forming your approach to pro forma building.
A close friend recently reintroduced me to audio books for daily commutes. I’ve been amazed at how much I can get through during a short car ride (repeated daily). The same can be true for breaking off a large, dense book on structuring real estate deals.
Mirror an Existing Pro Forma
If you have access to a spare laptop or PC, this can be a useful technique for learning how to model a specific deal. Try lining up an example pro forma you admire and build it over again in a new spreadsheet. Keep the screens side by side so you can quickly review the formulas and inputs from the existing pro forma. Then input them line by line into the fresh spreadsheet.
It’s a slow process. However the work put in to picking up the structure and specific modeling techniques will likely stay with you as you take on new deals.
There’s no silver bullet for picking up new pro forma skills. Patience and time are your best bets for growing or maintaining them. While the above strategies can be tedious, cumbersome, and time-intensive, I’m sure they’ll be worth the investment.