Three Basic Elements of any Development Pro Forma

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Creating pro formas for real estate developments, acquisitions, and dispositions can be a tedious endeavor! There are so many factors to consider when analyzing a development project.

In no time, several “back of the envelope” calculations can quickly turn into a jumbled mess of spreadsheet tabs, projections, convoluted formulas, and—worst of all—sleepless nights. However, wading through this messy process can be an important step in developing properties. After all, developers and investors have to make countless decisions based on imperfect information and unknown outcomes.

While it’s absolutely necessary to do proper due diligence for any project, developing detailed and useful pro forma models doesn’t have to be terribly complicated. One just needs a framework and an understanding of the end goals to start, sift through, and polish up an investment-grade pro forma.

Luckily we’re in an industry that deals with assets we can touch and see (buildings and spaces). This means that the relative timing of revenues and costs is reasonably easy to understand from a high level (compared to other industries). Though it takes time, developing a pro forma around these revenues and costs can follow a simple and straightforward process.

Quick note: There are countless resources available in print and online that explain the nitty-gritty details of development pro formas. For this article, we’re just going to focus on how to understand the over-arching structure needed to analyze a development project.  Because, once one understands how to structure a pro forma, the specific details that make that structure work gain more clarity.

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Three Essential Elements for Your Development Pro Forma

Every pro forma has three elements that guide their design, structure, and use. If you have a new project on the books and are faced with a mountain of messy information, start with these three pro forma elements and jump in!

1) Assumptions – Pro formas are essentially models that show us what we think will happen in the future. They are based on many assumptions which are unknown at the start. As a project develops, these assumptions get more and more refined. Here are typical types of assumptions that drive a pro forma:

  • Timeline – when will the key stages of the project start, continue, and end (typically: analysis, design, construction, lease-up, stabilization, and disposition)?
  • Costs – what are the hard and soft costs associated with construction, design, financing, etc.?
  • Sources and uses – what financing structure is in place and what will that money be used for?
  • General inputs – what are the physical characteristics of the project that drive development potential (number of units, lot size, zoning constraints)?

2) Cash Flow – Once assumptions are established, estimating cash flow is the next step. Below are the typical stages of a project that one considers when building this part of the pro forma:

  • Pre-construction and construction – what expenses will occur to produce a finished building or space that’s ready to be leased or sold?
  • Stabilization – if cash flow producing, what are the estimated revenues and expenses one incurs to operate the stabilized property?
  • Disposition – if looking to sell once stabilized, what are the anticipated terminal value and sale conditions?

 3) Returns – Every development is analyzed with respect to its estimated return on investment over time. Returns allow the developer to understand the relative risk of a project and compare that risk to other investment alternatives. Typical returns for the pro forma include:

  • IRR – internal rate of return
  • NPV – net present value

Pro formas are always developed iteratively. They are usually edited, updated, and refined as a project gains traction and becomes more real.   They go through a constant refinement and rebuilding process. Yet, if one sticks to the framework outlined above, that process can become easier to navigate and, over time, much less messy.  Good luck on your deals!
Photo: Dwonderwall

About Author

Kyle Zaylor

Kyle is the creator of realestate-java.com, a blog dedicated to commercial real estate development. Kyle is also a real estate development associate with Blu Homes, Inc. His company focuses on building sustainable homes throughout the country.

12 Comments

  1. Great article Kyle.

    My son and I met with a local big developer to look at one of his lands for sale. Knowing we are over our heads 65 acres, it was educational. He mentioned something about the city will finance 100% of the utilities, but we would need a letter of credit for 30%? He explained that is the cities safeguard should we not pay it back. Can you please elaborate on these whole process, the city, special taxes, do developers profit here, etc. He also mentioned the battles he gets in with some cities desires vs what is required. I guess he meant easements codes, platting, grading, etc…?

    So where does the developer’s profits come from, land sale, ? Around here he said builder’s in 2008 could expect 15% would settle @ 10, now 10% settle @ 6-8. Inventory is at an all time low, land is moving slow too I presume.

    • Hi Terry. Great to hear you are checking out projects. There are certainly a lot of moving pieces with developing properties. Because each market is so different, I’d reach out to real estate professionals in your neck of the woods. They should be up to speed on the nuances and mechanics of your market for development.

  2. I’m wanting to buy my first mutli-family and can use a jump start on all the business components like the proforma business model. Where might you suggest I look? I’m building my team, broker, lender, management here in Atlanta.

    tnx curt

    • Hey Curt. That sounds like exciting stuff!

      Frank Gallinelli’s book “What Every Real Estate Investor Needs to Know About Cash Flow” is a great resource. The book does a fantastic job going through the step by step process for analyzing and valuing income producing properties. Frank is a BP member and contributes often to the discussions on the site.

      I also really like Real Estate Financial Modeling (REFM) for tips and guides on financial modeling for real estate developments.

      You can also check out the FilePlace section of BP (in the Resources tab) for some Excel templates.

      Good luck with your deals and keep us posted!

  3. Great article Kyle. This is such an important topic – I can’t think of a more essential item for an investor to get their hands around than developing an accurate and reliable pro forma. Nice overview!

    • Thanks for checking out the article, Seth! I couldn’t agree more. I always find myself coming back to these three points when building pro formas. They can get over complicated quickly. So it definitely helps to have a good framework when jumping in.

  4. Kyle, Nice article, thanks.

    Do you have a go-to spreadsheet you use to analyze development deals? We are looking at a few development deals (Taking raw land to 10-15 unit developments) and could use a simple sheet to give potential deals a quick look to see if they should be pursued further.

    Please let me know, thx..

  5. Which other indicators/final metrics are used in CRE, I am in the process of building my template deal analysis spreadsheet and would like to include all of the formulations so I can have a birds eye-view.

    So far I have Cap Rate, ROI, cash on cash return, and reverse market value (sourced from desired cap rate).

    Thanks guys =)

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