New construction development projects (large ones, small ones, infill projects)—they all start with a pro forma.
Pro forma financial models are essential tools in a real estate developer’s toolbox. If you’re thinking about building any new construction project or acquisition/rehab—be it anything from a single-tenant industrial property to a 100-acre master planned mixed-use community—building your pro forma is one of the first steps you’ll take. Developers use pro formas to help negotiate with equity partners, structure financing with potential lenders, and create project specs with architects and engineers. Better yet, developers use pro formas to decide how big (or small) and how fancy (or simple) a specific project will be.
Like an architect communicating their design through blueprints, the developer communicates internally and externally through their pro forma.
In previous articles I discussed starting a real estate development pro forma from scratch and the 3-part framework (assumptionsàcash flowàreturns). If you want to build a new construction development, these are important things to keep in mind. However, if you really want to make your pro forma work for you, the absolute best thing you can do is build it with this in mind:
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Why is flexibility so important when building an investment-grade pro forma for a new construction project?
1) When starting with a blank slate, you have countless options and decisions to make. Your pro forma, through analyzing different scenarios, gives you the best way to maximize your investment. For example, which is a better use of your capital: rental or condo and should it be with 100 units or 150 units. These decisions, which can have enormous impacts on your financial bottom line, are analyzed with your pro forma before any shovel hits the ground.
2) Your project is always changing. As you go through the early development process—through due diligence, financing, design, and entitlements—information about your project becomes more available and solidified. As your project changes, so does your pro forma—which affects your investment and risk in the project.
How do you make a robust, yet flexible pro forma when questions like these pop up?
- The land seller has another parcel we can buy. What if we change our 80-unit multifamily project to 120 units? How will that impact our financial returns?
- There’s a new update with the entitlements. We have to push our construction start date back another four months. How does that impact our investment?
- We need to adjust our unit absorption assumptions because our competition across the street had a harder time filling up their units than we originally thought. What does a slower absorption period look like financially?
These questions and changes come up every day when developing a new property. Because of this, a flexible, well-built pro forma will save you time, money, and numerous headaches as you develop your project.
Here are two parts of your development pro forma where spending time and effort up front on your pro forma’s structure will save you time later in the development process.
Timing – Create a timing schedule in your pro forma that can be adjusted quickly as timelines change.
When starting a new construction project, developers typically have a general understanding for the project schedule. For example, they’ll anticipate design lasting four months and construction completion in 14 months. Despite early projections, project timing always changes. Construction may actually take 18 months while design lasted only 2.5 months. You’ll want your pro forma to adjust quickly to these changes because timing effects your bottom line.
When starting your pro forma, create a timing section in your assumptions tab that feeds into your entire financial model. When timing changes, you can quickly adjust this piece. If your cash flow timing feeds from these inputs, they’ll automatically adjust and save you hours of re-tooling your pro forma.
Simple Timing Schedule
Here’s an example of a simple timing schedule (built in your assumptions tab) that can be changed and updated quickly.
Property sizes change quickly and have a tremendous impact on your bottom line. When you want to change your unit mix from 100 one-bedroom units to 150 one- and two-bedroom units because the market is more accepting of two bedroom units, adjusting for this change with one input will increase flexibility and provide a way to analyze different scenarios.
Here’s an example of unit mix inputs in a pro forma assumptions tab that can quickly be modified.
While new construction development projects are inherently messy and can take months and years to complete, a flexible pro forma can save time and help maximize one’s investment.