Thursday, May 17, 2012

What On Earth Is a Proforma Income Statement And Does It Really Help Make Good Real Estate Investment Decisions?

The proforma income statement (or proforma) is regarded as a real estate investments report that investors and analysts normally use when it comes to predicting the revenues a rental real estate asset might produce for a prospective owner over time. Here's the idea.

As a result of projecting out across a certain number of years the income that the investment property could very well create, investors and analysts have the ability to undertake a profitability evaluation that will make it easier for them to measure the future over-all performance of a property. Thus lending support to their investing decision-making process.

There are no constraints over the amount of years that you would like the proforma income statement to present. I have spotted proformas (for instance) that provide statements which range from ten to twenty years; a few software companies in fact boast that their application delivers thirty-year estimates. In spite of this, I honestly think that these kind of longer span forecasts can turn out to be too unreliable to generally be granted very much weight. You will discover just too many factors which can affect any sort of cash flow estimate (even more so for that many years). So if you are using a real estate investment analysis software solution that generates a ten-year proforma income statement to conduct your rental property evaluations you can regard that sufficient.

Similarly, a proforma is not limited to the assortment of fiscal details it unveils. A first-rate statement will need to (at the very minimum) project annual (end of the year) results for income flows, rates of return, and the proceeds that are the result of a sale (known as reversion). However the better proformas additionally include the aspects of tax shelter; thereby enabling real estate analysts to also consider the the "after-tax" returns generated by the property. This is important. The income tax liability an investor encounters during ownership of the property plays a crucial role on whether or not the property is a profitable investment opportunity. Therefore it is smart to use a proforma that includes full consideration for income taxes.

Okay, but aside from all of that, there are two overriding issues crucial for you to consider.

1) That regardless what features and data you prefer, the proforma must accommodate your business objectives and show you the data you require to make a real estate investment decision.

2) That the forecasts you intend to make are relying on solid data. No proforma income statement is good for anything other than lining the birdcage if the data is faulty. When making your projections, for example, when you believe that rental cash flow can reasonably appreciate two percent a year than drive back the urge to bloat that number to three or four percent simply because you pray so. You may even look at staggering the amount of growth merely to be safe. Maybe three percent appreciation in year two, two percent in year three, and zero percent for the remaining years.

How do you go about obtaining a proforma income statement? Naturally, you can create your own with an Excel spreadsheet and some surplus time. In fact, a whole lot of surplus time. On the other hand you can consider just investing in a good real estate software program that will create the statement for you. Regardless, whether you make it yourself or invest in software, you definitely don't want to be without a proforma the next time you get around to investing in investment real estate.

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