5 Reasons why Pro-Forma Based Purchases Fail!
- kb4propertygroup
- Mar 7
- 2 min read
Relying solely on proformas when buying a property in real estate can be risky because proformas, which are essentially financial projections, often paint an overly optimistic picture. Typically these are created by the broker selling the property which is an incentive to use favorable numbers and information. Here are 5 reasons why you should never fully depend on them:
1. Overestimated Revenue
Proformas often assume the property will achieve full occupancy or have higher rental income than what’s realistically possible. Market conditions, tenant turnover, and other factors can impact actual rental income.
2. Underestimated Expenses
Proformas might underestimate maintenance costs, insurance, property management fees, taxes, or unexpected repairs. Maybe this property has an owner who did their own maintenance which reduced cost drastically. This makes it easy to miss hidden expenses or unforeseen costs that could eat into profits.
3. Assumption of Ideal Financing Terms
The proforma might assume that you’ll get ideal financing terms, but your actual loan terms might vary, impacting your cash flow and profitability. Especially with rates fluctuating so much right now, it’s hard to determine how the property would work when the owner had a 3% interest rate.
4. Misleading Capitalization Rates
Proformas sometimes use optimistic capitalization rates (cap rates) that are based on current market conditions, which may not be sustainable. If market conditions shift, the cap rate can change, lowering the property's value.
5. Lack of Due Diligence
Proformas often focus on numbers rather than thorough research into the property’s history, the neighborhood’s future, zoning laws, or potential redevelopment plans. Without proper due diligence, you could miss out on important factors that affect the property’s true value.
Bonus Reason: Risk of Overpaying
Because proformas might look attractive on paper, there’s a risk of overestimating the property's true potential. If you rely too heavily on the projections, you might end up paying more than the property is worth or fail to realize a negative return on investment.
What to Do Instead:
Review Real Historical Data: Look at actual, historical performance and trends in income and expenses for a better idea of the property’s real potential.
Get a Professional Opinion: Consult with real estate agents, property managers, or financial experts who can give you a more accurate view of the property’s potential.
Conduct Thorough Due Diligence: Investigate the property’s physical condition, the market’s future trajectory, and possible hidden costs.
Prepare for the Unexpected: Build a financial cushion into your projections to protect yourself from unanticipated changes or costs.
Ultimately, while proformas can be helpful as a starting point, they should never be the sole basis for making a property investment decision. Always ensure you're considering a broad range of factors and doing proper research.
Reach out to Bill or Bob to learn more about becoming an investor with KB4 →
Comments