Definition
A pro forma is a multi-year projection of a commercial property's income, operating expenses, debt service, and cash flow under a set of assumptions about rents, vacancy, expense growth, and exit. It's the financial story a sponsor or broker tells about how a deal is supposed to perform.
A pro forma is a projection. It is not actual results. The whole job of underwriting is figuring out which assumptions in a pro forma are reasonable and which are wishful thinking.
Tyler's Take
Every pro forma I've ever seen as a buyer has been wrong, and that's not a complaint, it's a fact. The seller's broker isn't trying to lie to you (usually). They're showing you the optimistic version of the deal because that's their job. My job as a buyer is to take their pro forma, strip it apart, and rebuild it with my own assumptions.
The trick I teach CRE Accelerator members: when you read a broker's pro forma, look at the difference between the trailing 12 months (T-12) and the Year 1 pro forma. That delta is where the broker is making their pitch. If T-12 NOI is $180k and the Year 1 pro forma says $230k, you need to know exactly where that $50k is supposed to come from. Lease-up of vacant space? Mark-to-market on expiring leases? Expense cuts? Each one has a different probability of actually happening.
A pro forma is also where most beginners get burned. They see the Year 5 cash flow and the projected IRR and they fall in love. Don't fall in love with the back end of a pro forma. Year 5 is fiction. Year 1 is the only year you can actually budget for. Underwrite Year 1 hard, sanity-check Years 2-5 against market growth, and assume your exit cap rate is 50-100 basis points higher than today's going-in rate.
What Goes in a Pro Forma
Income: Gross potential rent (GPR), vacancy and credit loss, effective gross income (EGI), other income (parking, laundry, CAM reimbursements).
Operating Expenses: Property taxes, insurance, management fees, repairs and maintenance, utilities (if landlord-paid), replacement reserves.
Net Operating Income (NOI) = EGI minus Operating Expenses
Debt Service (annual principal and interest)
Cash Flow Before Tax = NOI minus Debt Service
Capital Events: Year 0 (acquisition cost, closing costs, capex budget) and Year N (sale proceeds minus debt payoff minus selling costs).
Return Metrics: Cash-on-cash by year, IRR, equity multiple, average annual return.
Worked Example
Say I'm looking at a 10,000 SF Nashville flex building, asking $1.8M, T-12 NOI of $108,000. The broker's Year 1 pro forma shows:
GPR $144,000 (10,000 SF x $14.40 NNN)
Vacancy (5%) ($7,200)
EGI $136,800
Op expenses ($10,800) (NNN, mostly reimbursed)
NOI $126,000That's a 17% NOI bump from T-12 to Year 1 ($108k to $126k). When I dig in, I find the broker is assuming a vacant 2,000 SF suite leases up by Month 4 at $15/SF. Reasonable in this submarket? Maybe. But I'm not paying for $126k of NOI on Day 1, I'm paying for the chance at $126k.
My buyer-side rebuild assumes 9 months of downtime on that suite, $8/SF in TI, and a 7% vacancy reserve going forward. That brings my Year 1 NOI to about $112k, and my offer drops accordingly.
How to Stress-Test a Pro Forma
When I review a pro forma, I run four sensitivity scenarios:
Vacancy +200 bps. What happens if 5% becomes 7%?
Rent growth = 0. Strip out the broker's 3% annual rent escalations.
Exit cap +100 bps. Assume you sell at a higher cap rate than you bought at.
Interest rate stress. If the loan resets, can the property still service debt?
If the deal still makes sense after all four, it's real. If three of the four kill it, the pro forma is the only thing holding the deal together, and I walk.
Red Flags in a Pro Forma
Year 1 NOI dramatically higher than T-12 with no clear explanation. Vacancy assumption below 5%. Expense growth lower than rent growth. Exit cap rate equal to or lower than going-in cap rate. Management fee missing or below 3% of EGI. No replacement reserves. Capex budget that's a round number with no line items.
Frequently Asked Questions
Is a pro forma the same as actual financials?
No. A pro forma is a projection of what the property is expected to do. Actual financials (T-12, year-end statements) show what the property has actually done. Always look at both.
How many years should a CRE pro forma cover?
Typically 5-10 years, matching a typical hold period. Most sponsors model 5 or 7 years to match their exit strategy.
Who creates the pro forma?
The seller's broker creates the marketing pro forma. Sponsors create their own underwriting pro forma. Smart buyers always rebuild from scratch using their own assumptions, then compare.
Can I trust a broker's pro forma?
Trust the framework, verify the inputs. Brokers aren't lying, but they're showing you the most flattering version. Always rebuild it yourself before writing an offer.
Run Your Own Numbers
Use the CRE Underwriting Calculator to build your own pro forma and stress-test sponsor assumptions.
Related Terms
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