Wednesday, January 13, 2016

Analyzing a Property's Cash Flow Statement & How to Create a Real Estate Pro Forma (part 4 of pro forma building series)


(Reykjavik, Iceland)

Here's a list of everything we've covered so far:

Part 1 - Overview on how to calculate down to the NOI line item.
Part 2 - Intro to lease structures and calculating the gross potential revenue line item.
Part 3 - A look at reimbursement methods and how to calculate reimbursement income.
Part 4 - How to calculate the other income line item and an intro to income adjustments.
Part 5 - Rent abatements overview and calculation example.
Part 6 - Absorption and turnover vacancy explanation and intro to tenant improvements.
Part 7 - General vacancy allowance explanation and calculation example.
Part 8 - Operating expenses explanation.
Part 9 - Constructing a sources and uses table.
Part 10 - Building a debt schedule.
Part 11 - Calculating levered IRR.
Part 12 - DCF analysis.
Part 13 - Loan sizing.

Calculating Other Income


The last line item in the "Income" category is "Other income." Other income encompasses all the miscellaneous revenue streams a property might have. For example, a property might have a parking structure on it that generates income, or income from a food cart, vending machines, etc...

How most pro formas forecast other income is really simple. Typically, you just take the actual / in-place other income and grow it by a static growth rate every year. In the example pro forma (link here), we simply grow our 10k parking income by our specified 3% annual growth rate.

Introduction to Income Adjustments


Remember when projecting our gross potential revenue and reimbursement income we ignored when a suite would be empty? Gross potential revenue is supposed to look at the total rent we would get if there was no vacancy on the property. Likewise with our reimbursement income. Well, that's great, but it doesn't reflect reality. We need to account for when suites are empty and not collecting rent or reimbursements. That's where the income adjustments section comes in. Here we'll adjust the rent and reimbursements lower.

First, our total income needs to be adjusted lower because of rent abatements. Rent abatements are months of free rent a tenant negotiates as part of their lease agreement. During these free months, tenants won't be paying rent or reimbursements.

Second, we adjust it lower due to absorption and turnover vacancy. The absorption and turnover vacancy line item reflects the lost rent and reimbursement income due to a tenant leaving a suite and it becoming vacant while a new tenant is found.

Third, we adjust our income lower due to a general vacancy. General vacancy is an additional cushion built into most pro formas for conservatism. Think of it as an allowance for those unforeseen things that will lower income. It also represents the idea that a property will never be fully occupied and will be closer to 90-95% occupied in a best case scenario. 

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