A Pro Forma Analysis is a tool businesses use to project financial data. Authors at ehow.com say “A pro forma analysis is an analytical projection of the potential financial position of a company based on a review of historical information.” Whoa! That sounds complicated. No…You probably already do it to some level if you participate in the management of your residential investment property. Using analysis tools like the a pro forma analysis helps owners of rental properties re-frame the way they think about rental properties. This tool helps investors treat their rental property like an investment, and helps reduce “emotional” decision making.
Description of a Pro Forma Analysis
A pro forma analysis very simply projects all income and expenses on a rental property. Step one is to assess how much income your rental can produce. There are many ways to assess market rent, but the simplest is to research what comparable rentals are renting for.
Step 2 is to honestly project day to day expenses. Day to day expenses on the simplest level include: maintenance, grounds keeping, management, utilities, vacancy, cleaning, and taxes, insurance, and mortgage.
Step 3 is to honestly project capital expenses. Capital expenses include siding, windows, roofing, flooring, painting, appliances, and other items that only need to be purchased every few years. A reserve fund needs to be set up for replacement. For example, a rental owner projects that the roof needs to be replaced in 10 years. The cost of the replacement is $5000 (assume no change over 10 years) and owner divides the cost over 10 years so the cost is $83/month. Rental owner decides to set up a reserve account and put $83/month in that account so at the end of 10 years he has enough to pay for the roof. Depending on the time line of your investment some items may not need to be factored in, but will affect overall value.
Purpose of Pro Forma Analysis
An effective pro forma analysis helps you treat your rental property(ies) as a business. Other purposes might include:
- Analyze a rental property before you purchase.
- Assess and reduce expense items.
- Maximize rental income.
Data drives growth!
For an example of a simple single family home pro-forma analysis or if you would like a free pro forma analysis on your rental property click here.