Visualize this, the opportunity of a lifetime: 10 acres of land zoned for single family lots in your preferred location, part of your favourite NCP, and to make things even better it’s off-market. In all your excitement, you soon realize that the property has been shopped around to some of the savviest developers in Surrey. You will likely be in a position where you are bidding against other developers. Time to put your best foot forward.
Offers are due in a week and you must structure the best deal that will set you apart from the competition, while still allowing you to make material profit in the project. So, here’s the critical question we will be answering in today’s blog: how much should you pay in this scenario and still make a solid return on your investment through the process?
This is where the Pro Forma comes into play…
THE PRO FORMA
Pro forma, is a Latin term that literally means: “for the sake of form” or “as a matter of form.” In the world of real estate, pro forma refers to a method by which financial results are calculated. This method of calculation places emphasis on present or projected figures. A pro forma analysis is a set of calculations that projects the financial return that a proposed real estate development is likely to create. It begins by describing the proposed project in quantifiable terms. It then estimates revenues that are likely to be obtained, the costs that will have to be incurred and the net financial return the developer expects to achieve.
The pro forma is the basic “go/no-go” analysis that financially savvy developers use to decide upon whether or not to move forward with a project. There are very few absolutes as to how such analyses can be constructed; however, there are common practices and techniques that nearly all pro forma analyses attempt to provide in one form or another. A pro forma analysis will provide you with a summary of the estimated rate of return and equity multiple for the project, as well as the equity required, with or without financing.
One of the key aspects of pro formas is that they are financial models that are based on many assumptions that are unknown at the start of the development process. These unknown assumptions develop and become refined as the project develops. Some typical assumptions that drive a pro forma evaluation include:
Timelines: when do the key stages of your project start, continue and end
Costs: what are each of the hard and soft costs associated with your project, including design, construction, financing and contingency funds
General inputs: what are the number of units, lot size and other physical constraints that drive your project.
Sources and uses: what financing structure is in place? What will the funds be used for?
After establishing your assumptions, you must then estimate cash flow for the project. Typically, you will go through a few standard stages of your project including: pre-construction and construction, stabilization and disposition. During pre-construction and construction, you will analyze the expenses will occur to produce finished building or space that’s ready to be sold. During stabilization, assuming cash flow is being produced, you will have to consider the estimated revenues and expenses you must incur to operate the stabilized property. During disposition, if you are looking to sell the property once it has stabilized, you will have to prepare for the anticipated value and sale conditions.
Land development is all about investing, nurturing and seeking return. Every property development project is analyzed with respect to its estimated ROI (return on investment) over the course of time. You can easily gauge the success or failure of a project, as well as it’s investment potential, by estimating returns. Typical returns for the pro forma include:
Internal rate of return: IRR
Net present value: NPV
Cash on cash return: COC
It is essential that you know each and every cost you will be incurring before determining the value of land. If not an accurate figure, at least have well researched estimates of the costs from projects that have been completed on similar plots of land with the same zoning and density. To be safe, always over-estimate and have strict contingency controls in place. This will allow you to not only correctly finance a project, but also handle any unexpected development, material or time-delay related costs. In order to truly become a savvy developer, it is critical that you develop and enhance your understanding of real estate feasibility analysis (the pro forma). As with any successful technique of analysis, pro formas are always developed iteratively, undergoing edits, updates and refinement as your project gains traction and becomes more tangible.
If you have a project or property in mind, and would like help analyzing its feasibility, do not hesitate to contact Real Edge Property Group. We have our own proprietary pro forma templates that we use with a proven and successful track record. Our team leads have completed the BCIT real estate program, which has been consistently ranked as the best in Canada, and have also completed UBC’s Urban Land Economics program. If you have created your own pro forma, we will happily help you ensure your inputs are correct. Contact us today and see what the edge can do for you!
The following information is based on investment principles created by the Real Estate Investment Network of Canada in good faith without warranty or liability for any erroneous, incomplete or misleading information. Edge Real Estate Group is not responsible for any results or the results of any actions taken in reliance up on any information contained neither in this publication, nor for any errors contained therein or presented thereat or omissions in relation thereto. Edge Real Estate hereby disclaims all and any liability to any person arising in respect of this information and of the consequences of anything done or purported to be done by any such person in reliance, whether in whole or part, upon the whole or any part of the contents of this information.