208-231-1944 zane@zanegraser.com

Proformas – Is it a good underwriting strategy for rental properties?

I see many investors and sellers, especially for multi-family properties providing proformas in their numbers for why people should buy the property.  Proformas is the projected future earnings by increasing the rent over the next few years based on what’s happening the past few years.

I’m seeing multi-family properties for sale with proformas and the sellers are asking high prices based on the proformas rather than the current market rent.  The numbers don’t make sense at the higher asking price until you raise rents over time to make the numbers work.  That means you are underwater immediately at the time of buying the property “hoping” that the rents will go up over time to make money.  This is a dangerous strategy because then you are at risk of losing LOTS of money in a large acquisition.

There are many multi-family operators today that are underwater with their properties because they bought the properties at a high asking price and relying on the future earnings.  Just because the rents have steadily increased over the past few years doesn’t mean it will continue to increase over time.  There is a cycle with the markets and there is always a crash every 7-10 years typically.  Also, we are dealing with high interest rates in the past year which means it now costs twice more for the monthly mortgage payments than it was when rates were low.  Multi-family property owners now can’t refinance their properties because it no longer makes sense with the higher interest rate and they can’t sell the high-priced property along with the high loan balances owed on the properties.  It leads to foreclosure…  It’s unfortunate…

When I’m running my numbers on any deal, I always look at the current market rent rate.  I never assume what the future will hold for me.  Always assume the worst-case scenarios such as an increase in interest rates, property vacancies, market rent changes, etc.  When buying properties, I will focus on the current rent and not projected earnings.  My offer prices will be based on current earnings, not projected earnings.  No lender will give a loan on proformas and focus on the current rent unless you are willing to pay the difference just so you can acquire the property.

The only way I use proformas in my calculations is if I am buying a property at discount.  If they are vacant or only operating at 50% and they need some renovations, I can use proformas for my numbers.  I still focus on the current market rents and the value of the property for my calculations.  It’s easy to fix up a property, then fill the vacancies to get to where we need.  We can also be conservative with our numbers by dropping the monthly rent to be safe if we need to cut back on the monthly rental amount in order to fill the vacancies.  Other than that, proformas is not a great strategy when underwriting our deals!!!