Why are Pro Formas so misleading?

Question

Maybe this is more a vent session but being a new investor I'm shocked that Pro Formas are as misleading as they are.

I'm dealing with sellers who are selling to investors but their Pro Formas are written as if they were selling to consumers. A classic example is interest rate, as an investor the low bar is set at pretty much 5%. Yet, these Pro Formas are showing rates from 3.8% - 4.8%

I don't understand why investor centric sellers try to fudge the numbers in an effort to make their returns higher.

Barry Ruby · Answer

I have been doing pro forma analysis since the mid 1960's with primary focus on ground up development for a wide range of project types (shopping centers, multifamily, land deals and commercial solar PV). I recently became interested in acquiring apartment projects and have found the information presented in  Seller OMs to be misleading. The data coming from the selling side often presents the project on a pro forma basis, that is, income and expenses are shown as the deal "could be" rather than its actual historical performance.

Due Diligence should begin with gathering and analyzing the income and expenses as they are since that is what you are buying. Assuming the rents you think you can generate in the future, the expenses you think you will need to cover future rents and any capital costs needed to be invested to produce future cashflow are all in the Buyer's court.

Running a side by side pro forma analysis of "what is" and "what could be" on a line item comparison is both highly recommended and should form the basis of your offer. This kind of analysis forms an objective picture that demonstrates what you are buying compared to what you think you can turn the project into after its purchase. It also forms the basis for what you feel the fair and reasonable purchase price should be compared to the asset value you think you can create after you buy it.

Conducting pro forma analysis in this way employs but mitigates any sales "puffery" that may be in play and, speaking personally, allows me to maintain my blood pressure at a healthy level.

Bjorn Ahlblad · Answer

@Nic Stergion telling the truth takes skill and does not attract enough prospects. Pro formas are not meant to be accurate. "Pro Forma" is Latin for"Baloney". Annoying for sure but once you realize it is all baloney then you expect it.

Jason D. · Answer

@Nic Stergion if they told the truth, they couldnt get you through the door.

They want to sell, and when you cant sell the truth, you sell a lie

Barry Ruby · Answer

@Nic Stergion Nic it’s not the pro forma that’s misleading it’s the party that produces and presents it.

It’s your personal responsibility to analyze and amend it to reflect reality as you believe it to be and act on the performance that comes from your own independent due diligence.

Frank Wong · Answer

Pro forma is usually a view of the upper range of numbers. Sometimes they are pushed to the max which becomes unrealistic. The fact is a sucker is born every day and the majority of people have no idea on how to invest and will take the numbers for what it is.  It's up to the end buyer to do their own due diligence and underwrite the deal.  More people lose money than make this is a fact.

Joe Splitrock · Answer

@Nic Stergion their Pro Formas are written as if they are selling to newbie investors, which is how many of these properties are unloaded. What you are looking at is simply a marketing statement. Usually written by agents. It is more of a statement of "what is possible" than reality. No different than how mutual fund companies have been over promising returns for decades.

Ultimately just run your own numbers. I don't trust anything that a seller tells me. People cover up problems.

Another of my favorites is when the agent says, "the property could get higher rents, but the owner just decided not to raise them." I mean seriously if the owner thought they could get the money, they would do it.

Russell Brazil · Answer

I dont have a single loan as high as 5%.  Interest rate is highly dependent on the borrower and their situation.

Nic S. · Answer

Is it really balony?! That’s hilarious

Adonis Yancey · Answer

Hi there, Would someone be able to tell me how i would be able to acquire pro formas? I'm trying to learn how to use them in a evaluation technique that i read about.

Anthony Wick · Answer

@Nic Stergion

Why wouldn’t their Pro Formas attempt to make the property look as attractive as possible?! As a buyer, I ignore pro formas. If and when I sell, I hope my realtor attempts to get the highest price possible. If not, they won’t be my realtor for long.

Why are Pro Formas so misleading?

Most Popular Reply