How to Build Accurate Real Estate Pro Forma Projections

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Your CFO just asked you to evaluate a potential real estate acquisition. You open the broker’s marketing package, flip to the pro forma, and see projected NOI increasing by 4% annually over the next decade, with no explanation. Cap rate assumptions? Arbitrary. Lease rollover risk? Ignored. Capital reserve adequacy? Good luck finding it.

Welcome to real estate financial projections, where optimism often masquerades as analysis and brokers confuse “pro forma” with “wishful thinking.”

For finance professionals accustomed to rigorous corporate budgeting and SEC-quality disclosure, real estate pro formas can feel disturbingly casual. But property investments represent significant capital allocation decisions that demand the same analytical rigor you’d apply to any major corporate investment.

Key Takeaways

• Pro formas combine income statement and cash flow mechanics: Unlike corporate three-statement models, property projections use simplified structures—but require detailed lease-level analysis
• Revenue accuracy depends on lease rollover assumptions: Vacancy periods, tenant improvement costs, and lease renewal probability drive real cash flow more than base rent projections
• Capital reserves separate competent from incompetent projections: Underestimating CapEx, TIs, and leasing commissions destroys actual returns regardless of NOI growth assumptions
• Bottom Line: Real estate pro formas require granular operational assumptions grounded in market data—not top-down revenue growth rates copied from prior deals. Build projections that survive diligence, not just internal approval meetings.

Understanding Pro Forma Structure (And Why It’s Not a P&L)

Real estate pro formas look deceptively simple compared to corporate income statements. They’re essentially hybrid documents that combine income statement concepts with cash-basis accounting, creating both convenience and risk.

Why Properties Use Simplified Projections:

Corporate pass-through structures (partnerships, REITs) don’t pay entity-level taxes, eliminating tax provision complexity. Properties lack significant working capital dynamics—no inventory, minimal receivables, straightforward payables. Capital structure gets handled directly in the projection rather than through separate balance sheet modeling.

The pro forma starts with potential gross income (what the property could generate at 100% occupancy and market rents), then makes deductions for vacancy, free rent periods, and other adjustments to reach effective gross income—your actual collectible revenue.

Critical Distinction:

Base rental income represents the theoretical maximum revenue. Effective gross income represents reality after accounting for vacancy, lease-up periods, tenant concessions, and collection losses. The gap between these numbers reveals either conservative underwriting or wishful thinking.

Revenue Projections: Where Most Models Fail

Finance professionals love top-down revenue growth assumptions. “We’ll assume 3% annual rent growth across the portfolio.” Sounds reasonable, looks clean in the model, completely ignores how commercial real estate actually works.

Lease-Level Reality:

Every tenant operates under a specific lease with defined terms, expiration dates, renewal options, and rent escalation schedules. Your 3% growth assumption means nothing if your anchor tenant’s lease expires in Year 2, takes six months to backfill, and the replacement tenant negotiates 10% below market because of weak retail fundamentals.

Essential Revenue Components:

Base Rental Income: Current in-place rents, not aspirational market rates. If tenants are paying below-market rates, your upside comes from lease rollovers—but only if those tenants actually leave.

Absorption and Turnover Vacancy: Time required to find replacement tenants when leases expire. Brokers assume 3-6 months. Reality for secondary markets or challenging spaces? Try 9-12 months.

Concessions and Free Rent: New tenants don’t pay full freight immediately. Expect 1-3 months free rent as move-in incentive. Underestimate this, and Year 2 revenue projections become fantasy.

Expense Reimbursements: For triple-net and modified gross leases, tenants reimburse operating expenses. This isn’t “extra” revenue—it’s cost recovery. Misclassifying reimbursements as incremental income artificially inflates effective gross income.

The Lease Rollover Schedule Matters More Than Market Rent Growth:

If 40% of your NOI comes from tenants with leases expiring within 3 years, your pro forma should include detailed assumptions on renewal probability, replacement-market rents, downtime periods, and tenant improvement costs. Otherwise, you’re projecting science fiction.

Operating Expenses: The Line Items Everyone Underestimates

Operating expense projections should be straightforward—utilities, maintenance, insurance, property taxes, and management fees. Yet somehow, actual expenses consistently exceed projections by 15-25%.

Why Expense Projections Fail:

Property managers provide “stabilized” historical expenses that exclude one-time items that recur annually. Insurance costs are based on last year’s rates, even though property insurance has increased by 30-50% in many markets over the past three years. Property tax assessments get appealed, delayed, then hit with retroactive increases nobody modeled.

Expense Categories Requiring Detailed Analysis:

Property Management Fees: Typically 3-5% of effective gross income, but verify actual management agreement terms. Some charge higher percentages for lease-up activities or capital project oversight.

Property Taxes: Don’t assume last year’s assessment continues indefinitely. Property tax reassessments post-acquisition often result in 20-40% increases as assessed values catch up to sale prices.

Insurance: Factor in actual market conditions, not expired policy premiums. Coastal properties, properties in wildfire zones, or properties in areas with deteriorating infrastructure face substantial premium increases.

Utilities: Model separately landlord-paid and tenant-reimbursed utilities. Vacant space utilities fall entirely on ownership, and vacant space projections always prove optimistic.

Repairs and Maintenance: Age and condition matter enormously. 15-year-old HVAC systems don’t cost the same to maintain as new installations, regardless of what the property manager claims.

Capital Costs: Where Deals Actually Make or Lose Money

Net operating income gets all the attention. Capital costs determine whether projected returns actually materialize.

The Three Capital Cost Categories:

Capital Expenditures (CapEx): Non-tenant-specific building improvements—roofs, parking lots, HVAC systems, elevators. Items that benefit the entire property and typically have 10-30 year useful lives.

Tenant Improvements (TIs): Build-out costs for tenant spaces. Office tenants expect $30-70 per square foot in TI allowances. Retail tenants might require $20-100+ per square foot, depending on concept and condition. These costs recur every lease cycle—not annually, but predictably.

Leasing Commissions (LCs): Broker fees for new leases and renewals, typically 4-6% of total lease value for new leases, 2-3% for renewals. On a 10,000 square foot lease at $30/SF over five years, you’re paying $60,000-$90,000 in commissions.

The Reserve Allocation Debate:

Conservative underwriting establishes annual capital reserve allocations to smooth lumpy capital costs. Instead of showing $800,000 in Year 3 for a roof replacement, allocate $200,000 annually to reserves.

Some argue reserves shouldn’t reduce NOI because they’re not current-year cash expenses. This is technically correct and practically irrelevant—you still need to fund capital costs eventually. Better to reflect economic reality in NOI than pretend capital costs don’t affect property-level cash generation.

Industry Standards That Lack Certainty:

Brokers love quoting “$0.30 per square foot annually” for capital reserves. For 100,000 square feet, that’s $30,000 per year or $150,000 over five years.

Now, price the actual capital costs: Roof replacement ($300,000), parking lot resurfacing ($150,000), HVAC system replacement ($200,000), and tenant improvements for lease rollovers ($250,000). You’re at $900,000 in five years—six times the reserved amount.

Either accept that NOI in years with major capital costs will be dramatically lower than projections, or reserve adequately upfront. There’s no third option.

Building Credible Lease Rollover Assumptions

The single largest driver of pro forma accuracy? Lease rollover assumptions that reflect actual tenant behavior and market conditions rather than optimistic guesses.

What You Need to Know About Every Material Tenant:

• Lease expiration date and renewal options
• Current rent versus market rent (above, below, or at market)
• Tenant’s business performance and industry health
• Historical renewal behavior for similar tenant profiles
• Market absorption time for comparable spaces

Scenario Planning Required:

Best Case: Tenant renews at market rates with minimal downtime and modest TI requirements

Base Case: Tenant doesn’t renew; replacement tenant found within 6-9 months at market rates with standard TI package and leasing commissions

Downside Case: Extended vacancy (12+ months), below-market lease rates to secure occupancy, above-average TIs, full leasing commissions

Your pro forma should reflect base case assumptions, not best case fantasies. Sensitivity analysis should test downside scenarios to understand loss potential.

The NOI and Valuation Connection

Properties are valued based on projected NOI divided by market capitalization rates. If your NOI projections are inflated by 20% due to optimistic revenue assumptions and understated capital costs, your valuation is similarly inflated.

Cap Rate Application:

$5 million projected NOI ÷ 5% cap rate = $100 million property value

$4 million realistic NOI ÷ 5% cap rate = $80 million property value

That $1 million NOI error just cost you $20 million in valuation accuracy. In corporate finance terms, you’ve recommended a major acquisition at 25% above intrinsic value.

Why This Matters for CFOs:

Real estate investments appear on your balance sheet at cost, but economic reality eventually surfaces. Properties generating insufficient cash flow to service debt, fund capital costs, and provide acceptable returns get repositioned, recapitalized, or sold—often at losses.

Better to underwrite conservatively upfront than explain to your board why the “stabilized 7% cash yield” projection turned into a 3% reality requiring additional equity infusions.

The Mechanics: Excel vs. Specialized Software

Real estate professionals debate endlessly about Argus versus Excel for pro forma modeling. For most corporate real estate decisions, Excel provides sufficient functionality with superior transparency.

Excel Advantages:

Complete formula visibility and audit trail. Easier integration with corporate reporting systems. Lower learning curve for finance teams. Flexibility for custom analyses and scenario modeling.

When Specialized Software Makes Sense:

Portfolio-level analysis across dozens of properties. Complex lease structures with percentage rent, CPI escalations, and intricate reimbursement calculations. Institutional-quality reporting requirements for external stakeholders.

The tool matters less than the assumptions. Garbage in, garbage out applies regardless of software sophistication.

Real Estate Pro Formas for Finance Leaders

Real estate pro formas require the same analytical rigor as any major capital allocation decision—perhaps more, given the 10-30 year holding periods and illiquid nature of property investments.

Finance professionals accustomed to corporate financial planning often find real estate projections frustratingly imprecise. Embrace that discomfort. It signals you’re asking the right questions about assumptions that brokers and property managers would prefer remain unexamined.

Build pro formas that survive diligence scrutiny, stress testing, and comparison to actual results three years later. Your credibility—and your company’s capital—depend on projections grounded in operational reality rather than aspirational growth rates.

Wiss provides comprehensive real estate financial advisory services for corporations evaluating property acquisitions, including pro forma analysis, lease structure review, and transaction due diligence. Let’s build projections that protect your capital and support informed decision-making.

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