For many new developers – and urban planners, brokers, architects and consultants – the real estate pro forma is intimidating.
Using a Latin term (pro forma—which means “for the sake of form,” by the way—for a financial model certainly doesn’t help alleviate the intimidation.
When someone starts talking about IRR, cap rates, debt service coverage ratios and cash-on-cash returns, it’s easy to think:
“Maybe I can’t hack this”
My answer: You can.
Because despite all the financial terminology and acronyms, every development pro forma comes down to:
- Revenue
- Costs
- Profit
Revenue – Costs = Profit.
What makes a pro forma challenging is determining the assumptions that make up those three numbers.
The Hard Part Isn’t Really the Math
The math itself is relatively straightforward.
The challenge is understanding the assumptions.
- How much will the homes sell for?
- What rental rates are realistic?
- How much will construction cost?
- Will development charges change?
- How long will approvals take?
- Will interest rates move before construction starts?
- Will the project require off-site servicing or utility upgrades?
Those questions are usually more difficult than the actual Excel spreadsheet. They require market knowledge, local experience and an understanding of the risks that surround every development project.
The key is asking the right questions.
The best developers know what questions to ask when making their development assumptions.
That’s why experienced developers spend so much time discussing assumptions—not formulas.
A Pro Forma Is a Projection
A pro forma is simply a structured way of testing assumptions before significant money is committed.
The costs haven’t all been incurred. The revenue hasn’t been earned. You’re projecting what could happen based on the information you have today.
You’re asking: Can I make money on this project?
Those assumptions will never be 100% correct. Things will change.
As new information becomes available—updated construction estimates, municipal feedback, market data or financing terms—the pro forma should evolve with it.
Here are three tips.
1. Write Down Your Assumptions
One habit that separates experienced developers from inexperienced ones is documenting assumptions.
Don’t keep them in your head.
Write them down.
Make them clear.
Challenge them.
Debate them with your consultants and project team.
And, maybe most importantly, make sure they’re consistent and aligned with the project.
I’ve seen pro formas where timelines didn’t match a realistic municipal approval process, and where construction costs didn’t factor in servicing requirements. Be better than this.
Those inconsistencies can easily lead to decisions that cost tens of thousands of dollars—and on larger projects, hundreds of thousands.
A pro forma is only as good as the assumptions behind it.
2. Not All Pro Forma Assumptions Are Equal
Another lesson that takes many people years to learn is that not every assumption deserves the same amount of attention.
Some assumptions barely move the needle.
Others determine whether a project proceeds at all.
A modest increase in construction costs can significantly reduce profitability. A longer approval timeline increases financing costs and delays revenue. Achieving fewer units than anticipated can dramatically affect land value.
That’s why experienced developers don’t build one pro forma and call it done.
They test different scenarios to understand the impact. They ask questions like:
- What happens if construction costs increase by 5%?
- What if approvals take six months longer?
- What if sales values soften?
- What if interest rates go higher than expected?
This exercise gives you clarity. After testing different scenarios, you and your team will know what to focus on.
Testing scenarios provides more value than refining every line item to the nearest dollar.
This leads to my next point.
3. Don’t Mistake Precision for Accuracy
Real estate development involves uncertainty.
Of course you should build the best cost estimates you can. Every dollar matters when you’re investing significant amounts of money.
But don’t spend hours trying to estimate a future construction cost down to the nearest cent.
That level of precision often creates the illusion of certainty. In reality, that level of accuracy doesn’t exist.
Instead, spend your time understanding the assumptions that have the greatest influence on the project’s success.
Again, once you know what matters most, you can focus your efforts:
- Could approvals be accelerated?
- Is there an opportunity to increase density?
- Could a different construction approach reduce costs?
Those are the questions that create far more value than perfecting a spreadsheet.
The Spreadsheet Is Telling a Story
If you’re new to development pro formas, don’t let a spreadsheet with hundreds of rows and dozens of tabs intimidate you.
Whether you’re a planner, broker, municipal staff member, consultant, investor or aspiring developer, you don’t need to be a financial analyst to understand a development pro forma.
Instead of just seeing formulas, you’ll begin to see the story of a project and the decisions that determine whether it succeeds.
Still Need Some Help?
At SiteMentor Development Consultants, pro forma analysis is a core part of our feasibility studies.
We help clients understand the assumptions behind the numbers, identify the variables that matter most, test different scenarios and make informed development decisions with confidence.
