Chapter 5 Audio Interview | Property-Level Pro Forma Analysis (sample)
BRUCE KIRSCH: Taking a look at the next chapter, Property Level Pro Forma Analysis– pro forma, it’s a future projection. So it’s a fictitious story about how things are supposedly going to play out at a particular property. And if we’re just limiting it to operations, not integrating, you know, what price will be buy, and what price are we going to sell.
Let’s just talk for the moment about, this is an operating asset. Or in the case of a for-sale project, this is the business model. You know, this is how we’ll be selling units, and these are our net cash flows.
But let’s focus for the moment on operating asset, because that’s the bulk of commercial. And there’s a lot of seemingly dry exercise to do here. There are conventions. There’s a lot of vocabulary to know.
What are the things that students should focus on here? Obviously, we go through this chapter, literally line by line, telling you, this is the business relationship that we’re trying to simulate. This is how you would construct a formula to reflect that relationship accurately.
And that is a mechanical process. But what are the real things that students should be seeing in these numbers?
PETER LINNEMAN: So I think there’s two levels, Bruce. I think one is, if you’ve never analyzed a business before, each line of this is new to you. You probably never thought about, oh yeah, the income comes from rent. It comes from percentage rent. It comes from ancillary income from parking.
If you’ve been associated with being around businesses, that part comes easier. Similarly on the cost side, if this is your first exposure to a business– oh yeah, they have to pay property taxes and insurance, and they have to have the utilities, and they have– so I think there’s one level is that you’ve never looked at a business before.
This is a good introduction to look at any business. Where does its income come from? Is that income contractual? Is it already subject to a lease that says, this is what they have to do?
Or do I have to go out and, quote, drum up new business? Do I have to lease space to get it? Or at what point does the lease expire and I have to get a new business?
And on the cost side, the same way. Do I have some costs that are contractually in place? And what happens when those contracts expire? And a classic example, a very classic example, is when you come to property taxes.
And I can look and see the property taxes are $1 million a year. But if I know when I buy it, the property taxes go up, because this community adjusts it whenever a new buyer comes in. I’ve got to say not was it $1 million a year, but what will it be when I buy it?
OK, so it becomes a disciplined, systematic thought process, of where is a business getting its income? How much of that income is subject to contracts versus I’ve gotta get contracts, so to speak? And you take a hotel or an apartment, I gotta get a lot of contracts all the time. Nothing wrong with that, but I just understand that, as opposed to an office building, where 90% of my income may be contracted for the next four years.
Right, big difference. And expenses, one of the line items that matter. How do I analyze the property taxes, utilities, and so on?
So I think the big element is being systematic. And I think the second, you know, these little quotes that came from my class that we start each chapter with, you just have to understand, these numbers are your serious best effort. They’re making you think about, what really is the business I’m in?
The rows and columns are just a discipline of understanding what the business I’m in, what are the rents and costs, and the encumbrances and obligations? They’re never going to happen, almost never going to happen, but if you don’t do this analysis, you will not understand the business you’re signing up for.
Once having done the numbers, 90% of the exercises over someone’s life, once you’ve studied for the exam to the point you know the material, the exam is almost superfluous, because you know the material. What else can I do? You know the material, right?
It’s getting you to know the material, that’s what this serves. That would be my number one guidepost on this.