Understanding real estate development proforma like a boss
What is a real estate development proforma?
A real estate development proforma, also known as a real estate development model, is a feasibility study of a development project used to determine the project's financial viability.
Real estate development proforma considers all sources of financing & all uses (project costs) and projects the cash flow on a project timeline.
Read more about How to choose a property development feasibility template.
Planning your development proforma
Benjamin Franklin once said, "If you fail to plan, you are planning to fail". It couldn't be more true for your development project.
What is your real estate development strategy?
Start With The End In Mind
Do you plan to Develop & Sell or Develop & Hold or you will deploy a mix of both these strategies? I.e. selling some units to pay down the debt and holding on to a few units for long term operating income.
Develop & Sell
Develop & Sell is a common strategy. The developer will sell all developed units at the end of the project. Typically, the developer would:
- Acquire Land
- Get Development Approval (Development Permit)
- Sell everything at the end of the project to pay down debt.
This strategy typically involves two separate development loans:
- Land Acquisition Loan
- Construction Loan
Develop & Hold
You deploy Develop & Hold strategy when you wish to acquire your investment properties at Cost. It increases the yield and equity in the project and makes financing a lot easier. Typically the Cost of the units will be a lot lower than their market value at the end of the development.
Develop & Hold strategy inevitably will require three separate loans:
- Land Acquisition Loan - to settle on the land.
- Construction loan for building and or improvements.
- Permanent Loan, which pays out the construction loan based on the operating income from the leased units.
Sell Some & Hold Some
The developer can also sell enough units to pay down the construction loan. The catch is to hold enough units, so your operating cash flow is either neutral or positive during your hold period.
Planning your development pro forma timeline is crucial because it's your project timeline that forms the basis of all your assumptions. It includes keying in the start and end dates of all possible events of your development project.
Here is an example of Project Timeline with Gantt chart.
The following table outlines the Start & End dates for significant events in real estate development. Planning these dates helps allocate costs across your project timeline - which collectively forms your project cash flow.
A development pro forma timeline is typically in months, and your development proforma template must be able to expand dynamically to accommodate the length of your project.
How to prepare a development proforma
In a nutshell, the development proforma includes the proceeds from sales (total sales) and total development costs of the project.
Total sales or Gross Realisation Value (GRV) are the project proceeds realised when all developed units are sold.
Total Development Costs (Uses)
Total Development Costs (TDC) include both direct and indirect costs. Direct costs, aka hard costs, include all construction and improvement costs: indirect costs, or soft costs, including the architectural, engineering costs & professional fees. Soft costs also include all financing costs and all costs not directly related to the project's construction.
All real estate development proformas and property development feasibility studies are made up of two things:
- Uses - which include all project costs
- Sources - are all funding sources (debt + equity) used to fund the project.
Equity sources - developers equity
- Developer's equity
- General partners
- Limited partners (investors)
- Joint venture partners
Debt sources - development finance
Land acquisition loan - used to settle on land or when acquiring a development site.
Figure out the maximum amount you can borrow based on various funding options. For example, maximum debt available to you can be based on any one of the following:
- Lender's LTC (Loan To Cost Ratio). LTC based on total development costs as determined by your lender.
- LTC based on Actual Total Development Costs
- LTC based on Total Sales
- Fixed maximum debt, i.e. you know the maximum amount you can borrow either through your broker or your dealings with the lender.
- Fixed maximum equity, i.e. you know the maximum amount of equity you can inject in the project, and everything else needs to come from other sources.
Cash flow draws, order & Cost of capital.
Construction loan - used to fund construction or refurbishment costs.
Mezzanine Loan - underpins construction loan in case there is not enough equity to cover construction costs.
Order of Draws
In Lead Developer+, you can select the order to utilise various funding sources to fund the development costs. The Developer's (GP) equity is utilised; first, LP second, Mezzanine loan comes in third. And finally, when all these sources are exhausted, construction loan will be utilised last.
Permanent Loan - pays out the construction loan based on operating income from leased units.
- Rental Income
- Interest Income
- Sale of chattels, old house etc.
- Rock, soil, wood available on site
- Misc. Income
Real Estate Development Costs
Following is a list of property development costs to fund or uses:
- Land Acquisition Costs
- Statutory Fees & Contributions
- Finance & Interest Costs
- Finance - Ancillary Costs
- Holding & Running costs
- Services Connection Fees
- Selling & Marketing Costs
- Budgeting & Estimation
- Site Works - Developer
- Drawings & Consultants
- Site Reports
- Permit Fees
- Construction Costs
- Cost of Developers Equity
- Operating Expenses
- GST/VAT (if applicable)
For each of the development costs, input the following:
- Funding - are those costs funded by debt or by developers equity?
- Start & End Dates - based on your project planning, when do you expect them to occur in your project timeline.
- Decide the cash flow forecasting method between straight line and S-Curve.
- Select the steepness of the S-Curve
Types Of Real Estate Development Proforma
Depending on your strategy (i.e. Develop & Hold Vs Develop & Sell), you will need to adjust your development proforma. So you can account for construction costs, sale value & operating income arising from various residential and commercial units. No matter the type of real estate development model you are using, you need to figure out two main things:
- Cost of Construction of the type of units, i.e. residential, multifamily, condominiums, apartments, townhouses, single-family homes or commercial building like offices, retail, industrial etc.
- Total sale value of developed residential and commercial units.
Example 1: Residential Units - Develop & Sell
Step 1 - Calculate construction costs.
To calculate construction costs - find out the total built area of each type of unit. In the image below from Lead Developer Plus, you can use three different methods of calculating residential construction costs:
- Average construction cost per unit
- Average cost / UOM (Unit of measurement m2 or SF) or if you know your numbers well, you can use
- Average cost / individual area - this requires a breakdown of all built areas by various spaces, i.e. Net Saleable Area (NAS) + Non-saleable built area = Total built area. You can then multiply each area by a Value / UOM or $/SF or $/m2 to arrive at a more accurate construction cost.
Step 2 - Calculate total sale value.
To calculate total sale value, you can use two methods:
- Average market value per unit or
- Average $/UOM i.e. $/m2 or $/SF x total net saleable area
Step 3 - Time of Sale & Sales Commissions
Finally, to project total sales or cash inflows on a project timeline, you need to key in the date as to when you expect these sales to occur. If you are using a sales agent, you should allocate your sales commission percentages here.
Suppose your sales team requires that a percentage of sales commissions be paid when a sale contract is signed. In that case, you can also add the % of total sales commissions due when signing the contract. (see image below)
These dates are then used to project your cash flow across your project timeline, as shown in the image below:
Example 2: Operating Income Proforma
Operating forecasts should consider concessions such as free rent, tenant design, and construction costs. In addition, they should reflect future rent escalations. They must also take into account expenses for capital improvements and escalations of operating costs.
Follow the steps below to forecast operating income accurately:
Step 1 - Calculate construction costs (Leasable Units)
For a real estate development project, apart from calculating the Net Operating Income, you also need to calculate the construction costs of leasable units. (residential or commercial). In Lead Developer+, construction costs are automatically added to the total construction costs of the project.
To calculate construction costs - find out the net rentable area for each type of unit. In the image below from Lead Developer Plus, you can use two different methods of calculating residential construction costs:
- Average Cost per m2/SF
- Average Cost per individual area - where you can apply a different construction rate depending upon the space. For example, the Cost of common areas will be cheaper per m2/SF than the Cost of building a kitchen.
Step 2 - Calculate Potential Gross Operating Income
- Specify Monthly Rent
- Rent Free Months (if any)
- Annual rent escalation rate
- Market Capitalisation Rate
- Exit Capitalisation Rate
- And Closing Costs (Sales Commission Rate)
Step 3 - Calculate Effective Gross Revenue (EGR)
Gross Operating Income
- (less) Concessions Rent Free Months
- (less) Non-Revenue Units
- (Add) Recoverable income (if applicable)
- (Add) Other Income
= Gross Potential Income
- (less) General Vacancy
- (less) Credit Allowance
= Effective Gross Revenue
Step 4 - Calculate Net Operating Income (NOI)
NOI = EGR - (Operating Expenses + Recoverable Expenses + Other Fixed & Variable Costs)
Step 5 - Calculate Cash flow from Operations (CFFO)
Also knows as below the bottom-line expenses.
CFFO = NOI - (Capital Expenditure + Leasing commissions + Tenant Improvements (if applicable)
Step 6 - Calculate End Sale Value aka Reversion value
- Sale Value = NOI / Exit Capt Rate
Step 7 - Debt Service
The debt service is the amount of money that is paid to service the permanent Loan. It includes interest on outstanding loan balance as well as a principal loan reduction payment.
Step 8 - Before-Tax Cash Flow
Before-tax cash flow = Cash flow from operations - Debt service
Step 9 - After-Tax Cash Flow
After-Tax Cash Flow = Before-Tax Cash Flow - Applicable Taxes
Development Proforma Summary
A detailed development summary for a real estate development proforma should include the following:
- Project details like name, duration etc.
- Brief project description
- Project stats
- Project timeline / Gantt chart
- At a glance - Decision metrics
- Profit before tax
- Development margin
- On costs
- On sales
- Equity Multiplier = (Total Profit + Max. Equity Invested) / Max. Equity Invested
- Internal Rate Of Return (IRR)
- Present Value (PV) & Net Present Value (NPV)
- And hurdle rates used
Project Timeline/Gantt Chart
As a check and an assurance to investors and lenders, it should summarise the sources and uses of funds i.e. Debt + Equity must equal Project Costs.
It should clearly have a summary of:
- Net revenue
- Development costs
- Less and proceeds that we utilised to fund the project costs during the development phase.