Here's a trick I've taught for years. When a seller hands you a pro forma, take a pen, cross out the words “Pro Forma,” and write in the word “Pretend.”
Because that's what it is.
A pro forma is a seller telling you what the property could make if it were run properly. Which raises an obvious question: if it could make those numbers, why didn't he?
What he's actually asking
Think about it. He couldn't hit those numbers — but he wants you to pay him today as if he did. He wants to be rewarded for the job he didn't do, and while you're at it, take on all the risk of hitting numbers he already proved he couldn't hit.
“Hey, I couldn't do it. But let's pretend I did, and pay me for it. Then once you get the numbers up there, you can go be creative and try to make some money for yourself.”
Thanks, pal.
I get why sellers play the game. It's the greater fool theory — they're hoping there's a bigger fool out there who'll pay for the pretend numbers. And sometimes there is. There are institutions and buyers who'll accept a lot less yield than you and I want. Let them.
The rule
That's fine, because there are still plenty of deals for conservative investors who buy on reality. Here's the rule that's protected me and my clients through every cycle since 1996: buy the property on the actual, historical, reported numbers it has produced. Not the dream. The trailing twelve.
Want proof it's the right way? Look at your lender.
The lender will not underwrite on pro forma. He underwrites on actuals. The most conservative money in the whole deal — the bank — already refuses to play pretend.
That tells you exactly where to stand.