Pro Forma Cap Rate: What It Means and How It Differs From In-Place
A pro forma cap rate uses projected NOI, not actual NOI. See how a listing's pro forma and in-place cap rates differ on the same $500k house, and what to check.
By the CapRateCalculator.co team
A pro forma cap rate is projected net operating income divided by the purchase price. It shows what a property would yield if the rent increases, occupancy and expenses in someone’s forecast all came true. The in-place cap rate uses the income the property produces today. Listings usually lead with the pro forma number because it is higher.
The pro forma cap rate formula
Pro forma cap rate = projected NOI / price.
The math is the same as any cap rate formula. The difference is where the NOI comes from. A pro forma usually assumes rents raised to market, vacancy at a target rate, and an expense list the seller or broker put together. Each of those is an assumption you can check.
Pro forma vs in-place on the same house
Take the standard $500,000 house on this site. Today it rents for $4,000 a month. With 5% vacancy, $6,000 of taxes, $2,500 of insurance and 18% of collected rent for maintenance, reserves and management, NOI is $28,892. The in-place cap rate is 5.78%.
Now the listing’s pro forma. It assumes rent goes to $4,300 and leaves out management “because a new owner can self-manage.” Collected rent becomes $49,020, expenses fall to $13,402, and NOI rises to $35,618. The pro forma cap rate is 7.12%.
| In-place | Pro forma | |
|---|---|---|
| Monthly rent | $4,000 | $4,300 |
| Collected rent | $45,600 | $49,020 |
| Operating expenses | $16,708 | $13,402 |
| NOI | $28,892 | $35,618 |
| Cap rate at $500,000 | 5.78% | 7.12% |
At a 5.78% market cap rate, the pro forma NOI implies a value of about $616,000. Same house, same day. The extra $116,000 comes from $300 of rent that does not exist yet and a management fee that every buyer will pay one way or another.
In-place and trailing cap rates
The in-place cap rate uses current income: the leases in force today, annualized, less realistic expenses. A trailing cap rate uses the last twelve months of actual results, often called the trailing twelve months or T12. Both describe what exists. Neither assumes a plan.
Lenders and appraisers start from in-place or trailing figures. A pro forma is something they may give partial credit to on a value-add deal, with the renovation budget counted against it.
What to check in a pro forma
Rent. Compare the projected rent with signed leases on similar units nearby, not asking rents.
Vacancy. A pro forma at 2% or 3% vacancy is optimistic for most rentals. Five to 8% is a more common allowance.
Management and reserves. These are the lines most often left out. Each is worth 5 to 10% of collected rent.
Property taxes. Many counties reassess on sale. A pro forma built on the seller’s tax bill understates the new owner’s.
Timing. Even if the rent is right, it may take a year or more of lease turnover to get there. The cap rate valuation guide shows how much a single point of cap rate moves value, which is what is at stake in every one of these lines.
When a pro forma is fair
A pro forma is a reasonable tool for a buyer with a plan: renovate, re-lease, cut a bloated expense. The question is who gets paid for carrying out that plan. If you pay a price based on the pro forma cap rate, the seller gets paid for work you still have to do. Price on in-place NOI and keep the upside for yourself. The cap rate calculator runs both versions side by side if you enter the two sets of numbers.
Frequently asked questions
What does pro forma cap rate mean?
It is projected net operating income divided by the price. Pro forma means 'as a matter of form', and in real estate it means a forecast: rents after planned increases, vacancy at a target, expenses as the seller or broker expects them. It tells you what the deal could yield, not what it yields today.
What is the difference between pro forma and in-place cap rate?
In-place cap rate uses the income the property actually produces now, usually the trailing twelve months or the current rent roll. Pro forma uses income someone expects it to produce later. On a stabilized property the two are close. On a listing with below-market rents or missing expenses they can be more than a point apart.
Should I pay for a pro forma cap rate?
Usually not. Price the property on in-place NOI, rebuilt with your own expense figures, and treat the pro forma upside as your return for doing the work. Paying the pro forma price hands the seller the profit from a plan you still have to carry out.