Phase 2 - Real Estate 101 (How to or one big idea)

Podcast - Explaining The Pro Forma With Andrew Modrall

Tyler Stewert
September 13, 2021
Podcast - Explaining The Pro Forma With Andrew Modrall

Andrew Modrall, Chief Financial Officer at Select Strategies Realty, joined us on the podcast to discuss how to understand the different line items found in a Pro Forma. 

Andrew Modrall is Chief Financial Officer and a founding partner of Select Strategies Realty. Mr. Modrall directs the financial strategies of the organization and oversees the day to day asset management of client portfolios. In addition Mr. Modrall provides financial analysis with regard to the positioning and disposition of client assets.

Mr. Modrall is a retail real estate accounting and asset management executive with over 25 years of experience working with a wide range of retail assets. Prior to joining Select Strategies, Mr. Modrall held the position of CFO for North American Properties, a privately-held, multi-regional real estate operating company that has acquired, developed and managed more than $4 billion of retail, multifamily, mixed-use and office properties across the United States. During his 14 year tenure as CFO he oversaw all accounting functions, systems implementation and selection as well as tax and financing management. While Mr. Modrall has in-depth experience in accounting for a wide range of real estate assets, the majority of his experience encompasses his work with super regional centers, lifestyle centers and power centers.

Mr. Modrall began his career as a CPA with Deloitte. Mr. Modrall holds a Master of Business Administration in Accounting & Finance from Tulane University and a Bachelor in Economics from Earlham College. Mr. Modrall became a CPA in 1977.

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RealCrowd - All opinions expressed by Adam, Tyler and podcast guests are solely their own opinions and do not reflect the opinion of RealCrowd. This podcast is for informational purposes only and should not be relied upon as basis for investment decisions. To gain a better understanding of the risks associated with commercial real estate investing, please consult your advisors.

Tyler Stewart - Hey listeners, Tyler here. Before we start today's episode, I wanted to quickly remind you to head to to enroll into our free six week course on the fundamentals behind commercial real estate investing. That's Thanks.

Adam Hooper - Hey, Tyler.

Tyler Stewart - Hey, Adam. How are you today?

Adam Hooper - Tyler, I'm doing well. I'm excited.

Tyler Stewart - Why are you excited?

Adam Hooper - Well, we've got some snowflakes falling outside.

Tyler Stewart - It's kind of beautiful, isn't it?

Adam Hooper - Finally getting our winter here in Portland.

Tyler Stewart - Yeah, it just took March.

Adam Hooper - That's all it took. Well, why don't you tell us who we have on the show today.

Tyler Stewart - Well, today we have Andrew Modrall from Select Strategies Realty. He's the Chief Financial Officer over there.

Adam Hooper - He's been in the business for a long time. Started at Deloitte in Audit and Tax. Ended up getting into the real estate space, CFO for quite some time. We did a deep, deep dive on the construction of a proforma today.

Tyler Stewart - We went from top to bottom and asked every question in between.

Adam Hooper - We had the story of the proforma with Joe on a prior episode and this is really the nuts and bolts of how do you construct a proforma, what are the main components of it? Starting everywhere from, like you said, top to bottom. How do we generate the income? How do we pay for that income? How do we pay our mortgage and what's left over? Hopefully, hopefully what's left over.

Tyler Stewart - That's right. The goal here is for listeners to be able to then go out and read proformas and be able to look and see where the assumptions are being made, what's realistic, what questions should I ask the sponsor?

Adam Hooper - How do I identify those questions and then also again, you know feel empowered to ask those questions. I think that's a big part of it. Again, fairly nerdy on this one. We got into some pretty detailed topics, but pretty good base level information about how to look at proforma, where they're built. Talked about some of the expense ratios. Where some of those different expenses are paid. Some lease structure issues. But, overall, really good kind of foundational episode for listeners out there.

Tyler Stewart - It may be a good idea to open up a proforma if you can download one and just kind of follow along as we go through this episode.

Adam Hooper - Great idea.

Tyler Stewart - Thank you.

Adam Hooper - I think that's enough of us so... As always, though, if you have questions or comments, if you like this episode or more detailed dives like this, let us know. Send us a note to and with that, let's get to it.

RealCrowd - This podcast is brought to you by RealCrowd, the leader in online real estate investing. Visit to learn more about how we provide our members with direct access to commercial real estate investments. Don't forget to subscribe to the podcast on iTunes, Google Music, or SoundCloud. RealCrowd, invest smarter.

Adam Hooper - Well, Andrew, thanks for joining us on the show today. Why don't you give us a quick update on how things are going out in the Midwest.

Andrew Mondrall - Well, it's sunny and cold here at the moment. But the Midwest is a great area to invest in. It has fallen out of favor over, perhaps, the last eight to ten years because it's not as glamorous as some of the coastal areas of our country. There are a lot of people who live in the Midwest and they buy groceries and they buy clothes and they shop and they are just rank and file people. There's a lot of them and that's what makes the Midwest a great place.

Adam Hooper - Towards the end of the episode we'll definitely dig in on retail specifically. That's, obviously, a very hot topic of what's ecommerce going to do and is retail... I think it's very misunderstood right now for most of the folks we're talking with. Why don't you take us back to your entry into the real estate world. I know you've been in it for a long time as CFO. Why don't you tell us kind of how you got your start, what got you into the finance side of things and why real estate specifically?

Andrew Mondrall - Alright, my education is in both accounting and finance. I have an MBA. Coming out of school, I went to work for one of the big CPA firms. It was called Deloitte and did audit and tax work there for a variety of clients, but that included some real estate development companies. One of those companies made me an offer to come to work for them as their Controller and I did accept that offer. I worked there a total of fourteen years. First as Controller, later as VP of Finance. That was a company that was invested both in multifamily

Tyler Stewart - and also in retail. They are based in the Cincinnati area, but they are a multi-regional company throughout the eastern half of the United States. That's where I really learned a great deal about real estate and sort of cut my teeth as a CFO.

Adam Hooper - Okay, and then so the real estate industry that was the area you were doing in Deloitte. Anything specific about that was interesting to you or that's always been near your...

Andrew Mondrall - I could see that some people had developed and built quite a bit of wealth through their investments in real estate and I found that attractive. I said "Hey" and I figured I'm smarter than the average bear if these people can do it, I ought to be able to learn how to do it.

Adam Hooper - Right, right.

Andrew Mondrall - Going to work for that multi-regional company was good for them and very good for me as well. We both learned a lot and as a result I was able to leave there and do some real estate investing on my own and then help to form the company that we're a part of right now.

Tyler Stewart - What were some of those early lessons you learned?

Andrew Mondrall - I learned about how much money is worthwhile to spend, that is how much cost can you afford to incur based on your expected return. I also learned a great deal about debt. That is, how to find it, how to structure it, what to look for, what to look out for in terms of debt. Those are some of the things.

Adam Hooper - A lot of our listeners are professionals, entrepreneurs, successful in their own right. Some maybe have a finance background, some maybe not. Why don't you tell us a little bit about what the role of a CFO is in a real estate management company today.

Andrew Mondrall - The CFO is in charge of all things financial related to that company. That is overseeing the accounting, overseeing collections of money from tenants and others who might owe the company some money. Making sure all the bills get paid. Making sure that monthly financial reporting takes place and it's appropriate. Tax returns get prepared and sent where they need to get to. That debt gets attended to, it gets initiated, it gets serviced appropriately, it gets extinguished when the time is right. It's just pretty much all things financial, which is why they call a CFO the Chief Financial Officer .

Adam Hooper - Makes sense. From the overall management role down to the actual hands on asset level finances, which we're going to dig into today on the nuts and bolts of a proforma. How much has that role changed? Are you very involved in the proformas? In the financial forecasting and projecting in actual asset level finances or is that more operating company level that you're involved with now?

Andrew Mondrall - The answer to your question there depends on how big of an organization you're dealing with. Our group is relatively small in size and so as the Chief Financial Officer here, I do actively get involved in proformas and that sort of thing. If this was a company that was ten times larger than this one is then I might simply oversee that and direct other people to do that kind of work. But as it is, it's pretty hands on here.

Adam Hooper - Perfect. Well then let's dive right in. Why don't you tell us a little bit about what is a proforma? What purpose does it serve? As a listener to this show and as a potential investor in these, we peel back and see what we can learn from reviewing a proforma, but maybe lets start super high level for people who have never heard that term before, what is a proforma?

Andrew Mondrall - A proforma is a forward look at what will be the income statement, or sometimes called the profit and loss statement, of an investment property. You are projecting usually one year at a time, but it could be quarterly or some other period, but you're projecting into the future what you think revenues and expenses of that property are going to be.

Adam Hooper - As an investor looking at a deal, this is kind of their road map to their financial projections. This is how they can see as the real estate manager how you guys are thinking about the cash flows, what's coming in and what's going out and ultimately, hopefully, get a feel for how profitable or the actual financial aspects of the deal are going to be.

Andrew Mondrall - Exactly. If someone were considering making an investment in a particular property, they would want to examine that proforma pretty closely to get to the ultimate cash flows that are expected to come from this property because an investor's putting some money in and the natural thing that he or she wants to know is what am I going to get back out?

Adam Hooper - Got to get some money back out. Exactly.

Andrew Mondrall - And when?

Adam Hooper - How are they typically structured? Is there a standard format for proformas across the industry, everyone's going to be a little bit different? How do they usually look?

Andrew Mondrall - Well, no doubt they will look different just because different people put them together, but as I said a minute ago, they tend to mimic profit and loss statement. So they will start at revenues at the top, operating expenses in the middle, coming to a subtotal, which would be net operating income and then below that talking about any kind of debt service that's appropriate. That's the general look that any proforma's going to have.

Adam Hooper - Perfect. Then again you mentioned depending on size of the operations, maybe it's the CFO, maybe it's the analyst that will be putting these together, where does the information that goes into this proforma usually come from? Is it internal models? Is it internal marketing information? Reliance on external sources? How does all this information come together to get into this proforma?

Andrew Mondrall - It will be a combination of sources. First of all, you've got to think about are you putting together a proforma for an existing property that is going to be acquired? And if so, there has got to be some historical track record from that property that shows what it's revenues and expenses have been. Now, you may intend to change those, but at least you've got a starting point. Or on the other hand, perhaps you're talking about creating an investment property such as building an apartment complex or building a retail center from scratch, there it becomes a lot more theoretical and you're dealing with what you think you can accomplish.

Adam Hooper - And that's where, again, whether it's reliance on past numbers you have internally or looking to external data sources to support some of the aspects we'll talk about, market rents, vacancies and all that.

Andrew Mondrall - It's going to be a combination of internal and external. If there are existing leases, for example, whether it be retail, office or apartment complex, you can look at those leases and you can understand what are the rents that are going to be paid by the tenants behind those leases. That's internal. External is, I'm looking at real estate taxes, a pretty significant expenditure for any investment property. Well, what's the tax rate in that particular locality? What's the approximate fair market value of this property based on my acquisition of it? You can, therefore, develop an expectation of what the real estate tax expense will be. If you're not sure about what insurance is going to cost, well, call up your insurance agent. Tell him or her what your investment is going to consist of and get a quote. It's a combination of internal and external sources.

Adam Hooper - Perfect. The general setup is income, expenses that gets you to net operating income and then there's debt service and capital expenditures we'll get through. So let's start with the rental income. That's coming from tenants, whether again multifamily, office, retail, industrial, the whole point of owning an asset is so that you can lease it to someone who's going to pay you for that. Right?

Andrew Mondrall - Yes.

Adam Hooper - Those numbers you can either get from, like you said, leases in place or if it's a development, you're going to have maybe some projections as to what you might be able to rent it for. Let's dive a little bit into where that information is coming from, how an investor might be able to look at is that a reasonable assumption or are these reasonable rents and maybe some resources that investors can look to when they're trying to figure out how is this rental income is derived?

Andrew Mondrall - Well, the sponsor of an investment is going to be reading the actual leases that already exist and making sure that he or she understands what rent income can be expected from these existing leases. But if it is a to-be-built property or if there is some vacancy in the existing property that needs to be filled up then you've got to be doing some market research or talking to brokers in the area to understand what are some reasonable rents that you might be able to overlay on top of that vacancy or on top of this to-be-built property. So that's where you've got to come up with the rent income side of this.

Adam Hooper - Is that something that a manager would usually provide to a prospective investor or how much fidelity does a prospective investor usually have into some of these assumptions or sources of information?

Andrew Mondrall - A prospective investor probably would not be able to actually get a hold of the leases and read them themselves, nor would they probably want to...

Adam Hooper - Right.

Andrew Mondrall - Because leases can be pretty voluminous and pretty legalistic, but a summary of those leases, is what's called a rent roll, and most offering memorandums would include a rent roll showing either the existing tenants or tenant spaces expected to be filled by future leases and there, which is sort of summarized, you can see how many square feet is this space, who is the tenant, what is the rent that they're scheduled to pay? You can look at that and begin to get a sense of does this make sense to me? Is it reasonable in the market place that this property is located within?

Adam Hooper - Then for an investor, again to help to determine the reasonableness of some of these projections or rental rates, are there resources that they might be able to look to, either within a typical offering package or maybe some external resources where they can sniff test whether or not some of these assumptions are accurate?

Andrew Mondrall - Well, it depends on how much time and effort that prospective investor wants to put into this. At first glance, I would just say look at the rent roll that's in the offering memorandum and see how consistent are these rents per square foot. See if that makes sense to you. You could also talk to brokers in that community. Or you might possibly be able to look at offering memorandums of other properties in the same general area to see if the rent per square foot seem comparable.

Adam Hooper - I think what you mentioned there too would be interesting. If you've got a rent roll that paints one picture for what the current rents are and if the proforma is showing rents that are wildly different one way or the other, maybe that's a point where an investor could have that question of what is the strategy that's going to make that swing one way or the other?

Andrew Mondrall - I agree. I think if anytime you see just differences or discrepancies there it's worth asking a question.

Adam Hooper - When you're forecasting these rental rates, what kind of information goes into that? We've talked a lot on the show with economists and some other kind of market cycle folks, but what are some of those nuts and bolts things, when you're looking at forecasting and projecting a proforma that's, maybe, five or seven years long, what's the source of that information and how do you look at forecasting where those rental rates are going to go?

Andrew Mondrall - Well, our particular company is very retail focused and if we're looking at filling up space or we see that a property we're going to acquire has some space that is going to expire, the lease is going to expire, say two, three, four years from now and our whole time our horizon is longer than that, we'll talk with our own leasing specialist, who are on our own staff, about that space and about that particular tenant. How likely is that tenant to renew? And if it happens to be a national or regional tenant, what rents have we seen them pay in other instances? We get a feel for what's realistic in terms of what we can expect to have happen at the time that that lease matures or that we try to fill an existing vacant space.

Adam Hooper - Then are there any other major macroeconomic trends that investors would have access to that might indicate the general trend of where rental markets are going? Or is that more of a market by market specific property?

Andrew Mondrall - It's so specific from market to market. Yes, you can say the Trump tax cuts, perhaps, have boosted the entire economy. That may be a true statement, but that doesn't tell me whether I want to make an investment in this particular property, in this particular city, in this particular market. I think it's too broad for that.

Adam Hooper - That's where the investor's going to be relying on the manager to have done that work and to have been making those decisions?

Andrew Mondrall - Yes.

Adam Hooper - What are some of the red flags or warning signs when an investor's looking at the rental income side of a proforma right now that would cause him to pause and ask some of those questions?

Andrew Mondrall - I keep coming back to rent per square foot because that is a way you can compare rents between different spaces. A given space might be a thousand square feet within a shopping center, might be five thousand, ten thousand square feet, so the absolute dollar amount of rent is not comparable, but the rent per square foot becomes comparable. I would look at what is the average that's in place right now in a given shopping center per its rent roll. Then what is the sponsor of this investment saying that he or she can produce either to fill a vacancy or when a lease expires in a few years and just say does that make sense to me? If a whole shopping center is running for an average of twelve dollars per square foot and this person says I can rent this space for eighteen, you might say "Hmm I wonder why?".

Adam Hooper - That's pretty big delta there. Is there a variance that sets off those alarms if its within a reasonable band or is basically a kind of a gut check? Like, "Yeah it doesn't really look too reasonable?"

Andrew Mondrall - For the most part I'd say it's a gut check, but what we're doing at our level, and I would consider us a sponsor of an investment, is we're talking to our own leasing staff and saying "Hey, look. What can you lease this space for?" Knowing that our objective is to lease it for the highest rent we can get, but we do want to fill the space. I don't want to sit around saying I can rent space at eighteen dollars a square foot and it sits there vacant for five years because I can't. I'd rather put somebody in there at twelve or fourteen dollars a square foot and actually collect some cash.

Adam Hooper - And that's, I guess, the story, right? If you see those discrepancies or if there is a jump like that in some of those different rates, maybe there is a story there, right? Maybe there's relationship that a sponsor has with a tenant and they know what that tenant can pay or maybe there's some other mitigant to that change, but that would hopefully trigger the question, right?

Andrew Mondrall - It could be. And yes, but the question is a very valid one to ask. If that sponsor has the particular tenant in another shopping center that he or she owns and says yes, but over here in this other shopping center they're paying sixteen dollars a square foot. I think I can get them to sixteen dollars a square foot in the one under question right now. That may be very plausible.

Adam Hooper - What are some things as a sponsor when you're looking at rent forecasts, what are the green lights? What gets you excited when you're digging into the financials of a deal? What are some of that value that you see so that investors can identify some of those attributes?

Andrew Mondrall - Well, it's interesting because it's almost counterintuitive. On the one hand, if I'm looking at buying an existing property, I love to see distant maturity dates. That is nice long leases that are in place. That just makes me feel warm and fuzzy. I know I'm going to have these tenants paying me rent for long periods of time. What's interesting is if there is some vacancy or if there are some tenants that are going to expire in a fairly short term and they don't have any renewal options beyond that, I guess it gets down to are you an optimist or a pessimist? Is the glass half full or half empty? I would see that as opportunity. Here's some space that's either producing no income at all if it's currently vacant or won't be producing an income at all come two or three years form now lease expiration. What can I do with that? How can I better it? Maybe I've got a tenant that's been there a long time and they're likely to go out, but they've only been paying seven dollars a square foot when I think market is twelve. There's an opportunity. So there's some of the things that get me excited. The counterintuitive part is, on the one hand, I like nice, long leases, but short term leases or vacancies means opportunity.

Adam Hooper - That's one of the themes, at least, in some of these bigger retailers that are going either out of business or decreasing their footprint. Some of these legacy leases have been in place with rent that was set, you know, fifteen, twenty years ago and have very little, if any, escalations, right? The ability to get back into that space and get that to market, well, yes, does increase the risk potentially, but that also provides that value and provides that upside. That's a good picture of the income. Let's start getting into some adjustments to that income. Obviously, the biggest being expenses. One of the things that is in a proforma that not a lot of people maybe understand completely is a line called Vacancy Allowance. Why don't you take us through what vacancy allowance is and how that's determined and how that impacts the financials.

Tyler Stewart - Okay. Most of the time when you are investing in real estate there is going to be some debt involved. Either from a bank, a life insurance company or some debt source. And as a part their underwriting, they will automatically assume that a certain percentage of the square footage of the entire property is going to be vacant. It's sort of a conservative look at it. It's a cushion that they build in and typically anywhere from five to seven percent of the square footage they will assume is vacant. Not producing any income at all.

Andrew Mondrall - That's what a vacancy allowance is.

Adam Hooper - And how is that number determined? Is that something that as a sponsor they determine? That sounds like that might be determined by the lender? Are there different...

Andrew Mondrall - Its really driven by lenders, but I pretty commonly see five percent.

Adam Hooper - Okay.

Andrew Mondrall - Now it can be a little more or a little less depending on the circumstances. If you're in a really hot sub-market you might be able to go with a smaller, say, only three percent. And I've seen some more conservative lenders use seven, but five's pretty broadly used average.

Adam Hooper - And then just to clarify, this isn't necessarily directly related to current market occupancy or vacancy rates? This is just a financial buffer, essentially, to allow for downtime, to allow for re-tenanting and some of these other vacancy issues throughout the normal course of operations.

Andrew Mondrall - Yes, that's correct. And especially important because this whole conversation we're having is about putting together a proforma. In that proforma, it's unrealistic to expect that you're going to be at 100% occupancy through every year of the hold and so a vacancy factor is built in.

Adam Hooper - And is there anything that an investor would need to explore with that? I mean as long as it sounds like it's within a reasonable band. That's a fairly standard line item.

Andrew Mondrall - If it's sort of in the vicinity of five percent I'd say that's standard. If it's significantly different than five percent I'd think the investor would just want to ask why?

Adam Hooper - Yeah. And then again maybe it's a lender required issue at that point, yeah?

Andrew Mondrall - It could be.

Adam Hooper - We've got our income, we know where it's coming from. We've got this vacancy allowance and now we have to count for expenses. Operating expenses. What do those include? How do we find out what those include? You said maybe you have some historical financials, but let's talk a little bit about just operating expenses and then we can get into some specifics there, as well.

Andrew Mondrall - Well, pretty much any property, whether you're talking multifamily, industrial, retail, office, are going to have real estate taxes that have to be paid. There's insurance you've got to buy to protect the property. There may be utility payments depending on whether the landlord is making those payments or whether the tenants have to bear those. Then there will be some common area costs, such as lighting a parking lot or cutting the grass or removing snow. Things that just benefit the entire property. These are typical operating expenses of an investment property.

Adam Hooper - And now this also gets into lease structure, right? Whether it's in... Listeners might have heard of a triple net lease or a full service gross lease, maybe you can kind of talk through some of the different lease structures that we'll see out there. And how these operating expenses are reflected. Who's responsibility to pay those operating expenses based off of lease structure.

Andrew Mondrall - Well, the two book ends of that are an entirely gross lease or a triple net lease. A good example of an entirely gross lease would be an apartment lease. If you or I or just a resident at an apartment complex we know we are going to pay x dollars a month of rent and that's it. Now, we might have our own electric bill we have to pay, but we don't have to true up any other kinds of expenses that belong to the landlord. We're just paying our agreed upon gross rent and that's it. At the opposite extreme and, very typical in retail, is a triple net lease which means, the three things that make a triple net are cognary maintenance, real estate taxes, insurance. Those are the three things. And so those three things typically benefit the entire property. Typically, the landlord will pay them, but will turn around and charge them back to the tenants on a per square foot, pro rata basis. The cost is ultimately born by the individual tenants.

Adam Hooper - Right. And is there a... Again this is probably varies by asset class, right? But typical expenses ratios or if an investor is looking at this proforma, how do they get a feel for what's a reasonable expense ratio for these different operating expenses?

Andrew Mondrall - It's hard to pick one number because expense rates vary considerably around the country. They also vary by type of investment, but operating expense could be 30 or 40% of revenue. If they're getting up towards 50 that kind of seems high, but it's hard to just pick one number and make a blanket statement.

Adam Hooper - Well then what are some of the things that investor could look for in that operating expense portion of a proforma that might be concerning or would lead them to ask some of those questions?

Andrew Mondrall - Well, I think what an investor is ultimately concerned with, because at the end of the day they want to know how much cash are they going to get back, is no matter what the operating expenses are, for a given property, how much of that is recaptured by the landlord from the tenants? If I've got, let's just take real estate taxes for a moment because its pretty easy to understand, if I've got a certain dollar amount of real estate taxes the landlord is literally going to write the check to pay that, but how much of that can he recoup by passing it through to the tenants, per the terms of their triple net lease? Now, if you're 100% occupied with leases that permit full pass through then you're going to get 100 cents on the dollar back on that real estate tax and the landlord incurs no net cost. But if you had a vacancy or if you have leases whose terms do not allow for complete pass through of that, perhaps because its capped or some other reason, then the landlord will incur some net real estate tax cost. What the investor really wants to be concerned with is how much of the total operating expense is being recouped or recaptured from the tenants?

Adam Hooper - And again to get back to those book ends, you've got an apartment complex, multifamily, where almost the full burden of those expenses are going to be reflected in this proforma, right? There's very little, if any, collection of those expenses down to the tenants.

Andrew Mondrall - Exactly.

Adam Hooper - And then you contrast that with these triple net leases or an absolute net lease where as much of, potentially 100% of those costs or in some cases, even again absolute net, the tenant themselves is paying these costs. And then there's all different flavors of lease structures between that, right? So like you said that how much of those operating expenses are being recouped, recovered through these lease structures? That's the biggest thing to look for.

Andrew Mondrall - Yes.

Adam Hooper - Okay. Is there opportunity in the expense side of this proforma as a manager?

Andrew Mondrall - Well, you're question really kind of gets at underlying philosophy. I will just share with you ours. We want to operate our properties as efficiently as we can. Some landlords might say, "I don't care what it costs because I'm going to pass it all through my tenants so I don't care what it costs" but the reason why we don't look at it that way is that if you take a given tenant, just say a shoe store, there is only so much that a shoe store can afford to pay to be in your shopping center. Now you can call it rent or you can call it triple net charges that pass through. You can call it whatever you want to, but there's only so much they can afford to pay. If I can operate the common areas of the shopping center very efficiently and keep that cost to a very modest and reasonable number, then I can afford to charge them and they can afford to pay a higher rent. So to me it makes sense to try and control those costs and operate this as if it were coming out of your own pocket, instead of just saying, "Oh, heck somebody els is going to pay it so I don't care"

Adam Hooper - Yeah, definitely. That makes sense the efficiency of operations. And I guess maybe this is a... would be covered more under the rental income side, but one thing we didn't touch on, since we are talking about lease structures here potentially is percentage rents. Especially in the retail side of the world. I know we see those quite a bit. Maybe just a quick 30 seconds on what is a percentage rent and how would that effect more of the rental side than the operating expense side?

Andrew Mondrall - Well most leases are written in a way that has a fixed and determinable base rent. The tenant is paying the same amount of rent every single month during a given period of time. But there may also be in that lease a percentage clause and what that's trying to do is trying to let the landlord benefit from the tenants business if the tenant is doing great. If they're just having a super year or they're exceeding expectations. And so the way the lease might be written is to say that rent will be a percentage of what their gross sales are.

Adam Hooper - And is that fairly common these days?

Andrew Mondrall - It's less common now, I think, than it was 15 or 20 years ago, but you do still see those clauses.

Adam Hooper - K. And anything as an investor, again, if you're looking at these lease structures again will likely be summarized in the rent roll, correct?

Andrew Mondrall - They will.

Adam Hooper - And then that's where they can ask questions if they have more concerns or any clarifications that need to be made on how these leases are being structured and what that means ultimately for, like what we're trying to get to here, which is net operating income.

Andrew Mondrall - Yes.

Adam Hooper - And that is?

Andrew Mondrall - Net operating income. That's the subtotal on your profit and loss statement or your proforma. When you started with revenues and you've deducted operating expenses, you come to a subtotal cost called net operating income. It is the net cash that the property itself has produced in a given period of time. Now, completely absent from that is debt service. We're not to that point yet. We're just talking about the property. What does is generate in way of revenue? And what does it cost to run the shopping center itself? That's net operating income.

Adam Hooper - And then sometimes we'll hear, when you're looking at financials we'll hear, above the line, below the line, right? And this is the line of demarcation, right?

Andrew Mondrall - That is the line right there. And why it is important is that across different properties it is a tool or benchmark you can use to compare and come up with, at least, rough ideas of value because that's the amount of cash that the property itself is producing or is expected to produce. So you can then capitalize that to say that therefore I think that this property has a value of x.

Adam Hooper - Right. You said that's kind of that apples to apples, right? Some of the things we'll talk about here, which are going to be debt service, capital expenditures and more kind of strategy related expenses. Those are not a part of this net operating income, right? This is just purely how much money am I getting in from tenants and how much money do I need to pay to generate that revenue essentially?

Andrew Mondrall - Exactly. Let me just mention for a minute why debt service is not a part of that. Because some people might think to themselves, well you said a minute ago that I'm going to have to borrow money as part of this acquisition so why isn't it in there? It's just that two or three or four different prospective buyers of the same property might have different approaches to debt. Somebody at one extreme might pay all cash for a given property. They have no debt service whatsoever. Another person might load it up to the max that any lender will let them go to so its to minimize the amount of equity they've got to put into a deal. But the property itself is producing a certain amount of net operating income, regardless of how you decided to finance your purchase.

Adam Hooper - Right.

Andrew Mondrall - That's why debt service comes farther down the picture in this proforma and is not a part of net operating income.

Adam Hooper - Perfect. Then so as an investor you have looked at the rent that is coming in. Seems reasonable. I've looked at the expenses that are going out. Seems reasonable. The biggest difference between total potential rental income and net operating income, again, is going to be as you've said that amount of expenses that they are able to recapture from those tenants. In some cases, on the triple net, absolute net side of the world, that's going to be pretty close, right? Rental income and net operating income are going to be closer than they would be if you're looking at a full service gross or multifamily type property. Is that accurate?

Andrew Mondrall - Yes it is.

Adam Hooper - Is there anything when you're looking at NOI relative to, either, rental income or operating expenses that would be a yellow flag, red flag or anything that cause concern or questions? Or is all net operating income the same?

Andrew Mondrall - Well, I don't know you can say its all the same, but the way you have arrived at net operating income should be consistent and so it should be a reliable benchmark or indicator that you can use in making your investment decision.

Tyler Stewart - I got a question... With the net operating income, does that dictate the strategy you're going to utilize as we start talking about capital expenditures and debt or does your strategy as a sponsor already include what your strategy will be regardless of what you see in net operating income?

Andrew Mondrall - The strategy really comes from the sponsor. Now, it may be tweaked or tailored for a given property, but key to any investment decision is how much equity do you have available? And how much debt do you have available? And is there mix in combination of those two that will work to accomplish the acquisition? Most sponsors have a philosophy about debt. They either like a lot of debt or they don't like a lot of debt. I think that's more the driver than is the net operating income.

Adam Hooper - And now if we're looking at a property that's got a five or seven year hold, how consistent is net operating income? Can it be fairly lumpy? Can it be fairly consistent depending on the different strategies?

Andrew Mondrall - Well, I would expect it to be fairly consistent unless you are making this acquisition with the intent of implementing significant changes. That might be a redevelopment of the property or filling significant vacant space that already exists at the date of acquisition. But if you're buying either an apartment complex, office building or retail center that's steady state during a five or seven year period I would not expect big rollercoaster changes in net operating income.

Adam Hooper - That's maybe one of those things to look out for is does the strategy of this asset match with the smoothness or lack thereof in the net operating income line.

Andrew Mondrall - I would agree.

Adam Hooper - nything else we can infer from NOI or is it pretty much is what it is, yeah?

Andrew Mondrall - I think we're good to keep going.

Adam Hooper - So lets then... Do you want to talk about debt service or CapEx first?

Andrew Mondrall - I think CapEx. Any property is going to need capital expenditures. These are more just repairs and maintenance. Repairs and maintenance is just ongoing, short-lived problems. You know you're unclogging a drain that got clogged up or something of that nature. Those are repairs. Capital expenditures is you're either adding on to the property or you are replacing and entire roof. Or your replacing an entire parking lot. Or, here's a good one, you have a vacant space, you have attracted a new tenant to come to this space, but the landlord has to do some work to refit the space and make it suitable for this new tenant. Those are all examples of capital expenditures. They are typically dollars spent that have a useful life longer than one year and they are just a necessary part of any investment that's going to last five, seven years or longer.

Adam Hooper - Again that's largely a reflection of the strategy if it's a single tenant net lease property that's got a 20 year lease to a Walgreens or something, very little, if any, CapEx is going to be required there. But if you said if you're buying a partially vacant shopping center, you're going to need to re-tenant, there's going to be tenant improvement leasing commissions, is one that's going to be, all TILC's, that's kind of a term that's thrown around. Tenant improvements leasing commissions. These are all non-operational expenses that a sponsor would put into a project to improve it. I think as you mentioned before... One of the things that you kind of that you learn... Those are early learnings is that how much can you afford to spend on based off of what your expected return of that is, right? I assume a lot of that comes into this capital expenditure area?

Andrew Mondrall - It certainly does. Especially with regard to re-tenanting an existing space because you're planning to bring tenant ABC in and you've discussed with them what kind of rent they're going to pay and then they've told you what kind of improvements they want to see and you've got to balance can I afford to spend this kind of money Knowing I'm going to get that amount of rent.

Adam Hooper - And is there a way to ballpark that based off of strategy in terms of how much, you know maybe as a percentage of purchase price or as a percentage net operating income that's a reasonable band based off of strategies? Or all over the board?

Andrew Mondrall - No, it's all over the map. You really have to look at each one on a case by case basis. But what you ought to be able to see is that if I have to put out, I'm just making up some numbers here, $100,000 in order to get a particular space completely ready for a tenant, is the rent that I expect to receive in the next three, five or seven years worth that? Is it worth spending $100,000 to generate this new additional amount of rental income? It's just really case by case. There's no benchmark or average you can use.

Adam Hooper - Do you have a different return expectation for CapEx dollars versus original investment dollars or is it all kind of blended in the same return profile?

Andrew Mondrall - Well, I think that they would be in the same ballpark with one another, but I would hope that the opportunity to spend some capital dollars, to attract a new tenant, would have an incrementally higher rate of return on just that particular expenditure than I would for the entire property. Because if the entire property is sort of a blended rate based on money leases that are already in place, and here you've got a particular rifle opportunity to bring a tenant into this one space and you hope to capitalize on that and make a lot of money.

Adam Hooper - Anything when looking at CapEx as a line item, or I guess maybe before that question, how detailed of information can an investor usually get when it comes to potential capital expenditures?

Andrew Mondrall - Well, if it is something that is part of the strategy to acquire a property and make capital expenditures, to re-have the property or attract certain new tenants, that can all be built right into the proforma. But it can also happen that you've already bought a property and you're three years into it and then, I don't know, a tenant goes bankrupt, or there's some change that you didn't anticipate at the front end, that represents a new opportunity and challenge to face so you couldn't forecast that. For the individual investor, its difficult. I mean you're really largely having to just go along with the sponsor and know that you're in the same boat with the sponsor. And know what's good for one should be good for the other.

Adam Hooper - Before we get into the debt service component, mortgage component of it, lets talk about sources of capital for these expenditures. Typically we would see either an equity, a cash reserve, you know, at funding. Maybe there's debt financing. Maybe there's some other credits or extra hold backs. Can you talk a little bit about the different source of capital for these expenses and, maybe, rating those in order of preference from the managers, investors standpoint?

Andrew Mondrall - And we're still talking about capital expenditures, correct?

Adam Hooper - Capital expenditures.

Andrew Mondrall - Okay. Well, if you know in advance that you're purchasing a property and it needs certain capital, you could make that a part of your acquisition financing. You go to your lender and say, "Look, I'm buying the property for one number, but I know I'm going to have to spend these additional dollars within the first 12 to 18 months" so you just build all that in. On the other hand, because I mentioned a minute ago, if you're three years into a hold on a particular property and something unexpected happens and now you're all of a sudden faced with a capital expenditure that you didn't originally budget, that's either got to be funded out of current operating cash flow or you've got to go get some bank financing to accomplish it. You may be able to go back to your original lender, but many times those mortgages, if they happen to be with a life company or pension fund or something, they're fairly rigid. They're not really built to expand at a later date. You might be looking at some kind of secondary financing to accomplish capital expenditures midstream.

Adam Hooper - Mhm. And then the... I guess could you rank those in order of preference from an investor or managers perspective?

Andrew Mondrall - Well, I think you talked to you about them actually in that order. I'm not really intentionally... I mean if you know on the front end that you need some CapEx dollars, the best way to do it is just build it into your original proforma and get the financing through your original stack of debt and equity. Its then midstream when something comes along that's a change that there you've got to make a decision. Am I going to retain operating cash flow to fund to this capital expenditure or am I going to seek some form of secondary financing? There the sponsors got to make a decision and if it does mean holding operating cash flow, communicate that with all the people who are affected by it.

Adam Hooper - And that's, again, the key there being transparency and communicating the current status of the operations and maybe being able to forecast ahead of time that you're going to be having some of these issues coming up if you get a quarters heads up as investors out there, you know, communication like that and being upfront about everything is better than the out of the blue capital call, yeah? Alright so that's our capital expenditures. Now we get to debt service.

Andrew Mondrall - Your acquisition indebtedness may have an interest only period or it may be fully amortizing from day one. Typical rates of amortization are anywhere from 15 to 20 or even 25 years. That doesn't necessarily mean that you're going to hold the property for 20 or 25 years, but you are repaying the principle of a debt on a schedule that equates to that number of years. Then at some predetermined time in the debt contract, there'll be what's called a balloon payment or an actually maturity of a debt where you've got to payoff whatever the remaining balance is at that time. Banks are a source of this type of capital. Life insurance companies, pension funds. There's in-debt funds, there's a variety of sources for debt.

Adam Hooper - Debt usually comes in one of two flavors, right? You've got fixed rate and floating rate. Maybe you can talk a little bit about each of those real quick.

Andrew Mondrall - Well, fixed rate's pretty clear. You agree on the front end what the interest rate's going to be and it doesn't change for the life of the debt contract. Floating rate will be pegged to some index. It might be prime rate, it might be life or may be treasuries. It's just some published market index that's the underlying rate. Then there's a margin on top of that that the lender's collecting as sort of their profit and it might vary as often as daily. More often I see it vary monthly or quarterly. There is some interest rate risk to the borrower. Now the borrower can mitigate that risk if he wants to buy an interest rate cap or some type of financial contract that would limit his exposure there.

Adam Hooper - Then you mentioned, also, potentially a period of interest only term. That would be where the loan isn't amortizing, you're just paying the required interest. That usually would be on more of a value of add or repositioning strategy or are you seeing interest only periods on longer term fixed rate financing now, as well?

Andrew Mondrall - Well, it is available on both, but I agree that the more typical use of interest only is from the point of time of acquisition until something has been accomplished. It's usually one, two or three years long. It's perhaps because you are renovating the property or adding onto the property or doing something prior to being in a stabilized position. You make the smallest monthly service payment that you can which is interest only. You're not allowing the debt to change any. It's not getting larger or smaller in terms of its outstanding principle. You're paying the interest only. I have seen some contracts, to my surprise, that are seven or ten years long interest only.

Adam Hooper - Wow. That's pretty aggressive.

Andrew Mondrall - Well, I'm uncomfortable with that as a borrower because it just seems to me to be prudent to begin whittling down the amount of outstanding debt.

Adam Hooper - And some of the metrics that we see, as it relates to the mortgage side of the equation, obviously loan to value, which we've talked about how much of the initial acquisition is financed by debt. Debt service coverage ratio. You want to tell us a little bit about debt service coverage ratio? That's a big one that's out there.

Andrew Mondrall - A lender, as one of their underwriting metrics, is going to want to see how capable are you of making your required debt service payments. You can forecast for a quarter or for a twelve month period what is the debt service going to be, that is interest and principle payments combined. What's that going to be? And that they want to know that your net operating income is higher than that by some amount. A typical amount might be 1.25. And what that .25 means is that there's some cushion there, even if something goes wrong at the property, there's still some cushion there, that there's enough cash left to make the debt service payments.

Adam Hooper - Yeah. We talked about this on a recent episode, too, with Jamie at MBA, of the net income of a million and a debt service of a million is basically a 1.0 debt service coverage ratio. Probably not that great.

Andrew Mondrall - Yes. And that would be a scary place to be.

Adam Hooper - A scary place to be.

Andrew Mondrall - But yes, you've calculated it correctly.

Adam Hooper - Good. I can do that math. Alright so we know how much we're getting paid. We've paid the expenses to operate this thing. We've paid our mortgage and we've paid whatever capital expenditures might be in that year. What do we have left?

Andrew Mondrall - Assuming you've got something left. That would be your distributable cash flow from operations.

Adam Hooper - Perfect. That's a number...

Andrew Mondrall - It could be distributed to the owners in a pro rata fashion. It's not a return of your investment. It's a return on your investment.

Adam Hooper - Right. And now, again, depending on strategy, that cash flow available for distributions could potentially go back into the property, right? That doesn't necessarily guarantee that that cash flow is going to be distributed out to the investors 100%, right? Depending on the strategy, there might be different uses for that available cash flow.

Andrew Mondrall - I agree. And we talked about one of them a few minutes ago. If there was a need to re-tenant a particular space that was available and you've got to spend some significant capital expenditure dollars to do that, one way to fund that would be by retaining the positive cash flow of the property to pay that capital expenditure.

Adam Hooper - And whose determination is it to how much of that cash flow they distribute?

Andrew Mondrall - Well it certainly is the sponsor. Now the operating agreement of the entire entity may discuss cash flows from operations and it may require that there be some distributions, but I think ultimately it's the sponsor making those kinds of decisions.

Adam Hooper - And that's a not completely on the fly thing, but that's a situational case by case basis as to what the strategy is. What the best, in the sponsors mind, what the best use of that capital is, right? If there's maybe something that's coming up the next year. Maybe some that will be retained. I guess what I'm getting to is, that's come up from time to time, is where investors will look at a proforma, they'll look at projections and they'll see a number, a targeted cash on cash return or a targeted distribution some years in the future. I think the perception is that's a certainty, right? That's a guaranteed thing. And I think its not, right?

Andrew Mondrall - I would not say that that is a certainty nor a guaranteed thing. Its just a hope and expectation. Its a plan.

Adam Hooper - Yeah.

Andrew Mondrall - And plans change.

Adam Hooper - And so how do you reconcile that as an investor? I mean you're making an investment, as you said, for the potential to earn a return on that. You're given the information to the best of the managers ability that this is the target, sees their projections. This is what they assume given all their knowledge and insights that they can achieve. If those numbers don't get hit or if there's something that happens in the market or you get an unforeseen tenanting issue, how do you plan for that as an investor? Do you look at the projections and targets as, you know, just the best case? Are these a base case? What should the mindset be towards some of these projections?

Andrew Mondrall - Well, I tend to take a pretty conservative approach. I would look at a proforma as best case. And it wouldn't surprise me if reality is something less than that. I would also like to know that the sponsors interests and my interests are aligned. So that if I'm an investor and I'm feeling some pain because I was expecting one kind of cash distribution and I got something less than that, I would want to know that the sponsor's feeling some pain too.

Adam Hooper - How do you determine that as an investor?

Andrew Mondrall - That goes back to the operating agreement that is the underlying contract of the entire entity that discusses cash flows and cash distributions and who gets them and when.

Adam Hooper - Okay. So cash flow from operations, that's kind of your annual... You know, how much cash flows available after debt service expenditures that is available for distribution. And then we project four or five, six, seven, ten years out in the future and you've got the eventual sale of this asset. How do you look at the cash flows from distribution, that capital event, or maybe there's a refinance in the middle, right? That's maybe another capital event that would trigger some more lumpy cash flows. How do you look at the nature of where these returns are coming from? How much of these returns are coming from operations versus how much is coming from this big lump sum at the end?

Andrew Mondrall - Well, at the end there are no more decisions about how much to hold because the portfolio or the individual property is coming to a conclusion. All the debt is being extinguished and all the cash is being distributed. So you look at that operating agreement and you see who gets the cash upon disposition? Is it 100% pro rata to every investor? Or is there some preference that goes to the sponsor? And if so, what is that or how is it determined? And then what, ultimately, gets back to the investor?

Adam Hooper - And that's kind of start to finish there, isn't it?

Andrew Mondrall - Well, yes. It's fairly common that the sponsor would, assuming that they put a certain amount of their own cash in so that they are a participant in this as well, but if they can achieve a certain rate of return for the investors that they get some kind of a bonus or some kind of an extra payment, can be called a waterfall, a promote, it goes by various names, but its just something beyond pro rata distribution for having accomplished certain benchmark returns. That's common.

Adam Hooper - Yeah. And that's, again, those can be as simple as a straight pro rata or it can be as complex as a, you know we've seen multi-tiered, five different stages of waterfalls that can just be incredibly complex, right? There's no real standard on those either, unfortunately.

Andrew Mondrall - I agree.

Adam Hooper - That's a really good overview. And given your... We've kind of talked about this throughout, given your focus specifically on the retail space, what are some changes or some differences that an investor might expect to see when they are looking at a proforma for a retail property as opposed to maybe some of the other property types out there?

Andrew Mondrall - Well there's certainly been a lot in the news over the last three to five years about the internet's effect on traditional retail. And some people, I think, have actually overreacted and they've gotten very scared and said "Oh you can't make any retail investments, all retail is going away". It's not going away. People still shop. People still like to come out of their houses, stop looking at their computer screens and go get their haircut or their nails done or workout at a gym. You can't get your nails done over the internet.

Adam Hooper - That's a good point. Not yet at least.

Andrew Mondrall - So retail's not going away, but you do need to be smart about it. There are some categories of retailers that are shrinking or that are more susceptible to internet competition. So you just have to look and see what's the tenant mix right now of this perspective investment and what is my sponsors, what are they thinking about their ability to re-tenant this or to back fill spaces that may become empty. Whether it's because of the internet or some other reason.

Adam Hooper - We're going to follow this episode up with another recording with Reynolds and Brian about the state of retail market and some of those things, specifically, to look for in the retail space. Again, whether its tenant mix or some of these bigger box retailers that are downsizing or changing their business models. So we're going to definitely dive into that a little bit more into the next episode here, as well. Are there any thing that an investor, again, when looking at a proforma for retail asset... What are some just super high level, maybe top three to five things to look for or major red flags when you're looking at a retail proforma? Put you on the spot.

Andrew Mondrall - Good question there. I would be paying attention to what is the overall occupancy rate of the retail center right now, you'll get that from the rent roll, I mean is it 100% occupied? Is it 70% occupied or just what? I'd be looking at what are the sizes of the empty spaces? Are they 1,000 square foot shops? That's a mom and pop kind of thing. A sandwich shop, a jewelry store or something. Or are they 30,000 square foot spaces, which is something that's got to attract an anchor or junior anchor of some kind. Those have different degrees of difficulty in terms of your ability to back fill them. Smaller spaces are usually easier to back fill than larger space. There's a shorter list of people who could back fill a large space. So those are some things I would look at.

Adam Hooper - Are there any tools or resources for investors to start getting more comfortable in analyzing proformas? Or is it just a you got to roll up the sleeves and the more you look at it the more you'll understand?

Andrew Mondrall - Well I think there's no substitute for just looking at multiple proformas. Even if you're only considering investing in a particular property, go look at the proformas for five others that are all of the same category. That is they're all retail centers or they're all multifamily or they're all consistent type. And then just see what's different about them. Which ones are similar and which ones different? And the one you're talking about investing in, is it one of the ones that's similar or if it's different, why? Talk to the sponsor. Why do you think you can accomplish this? Or why can't you accomplish what these three other proformas say?

Adam Hooper - Right.

Andrew Mondrall - Just ask a bunch of questions and see what kind of response you get.

Adam Hooper - That's the goal of today is to help listeners understand maybe what some of those questions are that they should ask why about. And also then feeling, feeling empowered to ask why, right? These are answers that should have questions.

Andrew Mondrall - Sure.

Adam Hooper - From the managers. And often times sponsors are more than willing to answer those questions to get people comfortable with that, too. I think, hopefully, that's a good takeaway. Well, Andrew, is there anything that we didn't touch on that you want to add here at the end before we wrap this one up?

Andrew Mondrall - No, I think this has been a good overview of proformas and how they are made up and why they're important and what their critical components are. I feel good about it.

Adam Hooper - Perfect. I think that's a good place to wrap it up. We've got, like we've said, another episode coming up after this that'll dive into more of the nuts and bolts of what's going on on the retail space so hopefully listeners got a good dose of what's in a proforma. Andrew thank you so much for coming on the show today.

Andrew Mondrall - Indeed. You're welcome. Take care.

Adam Hooper - Perfect. Well, listeners, as always, appreciate comments, feedback, questions. Send us an email to and with that we'll catch you on the next one.

Tyler Stewart - Hey, listeners. If you enjoyed this episode, be sure to enroll on our free six week course on the fundamentals of commercial real estate investing. Head to to enroll for free today. In RealCrowd University, real estate experts will teach you the important fundamentals like the start with risk approach, how to evaluate real estate sponsors, what to look for in the legal documents and much more. Head to to enroll for free today. Hope to see you there.

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