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Proforma Income Statement Terms and Methods
for Investment and Development Cash Flow Analysis

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Accounting Rate of Return article

How is the Accounting Rate of Return calculated for commercial real estate investments and developments? What are the factors that the Accounting Rate of Return takes into consideration when shown in a proforma income statement, and what is ignored? Why is the Accounting Rate of Return useful for investment real estate? These are the questions that are explored using the Proforma Example in this article.

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How is the Accounting Rate of Return calculated?

Before Tax
Net Operating Cash Flow + Equity Buildup + Appreciation / Initial Equity = Accounting Rate of Return Before Tax as %
so $400,000 / $1,000,000 = 40%
Afet Tax
Net Operating Cash Flow After Tax + Equity Buildup + Appreciation / Initial Equity = Accounting Rate of Return After Tax as %
so $300,000 / $1,000,000 = 30%

Let's use the current Proforma Income Statement Example to look at how the Accounting Rate of Return can be used.

Downpayment = $1,023,344

	2010	2011	2012	2013	2014	2015
Total Gross Income	$365,472	$372,443	$370,410	$376,040	$384,217	$414,321
Less: Vacancy & Credit Loss	19,084	3,202	14,620	5,049	3,501	50,321
Effective Income	$346,387	$369,241	$355,790	$370,992	$380,717	$364,000
Total Operating Expenses	$69,400	$71,244	$73,141	$75,094	$77,103	$79,170
Net Operating Income	$276,987	$297,997	$282,649	$295,898	$303,614	$284,830
Total Debt Service	$230,823	$230,823	$230,823	$230,823	$230,823	$230,823
Net Operating Cash Flow	$46,164	$67,174	$51,826	$65,075	$72,791	$54,007
Sale Value	$3,329,006	$3,591,128	$3,800,275	$3,698,723	$3,795,175	$3,560,371
Less: Loan Repayment	2,164,359	2,113,745	2,141,394	2,079,651	2,012,784	1,940,367
Accounting RoR Before Tax		24.30%	1.17%	22.32%

In this case the 2012 Accounting Rate of Return was calculated by:

2012's increase in Sale Value	$3,698,723 - $3,800,275
+ 2012's Equity Buildup (Loan Repayment)	2,141,394 - 2,079,651
+ 2012 Net Operating Cash Flow	$51,826
divided by Initial Equity	$1,023,344
equals the 2012 Accounting Rate of Return	1.17%

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Considers:

• Price, Original Loan Amount, Scheduled Income (Current Year Only), Debt Payment (Current Year Only), Vacancies (Current Year Only), Expenses (Current Year Only), Sale Proceeds Increase (Current Year Only)

Ignores:

• Time Value of Money, Other Years NOI, Other Years Sale Proceeds
  
  ... and a lot of other things

Why is Accounting Rate of Return useful?

Accounting Rate of Return is not commonly used in commercial real estate analysis. It is a Return on Investment (ROI) type ratio where the cash flow is divided by an investment. The ratio is basically just like the Cash on Cash ratio with the one year's rise of sale value and decrease in loan principal added to the cash flow side of the ratio. This ratio can, therefore, increase the understanding of the Cash on Cash ratio.

What is the Accounting Rate of Return Sensitive to:

Scheduled Income (Current Year Only), Debt Payment (Current Year Only), Vacancies (Current Year Only), Expenses (Current Year Only), Sale Proceeds Increase (Current Year Only)

The Accounting Rate of Return is shown in these planEASe Reports:

• Proforma Income Statements
• Annual Statements

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Written by
Michael Feakins, CCIM
of planEASe Software