CRE Cash Flow Proforma & DCF Valuation

Published: March 24, 2026

Article by Ryan O'Connell, CFA, FRM

Every serious commercial real estate acquisition, disposition, or financing decision starts with a cash flow proforma. A commercial real estate proforma projects a property’s income and expenses year by year, producing the cash flow stream that investors then discount to arrive at a property value. This guide covers the full proforma framework — from potential gross income to property before-tax cash flow — along with reversion value, CRE discount rates, and DCF valuation applied to commercial property. For the general theory of discounting cash flows, see our DCF guide and NPV & IRR guide.

What Is a CRE Cash Flow Proforma?

A commercial real estate proforma is a year-by-year financial projection of a property’s income, expenses, and resulting cash flows over an expected holding period. Unlike a simple snapshot valuation, the proforma models how rents, vacancy, operating costs, and capital expenditures evolve over time.

The proforma captures two categories of cash flow: operating cash flows (recurring income minus expenses in each year) and reversion cash flows (the net proceeds from selling the property at the end of the holding period). Together, these form the complete cash flow stream that investors discount to determine property value.

Building the Proforma: PGI to PBTCF Step-by-Step

The standard CRE proforma follows a top-down waterfall structure. Each line item builds on the one above it, starting with the property’s maximum possible revenue and subtracting layers of real-world costs to arrive at the actual cash flow an owner receives.

Step 1 — Potential Gross Income (PGI): Start with the property’s rent roll — the contractual rents from existing leases. For periods beyond lease expiration, project market rent using an annual growth rate. PGI represents the theoretical maximum revenue assuming full occupancy.

Step 2 — Vacancy Allowance: Subtract a vacancy and collection loss reserve, typically 5–10% of PGI depending on property type and market conditions. This accounts for time between tenants, free rent concessions, and uncollected rents.

Step 3 — Effective Gross Income (EGI): PGI minus vacancy plus any other income (parking fees, storage rentals, antenna leases). EGI is the realistic revenue the property generates.

Step 4 — Operating Expenses: Subtract property taxes, insurance, utilities, maintenance, and management fees. Expenses are categorized as fixed (taxes, insurance) or variable (utilities, repairs). For a deeper breakdown of NOI and operating expense categories, see our NOI guide.

Step 5 — Net Operating Income (NOI): EGI minus operating expenses. NOI is the most widely quoted measure of property-level profitability, but it is not the bottom line for investment analysis.

Step 6 — Capital Expenditures: Subtract tenant improvements (TIs), leasing commissions, roof replacements, HVAC upgrades, and other major capital items. These typically consume 10–20% of NOI over the long run, or approximately 1–2% of property value per year.

Step 7 — PBTCF: NOI minus capital expenditures. PBTCF is the correct cash flow to use for DCF valuation because it reflects the actual dollars the property produces for its owner.

Modeling Lease Rollover: A critical detail in multi-year proformas is lease rollover — what happens when existing leases expire. The proforma should model a renewal probability (often 50–70% for office), vacancy downtime for non-renewals (typically 3–9 months for marketing and tenant build-out), and a mark-to-market rent reset where expiring rents adjust to projected market rates. Non-renewals also trigger capital costs: tenant improvement allowances and leasing commissions typically run 15–25% of a year’s rent for new tenants. These rollover mechanics are what distinguish a realistic proforma from a naive straight-line projection.

Projecting Reversion (Terminal) Value

Reversion is the net cash flow from selling the property at the end of the holding period. For most CRE investments, the reversion accounts for a substantial share of total investment value — typically well over one-third of the present value in a 10-year DCF, and sometimes more than half depending on the property’s cash flow growth rate and the discount rate used.

The standard method applies an exit (terminal) cap rate to the projected NOI one year beyond the holding period. If you plan to sell at the end of Year 10, capitalize Year 11’s projected NOI. Then subtract selling costs — typically 2–3% of the sale price for brokerage fees and closing costs — to arrive at net reversion. It is the net reversion figure that enters the DCF calculation.

The exit cap rate should generally be equal to or slightly higher than the going-in cap rate. Buildings age during the holding period, making them less competitive against newer properties. A common convention adds 25–100 basis points to the going-in cap rate to reflect this increased risk and reduced growth potential. The main exception is when the investor plans significant renovations or repositioning during the hold that would make the property more competitive at sale — in that case, a flat or even lower exit cap rate may be justified.

Choosing the Discount Rate for CRE

The discount rate in a CRE proforma represents the opportunity cost of capital (OCC) — the total return an investor requires to justify investing in the property rather than an alternative investment of comparable risk.

Where:

• r_f — risk-free rate, approximated by the average expected T-bill rate over the holding period (or the 10-year Treasury yield minus 100–150 bps for yield curve effect)
• RP_CRE — the risk premium investors demand for holding commercial property. Historical data from the NCREIF Property Index (1970–2003) suggests approximately 350–400 basis points over T-bills specifically for institutional-quality, core commercial properties

As an illustrative range, institutional-quality commercial real estate discount rates typically fall between 7–10%. However, the appropriate rate varies materially by property type (industrial tends to be lower risk than hotel), location (gateway cities vs. secondary markets), tenant credit quality, lease term remaining, and prevailing capital market conditions. The discount rate is not a fixed number — it must be calibrated to the specific risk profile of the property being analyzed.

In theory, cash flows within signed leases (intralease cash flows) carry less risk than cash flows projected beyond lease expiration (interlease cash flows), because contractual rents are more certain than future market rents. Some sophisticated analyses apply different discount rates to each stream, though a single blended rate is far more common in practice.

DCF Valuation Applied to Commercial Property

With the proforma’s cash flow stream and a discount rate in hand, the DCF valuation discounts each year’s PBTCF and the net reversion back to present value.

The resulting value (V) represents what the property is worth today given the projected cash flows and the investor’s required return. If the purchase price is less than V, the investment has a positive net present value — the expected return exceeds the required return. For a full treatment of NPV decision rules, see our NPV & IRR guide.

Commercial Real Estate Proforma Example: Office Property

The following worked example demonstrates a complete 10-year proforma and DCF valuation for a suburban office building. This example uses a triple-net lease structure where the landlord retains responsibility for a portion of operating expenses.

Reversion Calculation: Year 11 projected NOI is approximately $1,343,000. Dividing by the 7.0% exit cap rate yields a gross reversion of $19,180,000. After 2.5% selling costs ($479,000), net reversion is $18,700,000.

DCF Valuation: Discounting the 10-year PBTCF stream plus the net reversion at 9.0% produces a property value of approximately $14,496,000. The implied going-in cap rate is $980,000 / $14,496,000 = 6.76% — consistent with the 7.0% exit cap rate being slightly higher to reflect building aging.

Notice that the reversion accounts for approximately 54% of the total present value. This concentration highlights why the exit cap rate assumption is so critical. The sensitivity table below shows how the property value changes across different combinations of exit cap rate and discount rate:

For a detailed breakdown of how CRE returns are measured across the holding period, including leveraged vs. unleveraged IRR, see our CRE Investment Returns guide.

How to Build a CRE Proforma

Building a commercial real estate proforma requires assembling property-specific data and translating it into a structured cash flow projection. The key steps are:

1. Gather the rent roll: Obtain current lease terms, contractual rents, escalation schedules, and expiration dates for every tenant
2. Project market rents: Research comparable leases to establish current market rent and a defensible annual growth rate
3. Model vacancy and lease rollover: Estimate renewal probabilities, downtime between tenants, and mark-to-market rent resets at lease expiration
4. Estimate operating expenses: Use historical property data and market benchmarks to project fixed and variable costs, applying appropriate growth rates
5. Budget capital expenditures: Include tenant improvements, leasing commissions, and major repairs based on the building’s age and lease rollover schedule
6. Choose the discount rate: Derive the OCC from the risk-free rate plus an appropriate CRE risk premium, calibrated to the property’s risk profile
7. Value the reversion: Project terminal-year NOI and apply an exit cap rate, then subtract selling costs
8. Discount to present value: Apply the DCF formula to the PBTCF stream and net reversion to arrive at the property’s indicated value

Proforma vs Direct Capitalization: When to Use Each

CRE valuations rely on two primary approaches. Each has distinct strengths, and experienced investors use both in different contexts.

Direct capitalization is a shortcut — a useful one for stabilized properties where income is expected to continue at roughly the current level. The DCF proforma is the more fundamental approach, required whenever cash flows are expected to change materially over the holding period. For a deeper look at cap rates and how they relate to required returns, see our cap rate guide.

Market Value vs Investment Value in CRE

The same DCF framework produces two distinct types of value, depending on whose assumptions drive the analysis.

Market value uses market-derived inputs: typical cap rates, consensus growth expectations, and a discount rate reflecting the opportunity cost for the marginal investor in the market. Investment value substitutes the specific investor’s inputs — their tax rate, their management capabilities, their financing terms.

In well-functioning markets, most transactions occur at or near zero NPV from a market-value perspective. Meaningfully positive NPV typically arises when an investor possesses an operational advantage, tax benefit, or informational edge that allows them to extract more value than the typical market participant. The proforma cash flows and reversion feed directly into after-tax analysis as well — see our CRE after-tax analysis guide for that extension.

Common Mistakes in CRE Proformas

Even experienced analysts make recurring errors when building proformas. The following mistakes can lead to materially misleading valuations:

1. Overly Aggressive Rent Growth — Projecting above-market escalation rates without supporting comparable data. For aging buildings, real rents typically grow 1–2 percentage points below inflation as the property becomes less competitive against newer construction.

2. Assuming Full Renewal With No Downtime — Modeling 100% lease renewal probability with no vacancy between tenants. In reality, renewal rates vary (often 50–70% for office) and non-renewals create 3–9 months of downtime plus significant TI and leasing commission costs.

3. Using the Cap Rate as the Discount Rate — These are different metrics. The cap rate is a current income yield; the discount rate is the total required return including appreciation. Using a 7% cap rate as the discount rate in a DCF will dramatically overstate property value.

4. Inconsistent Cap Rate Assumptions — Applying a low going-in cap rate but then assuming an even lower exit cap rate 10 years later. Buildings age, and the exit cap rate should generally be equal to or higher than the going-in cap rate unless there is a specific justification (such as major renovations during the holding period).

5. Ignoring Capital Expenditures — Treating NOI as the bottom line instead of PBTCF. Over a 10-year hold, capital expenditures typically consume 10–20% of cumulative NOI. Omitting CapEx can overstate true cash flow by hundreds of thousands of dollars. Note that the proforma is a property-level analysis before any financing — for the impact of leverage on investor returns, see our CRE leverage analysis guide.

6. Projecting Sale Price by Appreciation Instead of Capitalizing NOI — Projecting the reversion by simply growing the purchase price at an assumed appreciation rate rather than capitalizing projected NOI. This approach is circular and disconnects the reversion from the property’s actual income-producing capacity.

7. Pairing Optimistic Cash Flows With a Low Discount Rate — Using aggressive rent growth and low vacancy assumptions while simultaneously applying a below-market discount rate. Each assumption alone may seem reasonable, but in combination they produce a valuation that is detached from market reality. Always stress-test the proforma by changing multiple assumptions simultaneously.

Limitations of CRE Proformas

While the proforma is the standard framework for CRE investment analysis, it has inherent limitations that investors should understand:

1. Sensitivity to Key Assumptions — Small changes in the discount rate or exit cap rate (50–100 bps) can shift property value by 5–10%. Always present DCF results with sensitivity tables showing how value changes across a range of assumptions.

2. No Optionality — Standard DCF does not capture the option value embedded in many CRE investments — the option to expand, redevelop, change use, or delay a sale. Real options analysis is a separate framework that can supplement the proforma.

3. Single-Scenario Focus — A typical proforma models one expected scenario. It does not capture the full distribution of possible outcomes or the probability of extreme events. Monte Carlo simulation can address this limitation but adds significant complexity.

4. Assumes Rational Pricing — Market value derived from DCF assumes that properties trade at prices consistent with expected cash flows. Private real estate markets are less informationally efficient than public securities markets, creating temporary mispricings that DCF alone may not capture.