Bob Puccini, Chairman and CEO of San Francisco-based Puccini Restaurant Group, doesn't understand how a prospective tenant can hope to succeed without a business plan. And an integral part of such a plan, says the design, development and consulting firm's chairman, are pro forma statements.

Pro forma projections help provide potential investors with answers to a variety of questions ranging from “Is this shopping center project feasible?” to “Can a potential tenant succeed in this center?” to “Is rent restructuring warranted?” But in the end, how reliable are these statements?

### Hit or miss

Pro forma projections make use of amounts and other information that are fully or partially assumed. Far from being an “educated guess” of future income, expenses and profitability, they are usually based on clearly stated assumptions. In fact, today's computer spreadsheet and modeling programs help refine the variables that constitute most pro forma statements.

Generally, a mathematical model describing the interrelationship among financial variables is used to generate pro forma financial statements as well as financial ratios. By analyzing potential tenants' income statements and financials and evaluating their ability to succeed in a shopping center, a developer helps the center itself succeed. Plus, by evaluating existing tenant pro forma projections, a developer can determine if rent restructuring is warranted.

“When it comes to pro forma statements,” Puccini says, “it is strictly ‘caveat emptor’ or buyer beware. A pro forma is a lot like kicking the tires of a car that you are thinking of buying. It can give you a good idea of what you are buying or buying into.”

By their very nature, pro forma projections are guesses about the future financial picture of the tenant. Fortunately, the path used to arrive at those estimates is an integral part of the pro forma statement. In other words, unlike the financial statements of an ongoing business, the projections of future income and expenses in a pro forma statement are accompanied by the base information and calculations used to arrive at those numbers.

### Evaluating the optimism

Although, as Puccini notes, most pro forma statements are optimistic, evaluating how realistic those projections are is a relatively easy matter. While Puccini specializes in the restaurant industry, the pro forma evaluation process is similar in almost every field: the figures must add up.

If a restaurant project's pro forma statement shows projections for food, beverage and labor costs outside the industry average of 65% to 75%, for example, that must be justified. Similarly, a proposed “tablecloth” restaurant projecting high per-check income located outside a Sears might raise warning flags.

### No legal guarantees

Surprisingly, there does not appear to be any law, regulation or even a penalty for erroneous pro forma statements — including those that wildly exaggerate the projections of a prospective tenant. Naturally, civil laws against fraud probably apply, although legal repercussions for surreal pro forma are rare.

Most leases do, however, contain so-called “performance clauses” under which a non-performing tenant may be removed or penalized. Thus, fraudulent pro forma statements do not appear to be a problem within the shopping center industry. Perhaps this is because a landlord will usually demand that a tenant live up to the projections presented in a pro forma statement and, as noted, will usually include clauses in the lease to guarantee this.

Pro forma projections are rarely used alone. They are always part of a plan. In other words, the pro forma contained in a plan, plus the experience and financial stability of the prospective tenant, are the most relevant factors. The developer analyzes that plan and takes into consideration not only the pro forma statement, but also the experience, capability and viability of the prospective tenant.

“Unless a reference is outstanding,” Puccini says, “We rarely take them into account. We'd much rather look at the track record of a prospective tenant and its operations. Experience has shown us that businesses rarely change. If an existing operation is shabby or dirty, chances are excellent that any new operations, despite rosy pro forma projections, will also be shabby or dirty.”

“We also look at capability,” Puccini says. “You can't expect someone whose only experience was at McDonald's to open and successfully operate a dinner house — no matter how much quality is reflected in their pro forma.”

The fact that a prospective tenant will go to the trouble of preparing a pro forma statement is, in the eyes of many developers, an indication of how serious that tenant is. Evaluating a prospective tenant's concept to determine how it will fit with that of other tenants is only occasionally a formal process, one that is usually limited to the center development phase.

Determining realistic profit potential from a pro forma is, according to industry experts, a process that depends as much on common sense as knowledge of the retail business. However, despite the lack of formal guidelines for evaluating them, pro forma statements remain excellent tools for shopping center developers.

Mark Battersby is a Philadelphia-based writer.