Funds From Operations (FFO): Essential for Evaluating REIT Performance

What Is Funds From Operations (FFO)?

FFO (Funds From Operations) is a non‑GAAP performance metric most commonly used to evaluate real estate investment trusts (REITs). Developed and popularized by the National Association of Real Estate Investment Trusts (NAREIT), FFO adjusts GAAP net income to more accurately reflect a REIT’s recurring operating performance by adding back non‑cash depreciation and amortization and removing gains or losses from property sales and other nonrecurring items.

Source: Investopedia (Sydney Burns).

Key takeaways

– FFO = net income adjusted for non‑cash depreciation and amortization, and for gains/losses on property sales and interest income.
– FFO is intended to measure a REIT’s recurring cash‑generating ability from operations — not total cash flow or liquidity.
– Analysts commonly use FFO per share and the price‑to‑FFO (P/FFO) ratio much like they use EPS and P/E for other companies.
– Adjusted FFO (AFFO) further subtracts recurring capital expenditures and other items to approximate distributable cash.
– FFO is disclosed publicly (often in REIT earnings releases, 10‑Ks/10‑Qs, and footnotes) but is a non‑GAAP metric and can be calculated in slightly different ways across firms.

FFO formula and components

Standard (basic) formula:
FFO = (Net Income + Depreciation + Amortization + Property Sales Losses) − Property Sales Gains − Interest Income

Where:

– Net Income (NI) = GAAP net income (from the income statement).
– Depreciation (D) and Amortization (A) = non‑cash GAAP expenses that are added back because real estate often appreciates.
– Property Sales Gains (PSG) and Property Sales Losses (PSL) = gains are subtracted (treated as nonrecurring); losses are added back.
– Interest Income (II) = often excluded because it’s not core property operating income.

Step‑by‑step guide to calculating FFO (practical)

1. Get GAAP net income for the period (income statement).
2. Add back depreciation and amortization related to investment properties (check income statement and notes for the amounts).
3. Add any losses on sales of properties (non‑recurring losses).
4. Subtract gains on sales of properties (non‑recurring gains).
5. Subtract interest income (if included in net income and you want operating focus).
6. Adjust for any noncontrolling interests or preferred dividends that are treated per the REIT’s reporting conventions (many REITs will list diluted FFO per share after these adjustments).
7. For per‑share measures, divide FFO by diluted weighted average shares outstanding.

Practical numeric example (simple)

Assume:
– Net income = $100,000
– Depreciation = $20,000
– Amortization = $0
– Gains on property sales = $40,000
– Losses on property sales = $0
– Interest income = $0

FFO = (100,000 + 20,000 + 0 + 0) − 40,000 − 0 = $80,000

– If diluted shares outstanding = 10,000, then FFO/share = $80,000 / 10,000 = $8.00.
– If market price per share = $120, P/FFO = 120 / 8 = 15.

AFFO: adjusted funds from operations (how and why)

Why AFFO? FFO adds back depreciation and amortization, but some recurring capital expenditures and rent accounting items still affect cash available for distribution. AFFO attempts to better estimate distributable cash by making additional adjustments.

Typical AFFO adjustments (may vary by firm):

– Start with FFO.
– Subtract recurring capital expenditures (maintenance capex: roofing, HVAC replacements, painting).
– Subtract recurring leasing costs that are capitalized (tenant improvements, leasing commissions) amortized over lease lives.
– Adjust for straight‑lining of rent (if GAAP accounting shows straight‑lined rent that inflates NOI).
– Adjust for other recurring, non‑cash items management deems relevant.

Example AFFO calculation (continuing above):

– FFO = $80,000
– Recurring maintenance capex (annualized) = $10,000
– Straight‑lining adjustment (reduction) = $2,000

AFFO = 80,000 − 10,000 − 2,000 = $68,000

Insights provided by FFO

– Measures recurring operating performance of a REIT by removing non‑cash accounting depreciation and nonrecurring property sale items.
– Better reflects cash generation from property operations than GAAP net income for asset‑heavy real estate businesses.
– Useful for comparing operating results across REITs (when definitions are consistent).
– FFO per share gives investors a per‑share operating earnings proxy; price‑to‑FFO gives a valuation multiple analogous to P/E.

Important limitations and cautions

– FFO is non‑GAAP; definitions and components can vary by REIT. Compare methodology across companies.
– FFO is not cash flow from operations; it excludes certain cash items (loan proceeds, principal repayments, some capex patterns) and excludes gains considered nonrecurring.
– FFO may overstate distributable cash if recurring capex and tenant improvement costs are material — which is why AFFO is commonly used as a complementary metric.
– Do not rely on FFO alone to assess liquidity, leverage, or ability to meet debt covenants and dividends. Always review cash flow statements and balance sheet metrics (debt, interest coverage, fixed charge coverage).

FFO vs. Cash Flow From Operations (CFO)

– CFO (found on the statement of cash flows) measures actual cash inflows and outflows from operating activities (includes working capital changes, cash interest payments if presented, etc.).
– FFO adjusts net income for accounting depreciation and property sale gains/losses to isolate recurring property operating performance.
– Numerically, CFO can be higher or lower than FFO depending on timing of receivables, payables, capex cash payments, financing cash flows, and one‑time receipts.

FFO vs. EBITDA

– EBITDA strips interest, taxes, depreciation, and amortization to measure operating profitability for many industries.
– FFO is specific to REITs and is intended to correct for real estate depreciation that may not reflect economic reality; it further adjusts for property sale gains/losses and interest income. The two metrics are therefore related but not interchangeable.

Where to find a REIT’s FFO

– REITs typically disclose FFO and AFFO in quarterly earnings releases, investor presentations, and in 10‑Ks/10‑Qs (often in the “Non‑GAAP financial measures” or footnotes).
– If FFO isn’t shown, you can calculate it from the income statement and notes (see the step‑by‑step guide).
– The company’s MD&A or investor relations page often provides the management definition and reconciliation (this matters because there is no single legally required formula).

Practical example from a large REIT

Simon Property Group (example noted by Investopedia):
– 2017 net income ≈ $2.2 billion.
– Depreciation & amortization added back ≈ $1.8 billion.
– Reported FFO ≈ $4 billion and diluted FFO per share = $11.21 vs. diluted EPS = $6.24.
This demonstrates how FFO can materially differ from GAAP net income for property companies.

Tips for analysts and investors

– Always check the REIT’s specific definition/reconciliation of FFO and AFFO. Some firms make additions/subtractions beyond the basic formula.
– Use FFO and AFFO together: FFO for standardized operating performance; AFFO for distributable cash estimation.
– Normalize for one‑time items (large property dispositions, acquisitions, or unusual nonrecurring expenses).
– Combine FFO metrics with balance‑sheet measures (debt/EBITDA or debt/AFFO ratios) to assess financial risk and dividend sustainability.
– For valuation compare P/FFO and P/AFFO across peers, but ensure like‑for‑like adjustments.

The bottom line

FFO is a key REIT metric that provides a clearer view of recurring operating performance than GAAP net income by adding back non‑cash depreciation/amortization and removing nonrecurring gains/losses from property sales. It is useful for valuation (FFO per share, P/FFO) and for comparing REITs’ operating results, but it is not a substitute for cash flow analysis or a comprehensive liquidity assessment. Use AFFO and cash‑flow measures alongside FFO to judge dividend sustainability and true distributable cash.

Primary source

– Investopedia — “Funds From Operations (FFO)” by Sydney Burns. (See https://www.investopedia.com/terms/f/fundsfromoperation.asp)

(Continuing)

…the company’s normal core operations during a reporting period — including receipts from tenants and payments to suppliers and employees — and is shown on the statement of cash flows. FFO, by contrast, is a non‑GAAP operating performance measure that starts with net income and adjusts for accounting items (not actual cash receipts or payments) that can distort a REIT’s operating results, most notably depreciation and gains or losses on property sales.

Below are additional sections, practical steps, worked examples, guidance on interpretation, and a concluding summary to give you a complete, usable guide to Funds From Operations (FFO).

Key takeaways (recap)

– FFO is a non‑GAAP metric created to show a REIT’s operating performance more clearly than GAAP net income by reversing depreciation and amortization and excluding certain nonrecurring items such as gains on property sales.
– Standard (NAREIT) formula: FFO = Net Income + Depreciation + Amortization + Property Sales Losses − Property Sales Gains − Interest Income (definitions and adjustments vary; always check the REIT’s disclosure).
– Investors commonly use FFO per share and Price/FFO as REIT valuation and performance metrics; many analysts prefer AFFO (Adjusted FFO) as a closer proxy for distributable cash flow.
– FFO is not identical to cash flow from operations and does not replace a full cash flow analysis or liquidity assessment.

Step‑by‑step guide to calculating FFO (practical steps)

1. Start with GAAP net income from the REIT’s income statement.
2. Add back depreciation and amortization applicable to the REIT’s investment properties. (This reverses GAAP accounting that may understate operating cash potential for appreciating real estate.)
3. Add losses on sales of property (treat these as operating adjustments).
4. Subtract gains on sales of property (sales gains are usually nonrecurring and not part of core operations).
5. Subtract interest income (NAREIT’s convention excludes interest income because it is not core property operating income).
6. Make any other company‑specific adjustments disclosed by the REIT (for example, certain noncontrolling interest portions of D&A).
7. Divide by diluted shares outstanding if you want FFO per share.

Tip: Use the REIT’s footnotes and investor presentation. Many REITs publish FFO and FFO per share in earnings releases or MD&A; if you compute it yourself, state your adjustments.

Worked examples

Example 1 — Simple FFO calculation

Inputs:
– Net income (NI): $100,000
– Depreciation (D): $20,000
– Amortization (A): $0
– Property sales losses (PSL): $0
– Property sales gains (PSG): $40,000
– Interest income (II): $0

Calculation:

FFO = NI + D + A + PSL − PSG − IIFFO = $100,000 + $20,000 + $0 + $0 − $40,000 − $0 = $80,000

Interpretation: The REIT’s FFO of $80,000 is intended to better reflect recurring property operating performance than the $100,000 net income (which was reduced by a $40,000 gain on a property sale and included non‑cash depreciation).

Example 2 — AFFO (Adjusted Funds From Operations) calculation

AFFO typically begins with FFO, then subtracts recurring capital expenditures, straight‑line rent adjustments, leasing costs, and other recurring items to better estimate distributable cash.

Inputs:

– FFO (from prior calc): $1,000,000
– Straight‑line rent adjustment (add back in FFO; to move from GAAP to cash, you may reverse it or adjust—definitions differ): −$20,000 (i.e., subtract if straight‑lining artificially raised FFO)
– Recurring capital expenditures (maintenance capex): $150,000
– Leasing costs amortized in FFO but paid in cash: $30,000

Calculation (one common approach):

AFFO = FFO − recurring capital expenditures − straight‑line rent adjustments − leasing costs
AFFO = $1,000,000 − $150,000 − $20,000 − $30,000 = $800,000

Interpretation: AFFO of $800,000 is a narrower measure that attempts to reflect cash available for distribution to equity holders, and typically is lower than FFO.

Interpretation: A Price/FFO of 12x can be compared to peers’ Price/FFO multiples; lower multiples may indicate relative cheapness given similar risk profiles, but differences in asset mix, leverage, and accounting conventions matter.

Where to find a REIT’s FFO and reconciling details

– Quarterly and annual reports (10‑Q, 10‑K): many REITs disclose FFO in the MD&A or shareholder presentation.
– Footnotes to financial statements: companies often reconcile GAAP net income to non‑GAAP measures including FFO and AFFO.
– Earnings press releases and investor presentations: commonly present FFO and FFO per share.
– Industry sources: NAREIT and some financial data vendors publish FFO figures for public REITs.

FFO vs. Cash Flow from Operations (CFO) — a clearer comparison

– Cash Flow from Operations (CFO): a GAAP metric on the statement of cash flows showing actual cash received and paid from operating activities (rent collections, interest paid/received depending on classification, payments to suppliers, payroll).
– FFO: non‑GAAP, accrual‑based measure beginning with net income and adjusted for non‑cash depreciation/amortization and property sale gains/losses.
Key differences:
– CFO captures real cash movements (including changes in working capital and certain timing items); FFO adjusts net income for accounting items.
– Gains on property sales normally appear in CFO (as a cash inflow from investing activities), but FFO excludes gains (or adds losses) to focus on recurring operations.
– Use CFO to assess liquidity and actual cash generation; use FFO/AFFO to assess operating performance and dividend sustainability.

Limitations, pitfalls, and variations to watch for

– Non‑GAAP inconsistency: There is no single legally mandated FFO definition; many companies follow NAREIT’s standard but may make company‑specific adjustments. Always read the reconciliation.
– Excludes important cash items: FFO does not account for debt principal repayments, capital markets activity, one‑time impediments, or many cash capital expenditures unless included in AFFO.
– Can mask capital intensity: High FFO with very high recurring capex needs (e.g., older assets) can overstate distributable cash if AFFO is not considered.
– Sales gains/losses treatment: Some REITs may have recurring property trading strategies; excluding sales gains may understate business models that rely on flipping assets.
– Potential for management to adjust: Because it’s non‑GAAP, management can present adjusted FFO definitions that make comparisons difficult. Always check the reconciliation tables.

How analysts and investors use FFO

– Valuation: Price/FFO is commonly used alongside Price/AFFO to value REITs (analogous to P/E for non‑REITs).
– Performance tracking: Compare FFO growth over time and across peer REITs to assess operational trends (same‑store NOI growth, occupancy, rent growth).
– Dividend coverage: Compare AFFO to dividends paid to understand sustainability of payouts.
– Credit analysis: FFO (often FFO adjusted for maintenance capex) is used in ratio analysis for leverage metrics and interest coverage in REIT credit evaluations.

Practical checklist for investors

– Confirm which FFO definition the REIT uses (NAREIT standard or customized).
– Look for FFO and AFFO reconciliations in press releases and filings.
– Compare FFO/AFFO per share across similar REITs (same sector, similar leverage) not across all REIT types.
– Reconcile FFO trends with cash flow from operations and known capital expenditure needs.
– Watch tenant quality, lease expirations, occupancy, and rent collections — these drive future FFO.
– For dividend safety, prioritize AFFO or funds available for distribution over simple FFO.

Additional examples and scenarios

Scenario A — Property sale distorts net income

– A REIT reports net income of $5 million, including a one‑time $4 million gain on selling an older property. Depreciation and amortization were $3 million.
– FFO = 5,000,000 + 3,000,000 + 0 + 0 − 4,000,000 − 0 = $4,000,000
– While net income was $5M, FFO of $4M excludes the nonrecurring gain and adds back D&A — giving a clearer view of recurring operating results.

Scenario B — Heavy maintenance capex (AFFO important)

– Another REIT has FFO of $10M but regular roof replacements and renovations costing $3M per year.
– AFFO = 10M − 3M = 7M
– Dividend of $8M would be unsustainable despite FFO coverage; AFFO reveals the shortfall risk.

Common FAQ (short)

– Is FFO the same as cash flow? No. FFO adjusts net income for accounting items and excludes some cash items; CFO shows actual cash flows.
– Why add back depreciation? REIT investment properties are often appreciating in value; GAAP depreciation is a non‑cash expense that can understate operating economics.
– Which is better — FFO or AFFO? AFFO is typically a better proxy for distributable cash flow because it deducts recurring capital expenditures and other cash items; both are useful.
– Where does NAREIT come in? NAREIT popularized the FFO metric and provides commonly accepted definitions and guidance widely used in the industry.

Concluding summary

Funds From Operations (FFO) is a cornerstone metric for evaluating REITs because it adjusts GAAP net income for non‑cash and nonrecurring accounting items, providing a clearer view of recurring property operating performance. While FFO helps compare operating results across real estate companies and supports valuation using Price/FFO, it is a non‑GAAP measure subject to definition differences and limitations. For assessing dividend sustainability and distributable cash, many investors prefer AFFO (Adjusted FFO) or funds available for distribution because they deduct recurring capital spending and other cash outflows. A thorough REIT analysis therefore uses FFO/AFFO alongside cash flow statements, balance sheet metrics, lease and tenant analysis, and management’s reconciliations.

Sources and further reading

– Investopedia — “Funds From Operations (FFO)” (Sydney Burns) — https://www.investopedia.com/terms/f/fundsfromoperation.asp
– NAREIT — Guidance on FFO and industry reporting standards — https://www.reit.com

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