What Is Funds From Operations (FFO)?

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What Is Funds From Operations (FFO)?

Let me explain funds from operations (FFO) directly: it's a key metric you use to evaluate REIT performance, giving you insights into cash flow and operational efficiency. Unlike metrics for regular corporations, FFO adjusts for depreciation and amortization, so you get a transparent view of how much income a REIT really generates from its properties.

Key Takeaways

Funds from operations is a key metric for evaluating the cash flow and operating performance of real estate investment trusts.
FFO adjusts net income by adding back depreciation and amortization while subtracting property sales gains and interest income to reflect REITs' true operational earnings.
Adjusted funds from operations provides a more accurate measure of a REIT's earnings potential by considering recurring capital expenditures.
FFO per share helps investors assess the income generated on a per-share basis, complementing traditional financial metrics like earnings per share.
REITs are required to disclose FFO in their financial statements, typically found in the footnotes of their income statements.

Step-by-Step Guide to Calculating Funds From Operations (FFO)

You calculate FFO using this formula: FFO equals net income plus depreciation plus amortization plus property sales losses, minus property sales gains, minus interest income. Start with the net income from the REIT's income statement— that's the profit at the bottom. Add back depreciation and amortization, which are just accounting ways to spread out asset costs and reduce net income artificially. If there are losses from selling business property, add those in too, since they're one-time events. Then subtract any gains from property sales and any interest income, as those aren't part of regular operations. For instance, if a REIT has $100,000 net profit, $20,000 depreciation, and $40,000 gains on property sales, the FFO comes out to $80,000. You usually won't have to do this math yourself, though—REITs disclose FFO in their financial statement footnotes.

Insights Provided by Funds From Operations (FFO)

FFO measures the cash a REIT generates from its regular activities, and it's what real estate companies use as a benchmark for operating performance. This is a non-GAAP figure pioneered by NAREIT, so remember it's not a substitute for cash flow or liquidity measures. Unlike a typical cash flow statement that includes asset sales or loan proceeds, FFO excludes those to focus strictly on income from business operations. Don't mix it up with cash flow from operations on the cash flow statement, which covers core earnings, or EBITDA, which factors out taxes and other costs for profitability.

Why Funds From Operations (FFO) is Essential for Evaluating REITs

FFO is essential because it corrects for accounting rules that don't accurately show a REIT's performance. Under GAAP, REITs depreciate properties over time, but many actually appreciate, so you add back depreciation and amortization to net income to fix that. It also subtracts property sale gains since those are nonrecurring and don't affect the taxable income REITs must distribute as dividends. You can look at FFO per share alongside EPS to see income per share, and use the price-FFO ratio instead of P/E to gauge value.

FFO vs. AFFO: Key Differences Explained

Adjusted funds from operations (AFFO) builds on FFO by subtracting recurring capitalized expenses like maintenance or roof replacements, and adjusting for straight-line rents. This gives you a better sense of the REIT's actual cash for dividends, sometimes called funds available for distribution.

Practical Example: How Funds From Operations (FFO) is Applied

Take Simon Property Group, a major mall REIT: in 2017, they reported $4 billion in FFO, up 6% from the prior year, while net income was $2.2 billion. They added back $1.8 billion in depreciation and amortization, then adjusted for minor items like preferred distributions and noncontrolling interests. That resulted in diluted FFO per share of $11.21 versus diluted EPS of $6.24.

Frequently Asked Questions

What do a company's funds from operations tell you? They show the cash generated from regular activities, measuring operating performance without including property sale gains. Where do you find a REIT's funds from operations? Look in the footnotes of their income statement, or calculate it from net income, depreciation, amortization, losses on sales, minus gains and interest. What's the difference between funds from operations and cash flow from operations? FFO focuses on operating performance with adjustments, while cash flow from operations is the total cash from core activities including working capital.

The Bottom Line

You need to understand funds from operations to properly evaluate REIT financial performance. It adjusts net income for depreciation, amortization, and sales impacts, excluding nonrecurring items, and NAREIT recognizes it as a standard. REITs disclose it in footnotes, so you can use it directly for insights into operational cash flows.

What Is Funds From Operations (FFO)?

Highlights