Definition
Funds From Operations (FFO) is a measure of the cash generated by a real estate investment trust (REIT) from its business operations. It is an important metric used by analysts, investors, and REIT managers to evaluate the operating performance and financial health of a REIT. Unlike traditional earnings metrics, FFO adjusts net income by adding back depreciation, amortization, and other non-cash expenses, as well as excluding any gains or losses on the sale of properties. This provides a clearer picture of a REIT’s ability to generate cash and sustain dividend payments.
FFO Formula
\[ FFO = \text{Net Income} + \text{Depreciation} + \text{Amortization} - \text{Gains/Losses on Property Sales} \]
Examples
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REIT A: If a REIT had a net income of $10 million, depreciation and amortization of $3 million, and it sold a property for a gain of $1 million, the FFO calculation would be: \[ FFO = $10\text{M} + $3\text{M} - $1\text{M} = $12\text{M} \]
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REIT B: Another REIT reported a net income of $6 million, depreciation, and amortization of $2 million but had a loss of $500,000 on the sale of a property: \[ FFO = $6\text{M} + $2\text{M} + $0.5\text{M} = $8.5\text{M} \]
Frequently Asked Questions (FAQs)
1. Why is FFO important for REIT investors?
FFO is important because it provides a clearer picture of a REIT’s cash generating ability from its core operations. Depreciation and amortization, which are non-cash expenses, are added back to net income, giving investors a better understanding of the income available for dividends and reinvestment.
2. How is FFO different from net income?
FFO differs from net income in that it adjusts for non-cash expenses such as depreciation and amortization, as well as gains or losses on property sales. This adjusts net income to better reflect the cash generated by a REIT’s operational activities.
3. Can FFO be negative?
Yes, FFO can be negative if the operational cash flows are outweighed by the expenses, leading to a reduced cash generation. This could be a red flag indicating financial trouble within the REIT.
4. Is FFO used globally?
While FFO is primarily a metric used in the United States for REITs, similar metrics are used globally, though they may have different names or slightly different calculations.
5. What are the limitations of using FFO?
FFO does not account for capital expenditures which are necessary for maintaining a property. Therefore, it may overstate the cash flow available for distribution.
Related Terms
- Adjusted Funds From Operations (AFFO): A more refined measure than FFO as it adjusts for recurring capital expenditures and other non-cash items.
- Net Asset Value (NAV): The total value of a REIT’s assets minus its liabilities, often used together with FFO to assess a REIT’s true value.
- Cap Rate: A measure used to estimate the return on investment of a real estate property, which can influence the FFO through the asset valuation.
Online Resources
- National Association of Real Estate Investment Trusts (NAREIT)
- U.S. Securities and Exchange Commission (SEC) - REITs
- Investopedia - Funds From Operations
References
- “Investing in REITs” by Ralph L. Block
- “The Intelligent REIT Investor – How to Build Wealth with Real Estate Investment Trusts” by Brad Thomas and Stephanie Krewson-Kelly
- “Real Estate Investment Trusts: Structure, Performance, and Investment Opportunities” by Su Han Chan, John Erickson, and Ko Wang
Suggested Books for Further Studies
- “Real Estate Investment Trusts: Structure, Performance, and Investment Opportunities” by Stephanie Krewson-Kelly and R. Brad Thomas
- “The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel” by Benjamin Graham
- “Real Estate Investing for Dummies” by Eric Tyson and Robert S. Griswold
