Operations fund the FFO.
REITs use Funds From Operations (“FFO”) to estimate their cash flow from operations. Real estate firms assess success with FFO. To calculate FFO, add depreciation, amortization, and asset sales losses to profits, then deduct asset sales gains and interest income. They are sometimes quoted per share. Consider using the FFO-per-share ratio instead of EPS when assessing REITs and comparable investment trusts.
Formula and Calculation of FFO
The formula for FFO is:
FFO=(NI+D+A+PSL)−PSG−II
Where:
FFO = Finances from operations
NI = Net income
D=Depreciation
A=Amortization
PSL = Property Sales Losses
PSG = Property Sales Gains
II = Interest Income
A REIT’s income statement lists all FFO calculation components. Steps to compute it:
- Find the company’s profit, or net income, at the bottom of the income statement.
- Company depreciation and amortization are the expensed components of tangible and intangible assets for the period. Accounting procedures like depreciation and amortization help organizations stretch asset expenses. Expenses lower accounting period net income. Adding depreciation and amortization to net income determines the REIT’s real cash or revenue.
- Include any commercial property sales losses. Property, plant, and equipment (PP&E) are often considered long-term assets. These losses are one-time and nonrecurring; hence, they should not be included in FFO.
- Calculate money from operations by subtracting property sales gains from net income, depreciation, and amortization.
- Subtract business interest income. The FFO calculation should not include interest income because it is not part of a business’s usual activities.
If a REIT has $20,000 in depreciation, $40,000 in profits from property sales, and $100,000 in net profit, its FFO would be $80,000.
FFO calculations are often not necessary for REITs, as they are required to disclose them in their public financial statements. The income statement footnotes usually disclose the FFO amount.
What You Can Learn From FFO
REIT FFO measures cash flow. Real estate firms measure success with FFO. The National Association of Real Estate Investment Trusts (NAREIT) introduced this non-GAAP metric.
Operating funds are a company’s net cash and equivalents from its daily operations. FFO is neither a substitute for cash flow nor a measure of liquidity.
FFO eliminates asset sales gains, affecting a typical company’s cash flow. A typical company’s CFS would indicate a cash inflow if it got bank loans. FFO omits such financial inflows. It is only a measure of business income.
Avoid confusing REIT funds from operations with other indicators like cash flow. This number on the statement of cash flows (CFS) indicates a company’s earnings from its main businesses. EBITDA also varies for companies. By excluding depreciation, amortization, taxes, and obligation costs, this statistic compares the company’s profitability to its net income.
Why FFO Measures REIT Performance Well
FFO corrects cost-accounting errors that misrepresent REIT performance. All REITs must use a standard depreciation method for their investment properties by GAAP. Unfortunately, many investment properties appreciate over time, making depreciation an unreliable measure of REIT value. Resolving this requires adding depreciation and amortization to net income.
FFO excludes gains from nonrecurring property transactions. REITs must distribute 90% of their taxable revenue as dividends and cash payments to investors. In measuring value and performance, REITs should not include property sales gains because they do not increase taxable income.
As indicated, corporations sometimes augment EPS with FFO per share. Divide a company’s net income by its outstanding equity shares to get earnings per share. EPS and FFO per share represent per-share income.
These measurements also show investors if management is using money well. Additionally, analysts and investors evaluate REITs’ price-FFO ratio alongside the P/E ratio, which measures stock price vs. EPS. REIT market price divided by FFO per share
FFO vs. AFFO
Real estate experts are also calculating REITs’ adjusted funds from operations (AFFO). To calculate a REIT’s FFO, deduct any capitalized and amortized recurrent expenses and rent straight-lining. Recurring capital costs may include painting or roof replacements. The use of AFFO to predict REIT profitability has grown in popularity.
AFFO measures a REIT’s cash-generating or dividend-paying potential more accurately. AFFO and funds available for distribution are other names for this metric.
Example of FFO Use
Mall REIT Simon Property Group is famous. In 2017, their income statement showed a 6% increase in funds from operations to $4 billion. Net income for the company was $2.2 billion.
The company found its FFO by considering $1.8 billion in depreciation and amortization, preferred distributions and dividends, and noncontrolling interests. These changes led to a $5.3 million and a $17.1 million drop in FFO, respectively.
Simon reported a diluted FFO per share of $11.21, compared to a diluted EPS of $6.24.
A company’s operations funds tell you what?
Funds from operations measure a REIT’s cash flow. This cash comes from several sources, including business. REITs measure operating success with FFO. FFO excludes REIT property sales gains. This doesn’t constitute a regular activity.
Where do REITs get their operating funds?
The public must see REITs’ operating funds. This statistic is readily available on REIT public financial statements. Find this figure in the income statement footnotes. Add the REIT’s net income, depreciation, amortization, and property sales losses to compute FFO. Subtract it from property sales and interest revenue.
How Are Funds From Operations and Cash Flow From Operations Different?
One may mistake a REIT’s funds from operations with its cash flow. However, they differ. The FFO measures operating performance by taking out interest income and property sales gains and including net income, depreciation, amortization, and property sales losses.
The cash flow statement shows operating cash flow. Total cash earned by a corporation during operations Working capital, income, and costs.
Bottom Line
Many techniques exist to measure a company’s performance. Corporation kind determines metric. Companies use EBITDA, or return on equity, to assess profitability. REITs employ operating capital. NAREIT created this industry-standard operating performance statistic. It considers depreciation, amortization, property sales losses, interest, and profits. Don’t worry—you won’t compute this amount. REIT income statement footnotes contain it.
Conclusion
- REITs calculate cash flow using funds from operations.
- Real estate firms assess success with FFO.
- FFO solely comprises company income, not one-time cash inflows like asset sales.
- In addition, to rent straight-lining, a REIT’s adjusted funds from operations exclude recurrent expenditures capitalized and amortized.
- REITs report FFO in income statement footnotes.
