Discover the Essence of Funds From Operations in REITs
Funds From Operations (FFO) is an essential metric used by real estate investment trusts (REITs) to signify the cash flow generated from their operations. This figure helps measure operating performance by starting with net income and adding back items like depreciation and amortization while excluding gains from asset sales and interest income. Often quoted on a per-share basis, FFO per share can be more informative than earnings per share (EPS) for evaluating a REIT’s profitability.
Key Takeaways
- FFO is the primary figure for assessing the cash flow and operational success of REITs.
- It focuses purely on income from core business activities, excluding gains from asset sales and non-operational interest income.
- REITs often disclose FFO details in the footnotes of their income statements.
Formula and Calculation of Funds From Operations (FFO)
To calculate FFO, use this formula:
1FFO = ( NI + D + A + PSL ) − PSG − II
2
3where:
4FFO = Funds from Operations
5NI = Net Income
6D = Depreciation
7A = Amortization
8PSL = Property Sales Losses
9PSG = Property Sales Gains
10II = Interest Income
Every component required for the FFO calculation is typically listed on a REIT’s income statement. Here are the steps to calculate it:
- Net Income: Locate net income at the bottom of the income statement.
- Depreciation & Amortization: These are added back to the net income since they reflect expensed portions of assets, not outflows of actual cash.
- Property Sales Losses: Add losses from sales of business property.
- Property Sales Gains: Subtract gains from the sale of property.
- Interest Income: Deduct any interest income, as it is not derived from core business operations.
For instance, if a REIT records a net income of $100,000, adds back $20,000 of depreciation, and subtracts $40,000 from property sales gains, its FFO would be $80,000.
Understanding What FFO Can Tell You
FFO reveals the net cash generated from a REIT’s core business activities, excluding non-recurring transactions. This measure provides a pure reflection of operational efficiency:
- Operating Benchmark: Often used to assess the effectiveness of a REIT’s operations.
- Excludes Infrequent Gains: Avoids distortions from one-shot transactions like property sales.
- Not Alternative Cash Flow: Shouldn’t be mistaken as actual cash flow or liquidity measure.
Why FFO is a Reliable Performance Measurement
Generally Accepted Accounting Principles (GAAP) require REITs to depreciate properties even if their market values rise. FFO corrects this and, by excluding gains from property sales, offers a clearer picture of operational performance. Its calculation also accounts for REIT dividend requirements, thus aiding investors in understanding how REITs effectively use their funds.
REITs and analysts are increasingly also using Adjusted Funds From Operations (AFFO), which adds even further adjustments for recurring capital expenditures.
Example: Simon Property Group
For example, Simon Property Group reported an FFO of $4 billion and net income of $2.2 billion in 2017. Adjusted for various depreciation and amortization expenses, this demonstrates why Simon’s FFO is a stronger indicator of their operational performance than net income or EPS.
Finding FFO in Financial Statements
Finding a REIT’s FFO is straightforward because it’s required in their financial statements, often disclosed within the footnotes of their income statements.
Differentiating Between FFO and Cash Flow From Operations
While both figures relate to company operations, FFO focuses on net income adjustments excluding property sales and interest income. Cash flow from operations, listed separately in financial statements, represents total income generated, inclusive of working capital changes.
Conclusion
Using FFO, investors can dive deeply into the operational success of REITs, offering clarity beyond traditional accounting metrics. Established by the National Association of Real Estate Investment Trusts (NAREIT), this industry standard helps assess management effectiveness and investment value.
Related Terms: EBITDA, Cash Flow from Operations, Earnings Per Share, Net Income, Depreciation, Amortization, Tangible Assets, Intangible Assets
