Funds From Operations (FFO)

What Is Funds From Operations (FFO)?

Funds from operations (FFO) alludes to the figure utilized by real estate investment trusts (REITs) to characterize the cash flow from their operations. Real estate companies use FFO as a measurement of operating performance.

FFO is calculated by adding depreciation, amortization, and losses on sales of assets to earnings and afterward deducting any gains on sales of assets and any interest income. It is sometimes quoted on a per-share basis. The FFO-per-share ratio ought to be utilized in lieu of earnings per share (EPS) while assessing REITs and other comparable investment trusts.

Formula and Calculation of Funds From Operations

Below is the formula for ascertaining funds from operations (FFO).

The formula for FFO is:

FFO = (Net Income + Depreciation + Amortization + Losses on Property Sales) - Gains on Sales of Property - Interest Income

Below are the steps to ascertain FFO:

All components of the FFO calculation are listed on a REIT's income statement.

1. Get the figure for net income, which is the company's profit and is situated at the lower part of the income statement.
2. Depreciation and amortization are the discounted portions of a company's tangible (physical) and intangible assets for the period. Depreciation and amortization are only accounting measures to assist companies with spreading out the costs of their assets. The discounted amounts at last reduce net income for the accounting period. Subsequently, depreciation and amortization are added back to net income to determine the genuine approaching cash or revenue from the REIT's operations.
3. Add any losses on the sales of business property, if any. This generally incorporates long-term assets like property, plant, and equipment. These losses are viewed as one-time and non-recurring, and are in this way not part of normal operations and ought not be remembered for the FFO calculation.
4. Take away any gains or revenue earned from the sale of property from the total figure of net income, depreciation, and amortization to acquire the funds from operations for the period.
5. Deduct any interest income the business earned. Interest income is generally not a standard part of a business' normal operations, and subsequently it ought not be remembered for the FFO calculation.

If, for instance, a REIT had depreciation of $20,000, gains on sales of property of $40,000, and net profit of $100,000, its FFO would be $80,000.

Generally speaking, an investor would have no need to compute a REIT's FFO since all REITs are required to show their FFO calculations on their public financial statements. The FFO figure is commonly revealed in the footnotes for the income statement.

Everything that Funds From Operations Can Say to You

FFO is a measure of the cash created by a REIT; real estate companies use FFO as an operating performance benchmark. The National Association of Real Estate Investment Trusts (NAREIT) initially pioneered this figure, which is a non-GAAP measure.

FFO isn't to be mistaken for a REIT's cash flow from operations, which is reported on the statement of cash flows (CFS). All things considered, FFO measures the net amount of cash and equivalents that flows into a firm from normal, progressing business activities. FFO ought not be viewed as an alternative to cash flow or as a measure of liquidity.

For instance, a commonplace company's cash flow would be impacted by the money earned from the sale of an asset, however FFO rejects those gains. Likewise, a commonplace company would show a cash inflow on its CFS in the event that the company received loan proceeds from a bank. Be that as it may, FFO does exclude such cash inflows, yet all things considered, it is just a measure of the income from business activities.

Why FFO Is a Good Measure of REIT Performance

FFO makes up for cost-accounting methods that may inaccurately impart a REIT's true performance. GAAP accounting expects that all REITs deteriorate their investment properties after some time utilizing one of the standard depreciation methods. Notwithstanding, numerous investment properties really increase in value after some time, making depreciation inaccurate in portraying the value of a REIT. Depreciation and amortization must be added back to net income to accommodate this issue.

FFO additionally takes away any gains on sales of property in light of the fact that these types of sales are viewed as nonrecurring. REITs must pay out 90% of all taxable income as dividends, which are cash payments to investors. Gains on sales of property don't add to a REIT's taxable income and should thusly not be remembered for the measurement of value and performance.

As mentioned, FFO per share is sometimes given by firms as a supplement to their EPS. Earnings per share is a company's net income partitioned by the outstanding equity shares. EPS and FFO per share give a measure of how much income is being produced on a per-share basis.

These measures likewise assist investors with determining whether the money is being utilized successfully by management. Likewise, numerous analysts and investors evaluate a REIT's price-FFO ratio as a supplement to the price-earnings ratio, which is the stock price separated by EPS. On account of a REIT, the market price of the REIT would be separated by its FFO per share.

Adjusted Funds From Operations

Progressively, real estate analysts are likewise working out a REIT's adjusted funds from operations (AFFO). This calculation takes a REIT's FFO and deducts any recurring expenditure that is capitalized and afterward amortized, as well as any straight-lining of rents. These recurring capital expenditures might incorporate such maintenance expenses as painting tasks or rooftop substitutions. AFFO has built up some momentum as a more accurate estimate of a REIT's earnings potential.

The AFFO measure was created to give a better measure of a REIT's cash produced or profit paying capacity. Notwithstanding AFFO, this alternate measure is sometimes alluded to as funds accessible for distribution or cash accessible for distribution.

Illustration of How to Use Funds From Operations

Famous shopping center REIT Simon Property Group reported funds from operations on its 2017 income statement of $4 billion, up 6% from 2016. The firm's net income, in the interim, totaled $2.2 billion.

To show up at FFO, the firm added back depreciation and amortization of about $1.8 billion, and further adjusted for other more modest figures — including a decrease of $5.3 million for payment of preferred distributions and dividends, and a noncontrolling interests portion of depreciation and amortization that came about in an extra $17.1 million decrease. Simon moreover reported a diluted FFO-per-share figure of $11.21, compared to a diluted EPS figure of $6.24.

Features

• Real estate companies use FFO as a measurement of operating performance.
• FFO bars one-time cash inflows like income from the sale of an asset; all things considered, it just incorporates income from business activities.
• Funds from operations (FFO) alludes to the figure utilized by real estate investment trusts (REITs) to characterize the cash flow from their operations.