However, actual recurring cash earnings were $800,000 if we add back the non-cash charge of deprecation. Adjusted funds from operations (AFFO) is an even more refined measure of REIT’s cash flows. It equals FFO minus any accruals of revenue minus any capital expenditures which must be incurred to maintain the properties owned and managed by the REIT. It is also called funds available for distribution (FAD) or cash available for distribution (CAD).

Understanding Funds From Operations (FFO) for REITs

Any operating results computed when using the cost accounting method do not usually serve as an accurate measurement of performance. Funds from operations (FFO) is the actual amount of cash flow generated from a company’s business operations. The National Association of Real Estate Investment Trusts (NAREIT) developed FFO as a non-GAAP measurement of cash generated by REITs to standardize their operating performance. It helps to measure the net cash generated by a REIT from its regular and ongoing business activities. It’s a proxy for free cash flow, although it’s not a replacement for that metric.

For instance, gains (or losses) on the sale of properties are to be removed/ added accordingly, as they are not like regular business operations and therefore do not contribute to the REIT’s ongoing dividend-paying capacity. In addition, some analysts further consider rent increases and certain Capex for calculating adjusted Funds from operations (AFFO). Thus, it is always better to rely upon a mix of measurements, rather than a single measure that can potentially be twisted. Investors also use FFO to measure a REIT’s operating performance relative to other periods and other REITs.

Yes, you should diversify with REITs because they offer exposure to the real estate sector without worrying about holding cash to maintain the property. When it comes to projecting dividends from long-term investments like REITs, it certainly is the case. So, even as the value of a given piece of real estate increases over time, the improvements made on the property (building, parking lot, fixtures) depreciate as they age.

Example of an Adjusted Funds From Operations—

1. Specifically, REITs are allowed to write annual depreciation losses off against the net income generated by the REIT.
2. On the other hand, cash flow measures the total gross cash that came in and went out of the business.
3. EPS and FFO per share provide a measure of how much income is being generated on a per-share basis.
4. It gives them more insight into a company’s ability to pay and maintain its dividend.

Non-operating expenses are excluded from the main business functions and, therefore, should be added back to net income. Big Time Real Estate Company declared a net income of $10M last year, a depreciation expense of $2M, an interest amortization expense of $1M, an interest income of $500,000, and a gain on the sale of various assets of $1M. The actual cash flow from business operations (FFO) for Big Time Real Estate Company comes out to $11.5M. Some REITs will also report an adjusted version of FFO to provide an even more accurate reflection of their recurring income for dividend purposes.

In most situations, you won’t need to calculate a REIT’s FFO because all REITs are required to show their FFO calculations on their public financial statements. The FFO figure is typically disclosed in the footnotes for the income statement. For information pertaining to the registration status of 11 Financial, please contact the state securities regulators for those states in which 11 Financial maintains a registration filing. All non-operating expenses are shown on the debit side and all non-operating incomes are shown on the credit side. If the debit side is more than the credit side, the difference is referred to as funds from operation. Furthermore, charging of depreciation and amortization of intangible and fictitious assets does not require the use of funds in the current period.

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The evaluation of REITs can be simple to understand once you learn the math and valuation metrics. However, there are many different types of REITs, such as mortgage REITs, commercial property REITs, and residential property REITs, and each has its own unique qualities that differentiate from the others. Traditional metrics such as EPS and P/E ratio are unreliable in estimating a REIT’s value.

Finance Strategists has an advertising relationship with some of the companies included on this website. We may earn a commission when you click on a link or make a purchase through the links on our site. All of our content is based on objective analysis, and the opinions are our own. If there is a loss, the opening balance appears on the debit side and the closing balance of loss appears on the credit side. Also, enterprises may have enough funds at their disposal, but they might still have incurred a substantial loss at the end of the year/period. A controversial point is what is funds from operations that an enterprise making a substantial profit may not have adequate funds at the end of the year/period.

The FFO represents the operating performance and takes net income, depreciation, amortization, and losses on property sales into account while factoring out any interest income and gains from property sales. REITs are required to disclose their funds from operations to the general public. Search for the income statement and look for this figure within the footnotes. You can also calculate the FFO by adding together the REIT’s net income, depreciation, amortization, and losses on property sales.

The rules within the generally accepted accounting principles (GAAP) accounting requires that REITs depreciate their investment properties over time using one of the standard depreciation methods. Since this is is a non-cash transaction, it must be added back to net income, along with any amortization expense. In such a scenario, the net profit would not portray the true operating picture of the company. In such cases, FFO is considered to be a reliable indicator of operational efficiency.