What Does Funds Available For Distribution Mean?
A REIT holds a portfolio of income-producing properties and/or mortgages and is required to distribute nearly all its taxable net income to maintain REIT status. While there is no standardized method for calculating funds available for distribution, many REITs calculate FAD in a similar way by adjusting the funds from operations value for straight-line rents, non-cash items, and any recurring real estate-related expenses.
- Real estate investment trusts (REITs) are required to pay 90% of taxable income to investors.
- However, there is no standardized method for calculating what funds are available for distribution (FAD).
- Nevertheless, many REITs calculate FAD by adjusting the funds from operations value for straight-line rents, non-cash items, and any recurring real estate-related expenses.
Understanding Funds Available For Distribution (FAD)
A REIT is a pool of properties and mortgages bundled together and offered as a security in the form of a unit investment trust. Each unit in a REIT represents a proportionate fraction of ownership in each of the underlying assets. To qualify as a REIT under Securities and Exchange Commission (SEC) rules, a property company must distribute at least 90% of taxable income to its investors.
Funds available for distribution, a non-GAAP measure, are a proxy for a REIT's cash flow for investors. Another yardstick is the funds from operations (FFO) metric, but FAD is considered more representative of cash flow because of certain adjustments that provide a truer economic picture of a REIT's operations.
Example of Funds Available for Distribution Calculation
Boston Properties (BXP) is a commercial property REIT that owns buildings in Boston, New York, San Francisco, Los Angeles, Washington D.C., and Reston, Virginia. In 2020, the REIT's FAD payout ratio was 96.4% compared with 86.7% in 2019.
Boston Properties calculates FAD by adding to FFO lease transaction costs that qualify as rent inducements, non-real estate depreciation, non-cash losses (or subtracting gains) from early extinguishment of debt, and stock-based compensation expense; eliminating the effects of straight-line rent and straight-line ground rent expense adjustment; and subtracting maintenance capital expenditures, hotel improvements, and equipment upgrades and replacements. This list of adjustment items is not exhaustive, but it shows how cash and non-cash items are handled to present a more accurate figure of actual funds available for distribution to investors.