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What are 'Funds From Operations - FFO'

Funds from operations (FFO) refers to the figure used by real estate investment trusts (REITs) to define the cash flow from their operations.

FFO is calculated by adding depreciation and amortization to earnings and then subtracting any gains on sales. It is sometimes quoted on a per-share basis. The FFO-per-share ratio should be used in lieu of earnings per share (EPS) when evaluating REITs and other similar investment trusts.

BREAKING DOWN 'Funds From Operations - FFO'

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

The formula for FFO is: FFO = Net Income + Depreciation + Amortization - Gains on Sales of Property.

All components of the FFO calculation are listed on a REIT's income statement. If, for example, 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. All REITs are required to show their FFO calculations on public financial statements. They normally disclose the measure as a footnote on the income statement.

FFO is not to be confused with a REIT's cash flow from operations, which is reported on the firm's statement of cash flows and instead measures the net amount of cash and equivalents that flows into a firm from regular, ongoing business activities. FFO should not be seen as an alternative to cash flow as a measure of liquidity.

Why FFO Is a Good Measure of REIT Performance

FFO compensates for cost-accounting methods that may inaccurately communicate a REIT's true performance. GAAP accounting requires that all REITs depreciate their investment properties over time using one of the standard depreciation methods. However, many investment properties actually increase in value over time, making depreciation inaccurate in describing the value of a REIT. Depreciation and amortization must be added back to net income to reconcile this issue.

FFO also subtracts any gains on sales of property because these types of sales are considered to be nonrecurring. REITs must pay out 90% of all taxable income in the form of dividends. Gains on sales of property do not add to a REIT's taxable income and should therefore not be included in a measurement of value and performance.

As mentioned, FFO per share is sometimes provided by firms as a supplement to their EPS figure for the reasons mentioned above. Similarly, many analysts and investors assess a REIT's price-FFO ratio as a supplement to the price-earnings ratio.

Adjusted Funds From Operations

Increasingly, real estate analysts are also calculating a REIT's adjusted funds from operations (AFFO). This calculation takes a REIT's FFO and subtracts any recurring expenditure that is capitalized and then amortized, as well as any straight-lining of rents. These recurring capital expenditures may include such maintenance expenses as painting projects or roof replacements. AFFO has gained traction as a more accurate estimate of a REIT's earnings potential.

The AFFO measure was developed to provide a better measure of a REIT's cash generated or dividend-paying capacity. In addition to AFFO, this alternate measure is sometimes referred to as funds available for distribution or cash available for distribution.

Example of a REIT's FFO

Popular mall 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, meanwhile, totaled $2.2 billion. To arrive at FFO, the firm added back depreciation and amortization of about $1.8 billion, and further adjusted for other smaller figures — including a reduction of $5.3 million for payment of preferred distributions and dividends, and a noncontrolling interests portion of depreciation and amortization that resulted in an additional $17.1 million reduction. Simon additionally reported a diluted FFO-per-share figure of $11.21, compared to a diluted EPS figure of $6.24.

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