Funds From Operations (FFO) & Adjusted FFO (AFFO)

What Are Funds From Operations (FFO)?

Funds from operations (FFO) is an accounting measure used by real estate investment trusts (REITs) to define the cash flow from a property or portfolio of properties.

FFO excludes gains or losses from the sale of property and depreciation and amortization expense, which can make it a more accurate measure of a REIT’s operating performance.

FFO can be useful for investors when analyzing REITs because it strips out one-time items that can distort net income.

For example, if a REIT sells a property for a gain, that gain will show up as part of net income even though it is not necessarily indicative of the REIT’s ongoing earnings power.

By excluding such items, FFO provides a better sense of the REIT’s core operating performance.

FFO is also typically used by REITs as a measure to calculate distributions to shareholders.

In order for a company to be classified as a REIT, it must distribute at least 90 percent of its taxable income to shareholders in the form of dividends.

Since FFO excludes items like gains on sales and depreciation, it provides a more accurate picture of the cash flows available for distribution.

As such, FFO can be thought of as the “operating cash flow” of a REIT.

 

How Is FFO Calculated?

Funds from operations is calculated via the following formula:

 

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

 

For example, assume a REIT has the following results for the year:

  • Net income: $10 million
  • Depreciation and amortization: $4 million
  • Loss on the sale of property: $1 million
  • Gain on sale of property: $2 million
  • Interest income: $1 million

FFO would be calculated as follows:

FFO = ($10 million + $4 million + $1 million) – $2 million – $1 million

FFO = $12 million

Why is interest income not part of the FFO calculation?

Interest income is generally not a part of a business’s regular operations (unless they’re a bank or other financial entity), and accordingly it’s generally not included in the FFO calculation.

 

Funds From Operations (FFO) to Total Debt Ratio

This ratio is a solvency ratio that measures the ability of a company to repay its debts with its FFO.

A higher ratio indicates more financial flexibility and a lower debt burden.

 

Adjusted Funds From Operations (AFFO)

Adjusted funds from operations (AFFO) is a measure of a REIT’s ability to generate cash flow that can be used to pay dividends.

AFFO focuses on the ongoing operating performance of the REIT.

It also takes into account straight-line rent adjustments and capital expenditures necessary to maintain the properties in their current condition.

By making these adjustments, AFFO provides a more accurate picture of a REIT’s “normalized” cash flow.

There is no official formula for calculating AFFO, but it might look something like:

 

AFFO = FFO – Capital Expenditures + Straight-Line Rent Adjustments – Other Maintenance Amounts

 

For example, assume a REIT has the following results for the year:

  • FFO: $12 million
  • Capital expenditures and maintenance: $4 million
  • Straight-line rent adjustments: $3 million

AFFO would be calculated as follows:

AFFO = $12 million – $4 million + $3 million

AFFO = $11 million

For AFFO, this measure is sometimes also called funds available for distribution or cash available for distribution.

 

Funds from operations and adjusted funds from operations: How to calculate and interpret

 

Summary – FFO

Funds from operations (FFO) is a metric used to assess the financial performance of real estate investment trusts (REITs).

FFO strips out one-time items that can distort net income, providing a better sense of the REIT’s core operating performance.

It is also typically used by REITs as a measure to calculate distributions to shareholders.

A related metric is adjusted funds from operations (AFFO), which focuses on the ongoing operating performance of the REIT and takes into account straight-line rent adjustments and capital expenditures necessary to maintain the properties in their current condition.

The funds from operations to total debt ratio is a solvency ratio that measures the ability of a company to repay its debts with its FFO.

A higher ratio indicates more financial flexibility and a lower debt burden.

 

 

by