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.