# Funds From Operations (FFO): Essential for Evaluating REIT Performance

## What Is Funds From Operations (FFO)?

Funds from operations (FFO) serve as a key metric for evaluating REIT performance by offering insights into cash flow and operational efficiency. Unlike traditional corporate metrics, FFO includes adjustments for depreciation and amortization, providing a transparent view of REITs' income-generating capabilities.  

### Key Takeaways

*   Funds from operations is a key metric for evaluating the cash flow and operating performance of real estate investment trusts.
*   FFO adjusts net income by adding back depreciation and amortization while subtracting property sales gains and interest income to reflect REITs' true operational earnings.
*   Adjusted funds from operations provides a more accurate measure of a REIT's earnings potential by considering recurring capital expenditures.  
    
*   FFO per share helps investors assess the income generated on a per-share basis, complementing traditional financial metrics like earnings per share.  
    
*   REITs are required to disclose FFO in their financial statements, typically found in the footnotes of their income statements.

![Funds From Operations (FFO)](https://www.investopedia.com/thmb/siMfIyqSxkQ4svvsQC6u1JhKv2k=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Investopedia_FFO_Final-f23ea5e9ccbf401f9837669ab4bfc043.jpg)

*— Investopedia / Sydney Burns*

## Step-by-Step Guide to Calculating Funds From Operations (FFO) 

###   

The formula for FFO is:

$\begin{aligned}&\text{FFO} = (\text{NI} + \text{D} + \text{A} + \text{PSL} ) - \text{PSG} - \text{II} \\&\textbf{where:} \\&\text{FFO} = \text{Funds from operations} \\&\text{NI} = \text{Net income} \\&\text{D} = \text{Depreciation} \\&\text{A} = \text{Amortization} \\&\text{PSL} = \text{Property Sales Losses} \\&\text{PSG} = \text{Property Sales Gains} \\&\text{II} = \text{Interest Income} \\\end{aligned}$

You can find parts of the FFO calculation on a REIT's [income statement](https://www.investopedia.com/terms/i/incomestatement.asp). Follow these steps to calculate it:

1.  Obtain the figure for net income, which is the company's profit and is located at the bottom of the income statement.
2.  Depreciation and amortization are the expensed portions of a company's [tangible](https://www.investopedia.com/terms/t/tangibleasset.asp) (physical) and [intangible assets](https://www.investopedia.com/terms/i/intangibleasset.asp) for the period. Depreciation and amortization are merely accounting measures to help companies spread out the costs of their assets. The expensed amounts ultimately reduce net income for the accounting period. As a result, depreciation and amortization are added back to net income to determine the actual incoming cash or revenue from the REIT's operations.
3.  Add any losses on the sales of business property, if any. This generally includes long-term assets such as [property, plant, and equipment (PP&E)](https://www.investopedia.com/terms/p/ppe.asp). These losses are considered one-time and non-recurring, and are therefore not part of normal operations and should not be included in the FFO calculation.
5.  Subtract any gains or revenue earned from the sale of property from the total figure of net income, [depreciation](https://www.investopedia.com/terms/d/depreciation.asp), and [amortization](https://www.investopedia.com/terms/a/amortization.asp) to obtain the funds from operations for the period.
6.  Subtract any interest income the business earned. Interest income is generally not a regular part of a business's normal operations, and therefore it should not be included in the FFO calculation.

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.  

> **Tip**
>
> You typically won't need to calculate a REIT's FFO, as it's shown in their public financial statements. The FFO figure is typically disclosed in the footnotes for the income statement.

## Insights Provided by 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)](https://www.investopedia.com/terms/n/nareit.asp) originally pioneered this figure, which is a [non-GAAP](https://www.investopedia.com/terms/n/non-gaap-earnings.asp) measure.

FFO shows the net cash from regular business activities. FFO should not be seen as an alternative to cash flow or as a measure of [liquidity](https://www.investopedia.com/terms/l/liquidity.asp).

For example, a typical company's cash flow includes money from asset sales, but FFO excludes these gains. Also, a typical company would show a cash inflow on its CFS if the company received loan proceeds from a bank. However, FFO does not include such cash inflows. Instead, it is only a measure of the income from [business activities](https://www.investopedia.com/terms/b/business-activities.asp).

> **Important**
>
> Don't confuse a REIT's funds from operations with other metrics, such as the cash flow from operations. This figure is reported on the statement of cash flows (CFS) and represents money that a company earns from its normal core operations. A company's earnings before interest, taxes, depreciation, and amortization (EBITDA) is also different. This metric measures the corporation's profitability to net income by factoring out depreciation and amortization expenses, along with taxes and liability costs.

## Why Funds From Operations (FFO) is Essential for Evaluating REITs

FFO adjusts for accounting methods that may not show a REIT's true performance accurately. GAAP requires all REITs to depreciate their [investment properties](https://www.investopedia.com/terms/i/investment-property.asp) over time using standard 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 90% of their [taxable income](https://www.investopedia.com/terms/t/taxableincome.asp) as [dividends](https://www.investopedia.com/terms/d/dividend.asp) to investors. Gains on sales of property do not add to a REIT's taxable income and should therefore not be included in the measurement of value and performance.

As mentioned, FFO per share is sometimes provided by firms as a supplement to their EPS. Earnings per share is a company's net income divided by the outstanding [equity](https://www.investopedia.com/terms/e/equity.asp) shares. EPS and FFO per share provide a measure of how much income is being generated on a per-share basis.

These measures help investors assess management's effective use of funds. Also, many analysts and investors assess a REIT's price-FFO ratio as a supplement to the [price-to-earnings (P/E) ratio](https://www.investopedia.com/terms/p/price-earningsratio.asp), which is the stock price divided by EPS. In the case of a REIT, the market price of the REIT would be divided by its FFO per share.

## FFO vs. AFFO: Key Differences Explained

Real estate analysts are increasingly calculating a REIT's [adjusted funds from operations (AFFO)](https://www.investopedia.com/terms/a/affo.asp). This calculation takes a REIT's FFO and subtracts any recurring expenditure that is [capitalized](https://www.investopedia.com/terms/c/capitalization.asp) and then amortized, as well as any [straight-lining](https://www.investopedia.com/terms/s/straightlinebasis.asp) of rents. These recurring capital expenditures may include such maintenance expenses as painting projects or roof replacements. AFFO is seen 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.

## Practical Example: How Funds From Operations (FFO) is Applied

Simon Property Group is a well-known mall REIT. It 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](https://www.investopedia.com/terms/n/noncontrolling_interest.asp) portion of depreciation and amortization that resulted in an additional $17.1 million reduction.

 Simon reported a diluted FFO per share of $11.21, compared to a [diluted EPS](https://www.investopedia.com/terms/d/dilutedeps.asp) of $6.24.

## What Do a Company's Funds From Operations Tell You?

Funds from operations show how much cash a REIT generates. This cash is derived from a variety of sources, including regular business activities. FFO is the way that REITs measure their operating performance. Keep in mind that FFO doesn't include the gains a REIT makes on the sale of its property(s). That's because this doesn't count as an ongoing or recurring activity.

## Where Do You Find a REIT's Funds From Operations?

REITs must publicly disclose their funds from operations. You can easily find this figure on a REITs public financial statements. 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. Then subtract that figure from any gains on property sales and any interest income.

## What's the Difference Between Funds From Operations and the Cash Flow From Operations?

It may be easy to confuse a REIT's funds from operations and the cash flow from operations. But the two are different from one another. 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.

The cash flow from operations, on the other hand, is reported on the cash flow statement. It's the total amount of cash that a company earns during the course of its operations. This includes working capital, revenue, and expenses.

## The Bottom Line

Understanding funds from operations is crucial for evaluating the financial performance of real estate investment trusts. Unlike other metrics such as EBITDA or return on equity, FFO provides a clearer picture of cash flows by adjusting net income for depreciation, amortization, and losses on the sale of properties, while excluding gains on property sales and interest income. Recognized as a standard by the National Association of Real Estate Investment Trusts (NAREIT), FFO offers insight into a REIT's operational effectiveness without the need for manual calculations, as these figures are typically disclosed in the footnotes of their financial statements.