Amanda Bellucco-Chatham is an editor, writer, and fact-checker with years of experience researching personal finance topics. Specialties include general financial planning, career development, lending, retirement, tax preparation, and credit. Yes, ratios like the price-to-FFO and price-to-AFFO multiples allow you to compare the relative value of different REITs. Note that we are showing price divided by FFO, which is market capitalization (market cap) divided by FFO. In this example, XYZ’s market cap (number of shares times the price per share) is about $8 million. As a knowledgeable investor, you should understand the meaning of FFO and how to calculate it.
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FFO helps adjust for the sales to give investors a more accurate reflection of the actual performance of the REIT’s business during the periods. The funds from operations (FFO) metric, in simple terms, measures the cash generated by a real estate investment trust (REIT). The funds from operations give a clear snapshot of how the company is performing and the kind of cash flows they have for the year. Therefore, you can use FFO to analyse how the company uses the cash it has in hand and if it can generate enough operating revenue.
Shareholders’ real estate holdings must be maintained by repainting apartments, for example, so FFO is not quite the true residual cash flow remaining after expenses and expenditures. In such a scenario, the net profit would not portray the true operating picture of the company. In such cases, FFO is considered to be a reliable indicator of operational efficiency. Companies and investors use it as a benchmark against which the efficiency of the REIT is measured.
Once you know how to arrive at this figure, you can use it to compare different companies and REITs before you make your investment decision. As mentioned earlier, FFO is an important metric when studying the financials of a company and assessing the operational efficiency of a company. Losses on the sale of assets – Loss is incurred when an asset is eliminated, and the selling price is lower than the net book value of the asset sold. To calculate the funds from operations (FFO) metric, follow the four-step process outlined here. The FFO metric was originally developed by Nareit to reconcile net income, the accrual accounting-based net profit metric per U.S. When investing in a REIT, you should never consider the numbers calculated through traditional cost accounting methods.
Therefore, both terms are similar in nature since it is important to know an organization’s ability to generate cash. The main purpose of funds from operations is to assess the cash returns of a business or company. It is therefore used as an indicator of financial health for an organization.
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The SEC filings from REITs nowadays contain a section dedicated to reconciling their reported net income to funds from operations (FFO). As a real-world example, the following screenshot is from the 10-K filing of BRE Properties. Let’s take funds from operations examples to understand the calculation of FFO.
How to calculate FFO
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All non-operating expenses are shown on the debit side and all non-operating incomes are shown on the credit side. If the debit side is more than the credit side, the difference is referred to as funds from operation. The reason for this paradox is that the profit and loss account records all expenses paid and outstanding, as well as all income (received and accrued). These measures also help investors determine whether the money is being used effectively by management.
Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Traditional GAAP metrics tend to fall short of portraying the actual operating profitability of REITs. The following pieces of information are necessary to calculate the funds from operations (FFO).
Unlike many non-GAAP measurements, the funds from operations (FFO) metric does have a quasi “official” formula. Most REITs adhere to Nareit’s formal definition and guidelines to compute FFO. That said, the funds from operations (FFO) metric is a practical method to estimate the capacity of a REIT to maintain, or perhaps raise, its current payout of cash dividends. The use of adjusted earnings in eps ensures that they are comparable to funds from operations.
It excludes the impact of certain items affecting a company’s net income for tax purposes to more accurately reflect the income produced from business activities during a certain period. CFO is how much money a company generates from its regular business activities and is reported on the cash flow statement. FFO, instead, refers to an REIT’s profitability by adding depreciation, amortization, and losses on sales of assets to earnings, then subtracting any gains on the sale of assets and interest income.
Growth in FFO and/or AFFO
However, an investor can easily find the variables needed to calculate FFO on a company’s income statement and balance sheet. Contrary to a common misconception, the funds from operations (FFO) metric is not designed to measure cash flow. Funds from operations can be defined as the difference between the inflow of funds in the form of expenses.
- The real estate industry has seen an upward trend, so investors prefer investing in REITs.
- FFO helps normalize a REIT’s earnings by adjusting for non-cash charges and one-time expenses that don’t fully reflect its underlying earnings.
- Traditional metrics such as EPS and P/E ratio are unreliable in estimating a REIT’s value.
For real estate investment trusts (REITs), standard metrics like earnings per share (EPS) or price-to-earnings (P/E) ratios may not deliver the most accurate picture you need of performance and value. Instead, professionals often turn to funds from operations (FFO) and adjusted funds from operations (AFFO) as key indicators. Understanding FFO and AFFO is thus crucial for accurately evaluating a REIT’s financial health, growth prospects, and overall investment potential. REITs are required to disclose their funds from operations to the general public. Search for what is funds from operations 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.
