The higher the FFO to total debt ratio, the stronger the position the company is in to pay its debts from its operating income, and the lower the company’s credit risk. The other limitations of FFO are the same as those for net income and earnings per share. Both FFO and net income are accrual measures of profitability, not cash measures of profitability. Also, neither accounts for the cost of capital necessary to maintain the existing level of earnings.
Why FFO Is a Good Measure of REIT Performance
Because of this, property owners are allowed to take an annual depreciation write-off. Depreciation is an investment principle that recognizes every tangible asset you buy will lose value and functionality over time. Newer, more modern assets come on to the market while your older asset continues to age. Fortunately, you don’t need to be an expert REIT analyst or look at income statements to get the FFO or AFFO for REITs that are publicly traded. You can let the experts do the work for you and simply look at the calculations yourself online. So, if you wanted to find details on a large REIT like Prologis (PLD) or Simon Property Group (SPG), you could simply do a Google search for “Prologis FFO” or “Simon Realty AFFO” and get all the numbers you need.
Picking the Best REITs With FFO
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. These measures also help investors determine whether the money is being used effectively by management. Also, many analysts and investors assess a REIT’s price-FFO ratio as a supplement to the price-to-earnings (P/E) ratio, 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. As mentioned, FFO per share is sometimes provided by firms as a supplement to their EPS.
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For example, if a REIT sold an asset during one period at a gain and another one during the next period at a loss, the sales could significantly affect a REIT’s reported net income between the two periods. They might lead investors to believe that the REIT’s operating performance has suffered dramatically. 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.
- Investors can also use FFO as a valuation metric similar to a price-to-earnings (PE) ratio.
- If the debit side is more than the credit side, the difference is referred to as funds from operation.
- For most businesses, depreciation is an acceptable noncash charge that allocates the cost of an investment made previously.
- Also, neither accounts for the cost of capital necessary to maintain the existing level of earnings.
FFO – Funds From Operations
Other variations include FFO as adjusted (FFOAA), normalized FFO, core FFO, and funds available for distribution (FAD). These metrics make adjustments for things such as straight-line rent, amortization of debt costs, share-based compensation, non-cash fair value adjustments, and some recurring capital expenses. It does not deduct the capital expenditures required to maintain the existing portfolio of properties. 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. To calculate the net FFO, one must add the non-cash expenses or losses that are not actually incurred from the operations, such as depreciation, amortization, and any losses on the sale of assets, to net income.
All the factors used while calculating the Funds from operations can be found in the company’s income statement. These factors include net income, depreciation, amortization, and gains on sales of property and extraordinary items. Funds from operations concept are required for the analysis of a REIT because when the underlying assets increase in value, then depreciation should not be factored into the results of operations. These finance terms are costs that need to be added back to net income to determine the actual earnings generated from the company’s core business operations.
Higher FFO often translates to higher dividend yields, attracting income-seeking investors. 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. 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. Finance Strategists is a leading financial education organization that connects people with financial professionals, priding itself on providing accurate and reliable financial information to millions of readers each year.
Adjusted Funds From Operations (AFFO) is an even more advanced and accurate way to measure a REIT’s performance. Although FFO is a popular measuring stick for a REIT’s performance, it is not a generally accepted accounting principle (GAAP), so investors who want to figure out an individual REIT’s FFO may have to calculate it themselves. The good news is, all the information you need to figure out a REIT’s FFO is available in its quarterly or annual income statement. Funds from operations give an actual picture of the cash inflow and the cash outflow in a company during a particular financial year. Thus, it helps you check how efficiently the what is funds from operations business uses its resources to generate sufficient funds for operations.
