REITS and Returns

REITS and Returns

Funds from operations (FFO) is an important measure of a REIT's operating performance. 

FFO includes all income after operating expenses, but before depreciation and amortization.

Growth in FFO typically comes from:

• higher revenues,
• lower costs, and,
• management's effective recognition of new business opportunities.

REITs with a growing FFO are generally more desirable,because this is a demonstration of an ability

• to raise rents and
• keep occupancy stable.

Beware of dividends that are being paid out of profit from the sale of property or from cash reserves; these payments may not be sustainable.

The National Association of REal Estate Trusts (NAREIT at www.nareit.com ) defines FFO as net income (excluding gains or losses from sales of property or debt restructuring) with the depreciation of real estate added back. 

• Most commercial real estate holds its value longer and more fully than other tangible equipment that a business may possess, such as tools or vehicles.
• The depreciation that the accounting process records each year is often overstated.

Current accounting processes may call for depreciation of a building (according to a certain formula) even though the real value of the building may have increased due to outside forces like

• increased demand or
• low supply of vacancies

in the area where the building is located. For this reason, adding back the depreciation is a clearer way to measure the operating profits of one REIT against another.

FFO is more like the cash flow measures used to evaluate other businesses, and in most cases more completely demonstrates annual performance.