Showing posts with label funds from operations. Show all posts
Showing posts with label funds from operations. Show all posts

Thursday 1 November 2012

Funds from Operations (FFO) of REITS


What It Is:

Funds from Operations (FFO) is a measure of cash generated by a real estate investment trust (REIT). It is important to note that FFO is not the same as Cash from Operations, which is a key component of the indirect-method cash flow statement.

How It Works/Example:

The formula for FFO is:
Funds from Operations = Net Income + Depreciation + Amortization - Gains on Sales of Property
Let's assume Company XYZ is a REIT that owns several properties. Last year, Company XYZ's income statement looked like this:



Using the formula above, we can calculate Company XYZ's FFO as follows:

$2,500,000 + $2,000,000 - $200,000 = $4,300,000

REITs and similar trusts typically disclose FFO in the footnotes to their financial statements (and in many cases in the headlines of their press releases), and they are required to show their calculations.

Why It Matters:

In general, the adjustments FFO makes to net income are intended to compensate for accountingmethods that may distort a real estate investment trust's true performance. This is especially true ofdepreciationGAAP accounting requires REITs to depreciate their investment properties over time. However, many REIT properties actually appreciate over time, and for this reason, the required depreciation expense tends to make net income appear artificially low. FFO also adjusts for gains (or losses) on the sale of properties because they are not recurring and therefore do not contribute to the REIT's ongoing dividend-paying capacity (REITs are required to pay out 90% of their taxable income in dividends). Some analysts go a step further and calculate AFFO (Adjusted Funds from Operations), which adjusts FFO for rent increases and certain capital expenditures.

Many analysts prefer to examine FFO instead of net income when measuring a REIT's financial performance. Similar to EPS (earnings per share), FFO per share is a carefully scrutinized metric that is often used as a barometer to gauge a REIT's profitability per unit of shareholder ownership. Meanwhile, the interpretation of price/FFO multiples may generate valuation insights similar to those generated by P/E multiples. As such, FFO is a key driver of share prices.

Though FFO is widely considered to be the most popular method of quantifying a real estate firm's profitability, it's important to remember that FFO can often be susceptible to manipulation, accounting changes, and restatements. Nevertheless, FFO remains the industry standard in determining investment-trust profitability for shareholders.


Saturday 4 July 2009

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.