What Is Funds From Operations (FFO)? How to Evaluate REITs

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Funds from operations (FFO) is a measure of a real estate investment trust’s operating performance. It starts with net income and adds back real estate depreciation and amortization. It then removes gains and losses from selling properties, along with impairment write-downs on real estate. What remains is the income produced by owning and leasing properties, without the accounting charges and one-off transactions that make a REIT’s net income hard to read. FFO is a non-GAAP measure. The National Association of Real Estate Investment Trusts (Nareit) created it, and it is the standard earnings figure for REITs, in the way earnings per share is for most other companies.

What FFO means and why it exists

Under GAAP, a REIT must depreciate its buildings over their useful lives, the same way a manufacturer depreciates machinery. The depreciation expense reduces net income every year, even though well-located real estate often holds or gains value over time, and the expense involves no cash leaving the business in that period. A REIT with a large, mature portfolio can therefore report modest net income while its properties generate strong rental income.

Property sales distort net income in the other direction. A REIT that sells a building at a large gain reports a jump in net income for that quarter, but the gain says little about the rent the remaining portfolio will produce.

FFO deals with both problems. It adds the depreciation back and takes the sale gains out, which leaves a figure that reflects recurring property operations. Nareit published its definition in the early 1990s and has clarified it several times since. The goal was to give investors one consistent figure they could compare from one REIT to another.

The FFO formula

Nareit’s definition can be written as:

FFO = Net income + Real estate depreciation and amortization + Impairment write-downs of depreciable real estate − Gains on sales of real estate + Losses on sales of real estate (± adjustments for unconsolidated joint ventures and partnerships)

Each term does a specific job:

1. Net income. This is the GAAP figure at the bottom of the income statement. If the REIT has preferred stock, analysts usually start from net income available to common shareholders so that FFO per share reflects common equity only.
2. Real estate depreciation and amortization. Add back the depreciation on buildings and improvements and the amortization of real estate intangibles, such as acquired in-place leases. Depreciation on non-real-estate assets, such as office equipment, generally stays in the calculation.
3. Impairment write-downs. When a REIT writes down the carrying value of a depreciable property, the charge reduces net income. Nareit’s definition adds it back, so an impairment on real estate does not lower FFO.
4. Gains and losses on property sales. Subtract gains and add back losses. Selling buildings is treated as a capital transaction rather than part of running the portfolio.
5. Joint venture adjustments. If the REIT owns part of properties through unconsolidated ventures, its share of their depreciation and sale gains is adjusted the same way.

Some simplified versions of the formula also subtract interest income. That step is not part of Nareit’s definition. Interest expense, on the other hand, is never added back. FFO is measured after the cost of debt, which is one of the main ways it differs from EBITDA and NOI.

FFO per share is FFO divided by the weighted average number of diluted shares (and, for REITs organized as UPREITs, often operating partnership units as well).

Where to find FFO

You rarely need to calculate FFO yourself. Publicly traded REITs typically report FFO and FFO per share in their quarterly earnings releases and supplemental financial packages, and discuss it in the management’s discussion section of their annual and quarterly filings. Because FFO is a non-GAAP measure, SEC rules require the company to reconcile it to net income when it presents the figure. That reconciliation table is the most useful place to look: it shows each adjustment line by line, including any items management added beyond the Nareit definition.

Worked example (hypothetical)

Take a fictional REIT with 100 million diluted shares that reports the following for the year:

FFO = $50M + $30M + $5M + $4M − $12M = $77 million

FFO per share = $77M ÷ 100M shares = $0.77, compared with EPS of $0.50.

The gap between $0.50 and $0.77 is mostly depreciation. The $12 million gain inflated net income, and FFO removes it. Without the adjustment, an investor might read the year as stronger than the rental business justifies.

Now suppose the shares trade at $11.55 (a hypothetical price):

• Price-to-FFO = $11.55 ÷ $0.77 = 15x
• FFO yield = $0.77 ÷ $11.55 ≈ 6.7%

A historical example

Simon Property Group, a large mall REIT, reported net income of about $2.2 billion for 2017 and FFO of about $4 billion, up 6% from 2016. Most of the difference came from adding back roughly $1.8 billion of depreciation and amortization, with smaller adjustments for preferred distributions and noncontrolling interests. Diluted FFO per share was $11.21, against diluted EPS of $6.24. A P/E ratio built on the $6.24 figure would have made the stock look far more expensive than the P/FFO multiple suggested.

How investors use FFO

Valuation. Price-to-FFO is the REIT counterpart of the P/E ratio. Comparing it with the multiples of similar REITs (same property type, similar leverage) shows how the market prices each dollar of operating earnings. FFO yield is the inverse view, useful when comparing REIT earnings with bond yields. Many investors pair FFO multiples with a property-value view such as net asset value, because the two answer different questions: what the earnings stream is worth versus what the buildings would fetch.

Growth. Year-over-year growth in FFO per share shows whether rent increases, occupancy gains and acquisitions are adding to earnings for shareholders, after the effect of issuing new shares.

Dividend coverage. U.S. REITs must distribute at least 90% of their taxable income as dividends to keep their REIT status, so dividends tend to absorb a large part of earnings. Comparing the dividend per share with FFO per share gives a payout ratio. In the hypothetical above, a $0.60 dividend would be about 78% of FFO. As the next section shows, FFO can overstate how comfortably a dividend is covered.

FFO vs. AFFO

FFO adds back all real estate depreciation, but buildings do wear out. Roofs, parking lots, HVAC systems and tenant improvements cost real money to replace. Adjusted funds from operations (AFFO) subtracts these recurring capital expenditures. It also typically removes straight-line rent, the accounting practice of spreading scheduled rent increases evenly over a lease, which books more rent than tenants actually pay in the early years.

Continuing the hypothetical: if the REIT spent $10 million on recurring maintenance capital and had a $3 million straight-line rent adjustment, AFFO would be $77M − $10M − $3M = $64 million, or $0.64 per share. The same $0.60 dividend now consumes about 94% of AFFO instead of 78% of FFO. That leaves much less room if rents fall.

AFFO is generally viewed as the better estimate of dividend-paying capacity. It also goes by names such as funds available for distribution (FAD) or cash available for distribution (CAD). The trade-off is that no industry body standardizes AFFO, so each company decides what counts as recurring capital spending. Comparing one REIT’s AFFO with another’s requires reading both reconciliations.

FFO vs. other measures

Cash flow from operations. This figure comes from the GAAP statement of cash flows. It includes changes in working capital, such as rent collected in advance or bills not yet paid, so it can swing from quarter to quarter for reasons unrelated to the portfolio’s earning power. FFO is an earnings measure, not a liquidity measure. It ignores working capital timing, and it excludes cash from financing (such as loan proceeds) and from property sales.

Net operating income (NOI). NOI is a property-level figure: rental and other property revenue minus property operating expenses. It is calculated before interest expense, corporate overhead and depreciation. NOI describes how the buildings perform. FFO describes what the company earns for shareholders after paying for its debt and management.

EBITDA. EBITDA adds back interest, taxes, depreciation and amortization, so it measures earnings available to all capital providers. FFO keeps interest expense in, which makes it a measure of earnings for equity holders.

EPS. Earnings per share uses GAAP net income, including depreciation and sale gains. For most companies it is the headline figure. For REITs, it is usually read next to FFO per share rather than instead of it.

FFO in credit analysis. Outside real estate, credit analysts use leverage ratios such as FFO to debt for corporate borrowers. In that setting FFO is defined by the analyst or rating agency, roughly as operating cash flow before working capital changes. It is not the Nareit REIT measure, even though it shares the name.

Limitations of FFO

• It ignores maintenance spending. Adding back all depreciation treats buildings as if they never need reinvestment. Property types with heavy upkeep or frequent tenant turnover can show high FFO that overstates distributable cash.
• Company adjustments vary. Many REITs report “core FFO,” “normalized FFO” or similar figures that strip out additional items such as acquisition costs or debt extinguishment charges. These go beyond the Nareit definition and differ by company. Comparisons are most reliable when both REITs are measured on the same basis.
• Excluding sale gains is a judgment call. Some REITs regularly sell and recycle properties as part of their strategy. FFO treats those gains as nonrecurring even when they happen every year.
• It is not cash flow. A REIT can report healthy FFO while working capital needs, development spending or debt maturities pull cash the other way.
• It says nothing about balance-sheet risk. Two REITs with identical FFO per share can carry very different debt loads. A highly leveraged REIT’s FFO is more exposed to rising interest rates when its debt refinances.

FAQs

The Bottom Line

REIT investors should read FFO per share and price-to-FFO alongside EPS, because GAAP depreciation can make a property portfolio look weaker than its rental income shows. For judging dividend safety, AFFO gives a more realistic view because it subtracts recurring capital spending. Check each company's reconciliation table before comparing figures, since core FFO and AFFO adjustments vary from one REIT to another.