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FFO (Funds from Operations)

December 5, 2023
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Key Takeaways

Introduction:

Funds from Operations (FFO) is a financial metric used by real estate investment trusts (REITs) to evaluate their operating performance and measure the cash flow generated from their operations. 

FFO provides investors with valuable insights into the cash flow and profitability of REITs, allowing for better evaluation and comparison of these investment vehicles.

Key Takeaways:

  • The FFO calculation involves adding depreciation, amortization, and losses on sales of assets to earnings, and then subtracting gains on sales of assets and interest income.
  • FFO is commonly reported on a per-share basis, providing a more meaningful measure for evaluating REITs.
  • It’s important to differentiate FFO from earnings per share (EPS) when assessing the performance of REITs.

How it Works:

The calculation of FFO involves adding several components to the net income of a REIT. These components include depreciation, amortization, and losses on sales of assets. These are added to the earnings to reflect the cash flow generated by the REIT’s operations. From this sum, gains on sales of assets and interest income are subtracted.

The FFO-per-share ratio is often used as a more meaningful measure for evaluating REITs. It allows investors to assess the cash flow generated per share of the REIT, giving a clearer picture of the company’s profitability and ability to distribute dividends.

Key Components:

The components of the FFO calculation are derived from a REIT’s income statement. These include:

  • Net Income (NI): The total income generated by the REIT.
  • Depreciation (D): The accounting method used to allocate the cost of an asset over its useful life.
  • Amortization (A): The gradual reduction of an intangible asset’s value over time.
  • Property Sales Losses (PSL): Losses incurred from the sale of assets.
  • Property Sales Gains (PSG): Gains realized from the sale of assets.
  • Interest Income (II): Income earned from interest on investments.

Benefits:

  • Operating Performance Benchmark: FFO provides a benchmark for evaluating the operating performance of a REIT, allowing investors to assess its profitability and cash flow generation.
  • Supplement to EPS: FFO serves as a supplement to earnings per share (EPS) when evaluating REITs, as it provides a more comprehensive measure of the company’s cash flow and profitability.
  • Valuation Tool: FFO per share can be used alongside other metrics, such as price-to-earnings (P/E) ratio, to determine the value and potential of a REIT.

Takeaway:

Funds from Operations (FFO) is a crucial metric for evaluating the financial health and operational efficiency of Real Estate Investment Trusts (REITs). 

By accounting for depreciation and amortization, FFO offers a clearer view of a REIT’s cash flow than traditional earnings metrics, making it a vital tool for investors. 

FFO per share is particularly useful as it provides a direct measure of the income generated per share, allowing for more accurate assessments of a REIT’s profitability and potential for dividend distribution. 

Investors and analysts should use FFO in conjunction with other financial measures for a well-rounded analysis of a REIT’s performance. Understanding FFO is key to making informed decisions in the complex world of real estate investments.

Disclaimer: The information on this website, including glossary definitions, is for educational and informational purposes only and not intended as professional advice. While we strive for accuracy, we make no guarantees regarding the completeness, reliability, or timeliness of the information provided. We are not liable for any loss or damage arising from your use of the site. Investment decisions in commercial real estate should be made based on individual due diligence and professional advice. Laws and regulations are subject to change; always consult legal and financial experts before making decisions.

Sources:

https://www.investopedia.com/terms/f/fundsfromoperation.asp

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