Funds From Operations (FFO)
Funds From Operations (FFO) is the key performance metric used to evaluate the operating performance of equity Real Estate Investment Trusts (REITs). Unlike traditional earnings per share (EPS), FFO adjusts for accounting distortions specific to real estate and provides a clearer view of a REIT’s recurring income-generating capacity.
Introduced in the early 1990s by NAREIT (National Association of Real Estate Investment Trusts), FFO was designed to address the limitations of GAAP net income for REITs. Standard accounting rules require REITs to deduct significant non-cash depreciation and amortization expenses, even though real estate assets often retain or increase their economic value over time. FFO adds these charges back to better reflect underlying operating performance.
Basic FFO Calculation – According to the standard NAREIT definition:
FFO = Net Income (GAAP)
+ Depreciation and amortization of real estate assets
– Gains on sales of real estate
FFO is typically reported on a per-share basis (FFO per share), allowing investors to compare operating performance across REITs and over time.
Why Income Investors Care About FFO
REITs are required to distribute at least 90% of taxable income to maintain their tax-advantaged status. FFO serves as a widely used proxy for the income available to support these distributions. Stable or growing FFO per share often translates into sustainable and rising dividends, making it a core metric for income-focused investors.
For example, a REIT reporting $500 million in GAAP net income and $200 million in depreciation may appear modestly profitable under traditional earnings metrics. However, its FFO would be $700 million, revealing significantly stronger income-generating capacity and clearer dividend coverage.
FFO versus Adjusted Funds From Operations (AFFO)
While FFO improves upon GAAP earnings, it does not account for recurring capital expenditures required to maintain properties. For this reason, many investors prefer AFFO (Adjusted Funds From Operations), which subtracts maintenance capex, leasing costs, and other recurring adjustments. AFFO is often viewed as the best approximation of cash truly available for distribution.
Example:
Consider a REIT that reports $200 million in FFO. On the surface, this suggests ample capacity to support dividends. However, the REIT also incurs:
- $40 million in recurring maintenance capital expenditures
- $15 million in tenant improvements and leasing costs
After these adjustments, the REIT’s AFFO falls to $145 million.
If the company pays $140 million in dividends, the payout appears conservative when measured against FFO, but much tighter when evaluated using AFFO. This distinction helps investors better assess dividend sustainability and avoid overestimating the strength of a REIT’s income stream.
Limitations
FFO is not a perfect metric. It is not a cash flow measure, excludes capital maintenance needs, and may vary slightly in calculation across companies. Investors should focus on FFO trends over time and compare REITs within the same sector.
In income investing and FIRE strategies, consistent FFO growth is a hallmark of high-quality REITs. It signals the ability to sustain attractive yields while gradually increasing distributions—an essential trait for investors seeking reliable and durable passive income.
See also: REIT, Total Return, FIRE.
FFO Definition must be know by serious income investors.