What it means
The problem FFO solves is that accounting depreciation badly misrepresents property. Standard accounting writes buildings down year after year as though they were wearing out, while well-maintained real estate in a good location often holds or increases its value, so reported net income can look far weaker than the rent actually collected.
FFO therefore adds property depreciation and amortisation back to net income. It also removes gains on property sales, because selling a building at a profit is a one-off event rather than evidence that the ongoing portfolio is producing more cash, and losses on sales are added back for the same reason.
The measure matters commercially because it drives how property companies are valued and how much they can distribute. Investors compare share price to FFO per share in much the same way they use a price to earnings ratio elsewhere, and dividend cover for a real estate investment trust is normally assessed against FFO rather than net income.
There is an important refinement called adjusted funds from operations, or AFFO. It subtracts recurring capital expenditure and straight-lining adjustments, which is closer to the cash genuinely available to shareholders because buildings really do need new roofs, lifts and tenant fit-outs.
The main caution is comparability. FFO follows a widely accepted industry definition, but AFFO and similar variants are not standardised, so two companies can present very different numbers from the same underlying portfolio and the adjustments need reading rather than trusting.
In practice
Real-world examples.
Example
An industrial property trust reports net income of $12,000,000 but FFO of $40,000,000, because depreciation on its warehouse portfolio is large. Analysts base their valuation on the FFO figure, noting that occupancy and rent collection were both above 97%.
Example
A retail property company sells three shopping centres at a profit, which triples reported net income for the year. Because the gains are excluded from FFO, the FFO line correctly shows that like-for-like portfolio performance was flat.
Example
A residential trust announces a dividend increase and justifies it by pointing to a payout of 72% of FFO. An analyst asks about AFFO instead, since the trust's older buildings require heavy recurring capital spending that FFO ignores.
Think of it
“FFO is cash flow measure for REITs-net income plus depreciation minus gains.
Formula
Calculation
FFO = Net income + Depreciation and amortisation on property + Losses on property sales - Gains on property sales. FFO per share = FFO / Weighted average shares outstanding.
Suppose a real estate investment trust reports net income of $28,000,000 for the year, property depreciation and amortisation of $45,000,000, and a $6,000,000 gain on the sale of an office building. FFO is $28,000,000 + $45,000,000 - $6,000,000 = $67,000,000. With 50,000,000 weighted average shares outstanding, FFO per share is $67,000,000 / 50,000,000 = $1.34. If the shares trade at $20.10, the price to FFO multiple is $20.10 / $1.34 = 15.0 times. Had the trust also spent $9,000,000 on recurring maintenance capital expenditure, AFFO would be $67,000,000 - $9,000,000 = $58,000,000, or $1.16 per share.Case study
Seen in the real world.
This is an illustrative and entirely fictional example. Kestrel Yard REIT, an invented owner of urban logistics warehouses, reported net income of $28,000,000 in a year when several long-standing investors complained that earnings looked thin relative to the dividend.
Management walked through the fictional bridge at its results presentation: adding back $45,000,000 of property depreciation and removing a $6,000,000 gain on an office disposal produced FFO of $67,000,000, or $1.34 per share against 50,000,000 shares. The dividend of $0.94 per share represented 70% of FFO rather than the alarming multiple of net income the complaint had implied.
Management then pre-empted the obvious follow-up by publishing AFFO as well. After $9,000,000 of recurring capital expenditure, AFFO was $58,000,000, or $1.16 per share, putting the dividend at 81% of AFFO, a number the board described as its real constraint on future increases.
Watch out
Common mistakes.
- Treating FFO as cash flow. It is an adjusted earnings measure that ignores working capital movements, debt repayments and capital expenditure, so it is not the same as cash from operations.
- Comparing FFO with net income as if the gap indicated poor quality earnings. For property companies a large gap is normal and is mostly explained by depreciation on assets that are not actually losing value.
- Assuming AFFO is defined the same way everywhere. Unlike FFO, adjusted measures vary between companies, so the adjustments must be read line by line before comparing two trusts.
Questions
People also ask.
Why exclude gains on property sales?
Because a disposal profit is a one-off event that says nothing about how the retained portfolio is performing, and including it would make earnings jump around with transaction timing.
Is FFO used outside real estate?
Rarely; other sectors use measures such as EBITDA or free cash flow, because the depreciation distortion FFO corrects is specific to long-lived property assets.
Which matters more for dividend safety, FFO or AFFO?
AFFO, because it deducts the recurring capital spending a building genuinely needs, so it is closer to the cash a trust can distribute sustainably.
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