With this FFO calculator, you can easily calculate the funds from the operation of a company. The fund from operation (FFO) is a metric that will help you analyze the performance of a real estate investment trust (REIT).
This article will help you understand what FFO is and how to calculate the metric using the FFO formula. We will also show you its application by demonstrating some examples.
What are funds from operation (FFO)? The FFO meaning
Funds from operation, also known as the FFO, is probably one of the most popular metrics used to analyze REITs (real estate investment trusts). When analyzing the REITS, FFO is seen as an improvement on the operating cash flow. This is because, as per the FFO definition, the metric excludes any one-time cash inflows, such as the gains and losses from property sales.
Besides, the FFO also strips away interest income as it is considered earnings from financial activities. Hence, the funds from operation are always used to analyze the REIT's ability to pay out dividends. The higher the FFO, the more secure the dividend payment from the REIT is. Our dividend calculator can help you understand how dividends work.
How to calculate the FFO. The FFO calculator in action
Now that you understand the FFO definition, we can talk about the funds from operations calculation.
To understand the funds from operation formula, let's take REIT Alpha with the following information as an example:
- Net income:
- Depreciation and amortization:
- Gains from property sales:
- Losses from property sales:
- Interest income:
There are five steps the FFO calculator follows:
Determine the net income
net incomecan be found on the bottom line of the company's income statement. The
net incomefor REIT Alpha is
Determine the depreciation and amortization
The depreciation and amortization, or
D&A, is the depreciated value of the company assets. You can find it in the income statement too.
The REIT Alpha's
Determine the gains and loss from property sales
lossesfrom property sales are any money earned or lost while selling properties, respectively.
lossesfor REIT Alpha are
Determine the interest income
The next step is to determine the
interest income, which for REIT Alpha is
Calculate the funds from operation (FFO)
The last step is to calculate the FFO using the FFO formula below:
FFO = net income + D&A + losses - gains - interest income
Hence, the REIT Alpha's
$500,000 + $150,000 + $80,000 - $125,000 - $75,000 = $530,000.
Why is the FFO formula a good way to analyze a REITs' performance?
After understanding what FFO is and how to calculate funds from operations, it is time for us to talk about the true meaning of FFO - why is this metric so suitable for analyzing REITs?
The funds from operations formula was invented to analyze REITs because conventional accounting methods are not suitable for REITs. This is due to the fact that most accounting methods require companies to depreciate their property. However, for REITs, most of their properties actually increase in value over time. You can use our depreciation calculator to calculate the depreciation.
Moreover, the FFO always strips away any gains or losses from property sales as these earnings are considered non-recurring. With these two features, FFO can create a more accurate picture than other metrics when it comes to analyzing REITs.
What is a REIT?
REIT stands for a real estate investment trust. REITs are companies that own and operate income-producing properties.
These can include residential or commercial properties. They usually reward their investors by paying out high dividends.
Can FFO be negative?
Yes, FFO can be negative. A negative FFO usually means that the real estate investment trust (REIT) is performing poorly and is not generating enough cash to pay its investors.
What is a good FFO?
There is no hard and fast rule for a good FFO. It depends on the industry that the REIT is in. Hence, the best way to assess this metric is to compare it to the industry mean.
What is AFFO?
AFFO stands for adjusted funds from operation. AFFO is defined as FFO that takes into account recurring maintenance costs and straight-lining of rents.
How do I calculate funds from operations?
To calculate the funds from operations:
- Check the net income.
- Find the depreciation and amortization (
- Estimate the gains and loss from property sales.
- Determine the interest income.
- Sum the net income, D&A and losses and subtract the gains and interest income to find the FFO.