Funds from Operations (FFO): Tutorial + Excel Examples (2024)

Funds from Operations (FFO) Definition: For Equity REITs, FFO equals Net Income + Real Estate-Related Depreciation & Amortization + Losses / (Gains) on Property Sales + Impairments. It is an improved version of Net Income that more accurately represents a REIT’s operating performance and may better indicate the Dividends a REIT can issue, which is critical for its business model.

Here’s an example calculation for AvalonBay, a multifamily REIT in the U.S.:

As background information, a real estate investment trust (REIT) is a company that buys, sells, develops, and operates properties and complies with very specific requirements to be exempt from corporate taxes (or pay very little in corporate taxes).

For example, U.S.-based REITs must distribute 90% of their Net Income as Dividends and earn 75% of their profits from real estate; also, 75% of their total assets must be real estate-related.

Due to the Dividend requirements, REITs maintain very low Cash balances and must, therefore, raise Debt and Equity constantly to acquire and develop properties.

For REITs, the FFO metric is an improved version of Net Income that more accurately captures their ability to issue Dividends.

Depreciation is a large non-cash expense for REITs, but it does not reduce their cash flow, so FFO adds it back.

Gains and Losses are non-recurring items that get reversed in the FFO calculation because they do not affect a REIT’s long-term ability to issue Dividends.

They do reduce the REIT’s income from properties, but the REIT typically redeploys the proceeds from these sales into new properties and makes up for it like that.

FFO does not “replace” traditional cash flow metrics such as Free Cash Flow (FCF) or Unlevered Free Cash Flow (UFCF).

It is a more relevant version of Net Income designed for the specific business nuances of REITs.

You can see the differences between FFO, FCF, and UFCF in this chart below for AvalonBay:

Files & Resources:

Funds from Operations – AvalonBay Calculations and Public Comps (XL)

Funds from Operations – Slides (PDF)

AvalonBay – 10-K Excerpts for FFO Calculation (PDF)

Vicinity Centres – Annual Report Excerpts for FFO Calculation (PDF)

Full Annual Reports – AvalonBay | Vicinity Centres

Video Table of Contents:

• 0:00: Introduction
• 4:20: Part 1: Why We Use FFO for REITs
• 6:42: Part 2: Using FFO to Value REITs in Real Life
• 8:19: Part 3: IFRS vs. U.S. GAAP Differences
• 9:52: Part 4: FFO vs. FCF vs. NOI
• 11:48: Part 5: AFFO and Other Variations of FFO
• 13:20: Recap and Summary

Using Funds from Operations (FFO) to Value REITs in Real Life

In REIT valuation, you can use standard metrics and multiples such as EBITDA and TEV / EBITDA.

However, instead of Net Income and the P / E multiple, you should use Funds from Operations and the P / FFO multiple (Price per Share / FFO per Share or Equity Value / FFO).

If a REIT is growing its FFO more quickly than other, similar REITs, it should, in theory, trade at a higher FFO multiple.

In this set of public comps for AvalonBay, we see this expected, boring result:

In reality, this relationship between growth rates and multiples doesn’t always hold up for REITs because factors like leverage, development/acquisition activities, and focus geography also play big roles.

FFO multiples often vary more by REIT sub-sector (e.g., office vs. industrial vs. apartment) than by specific growth rates, especially since most REITs grow in a narrow range.

Outside of valuation, many investors and analysts also use FFO to benchmark REITs and compare their operational efficiency, profitability, and dividend-paying potential.

IFRS vs. U.S. GAAP Differences in the Funds from Operations Calculation

Under IFRS rules, REITs do not depreciate their properties; instead, they periodically revalue them and record the Unrealized Gains and Losses from these revaluations on their financial statements.

So, for non-U.S. REITs, we must adjust for both Realized and Unrealized Gains/Losses when calculating FFO to ensure it accurately reflects the operational performance.

There is no Depreciation add-back, but the adjustment for Gains and Losses is even bigger because Realized and Unrealized Gains and Losses are included.

Here’s an example for Vicinity Centres, an Australian REIT:

In other regions, REITs often use variations on FFO.

For example, many European REITs use EPRA Earnings, which is similar to FFO, but with these Unrealized Gains and Losses in place of Depreciation and additional adjustments for Deferred Taxes and a few other items.

Funds from Operations vs. Free Cash Flow

Free Cash Flow (FCF) more accurately represents the ongoing cash-flow generation of any company, including REITs, because it fully deducts Capital Expenditures (CapEx) and reflects the Change in Working Capital.

Free Cash Flow is normally defined like this:

FCF = Net Income + Depreciation & Amortization + Losses / (Gains) + Impairments +/- Change in Working Capital – CapEx

Because of this deduction for CapEx, which is always high for REITs, FCF is always significantly lower than FFO.

Here’s a full comparison for AvalonBay:

Since property acquisitions, developments, redevelopments, and sales are all recurring activities core to the business, they should all be part of a REIT’s CapEx.

Unlevered Free Cash Flow (UFCF) is similar in many ways since it also fully deducts CapEx; the difference is that it adds back the Net Interest Expense so that it’s capital structure-neutral:

Technically, we should adjust the Taxes for this Interest Expense add-back as well, but since they’re negligible for AvalonBay here, we don’t bother with that.

Funds from Operations (FFO) vs. Net Operating Income (NOI)

Funds from Operations (FFO) and Net Operating Income (NOI) are both important metrics for REITs, but they are calculated differently and represent different aspects of a REIT’s performance.

NOI is a property-level metric representing the total income generated from a REIT’s properties minus the cash operating expenses incurred, such as insurance, property taxes, management fees, and the sales and marketing required to attract new tenants.

It does not factor in the REIT’s corporate-level expenses, such as administrative costs, management fees, executive salaries, depreciation on the properties, or the interest payments on debt:

NOI is similar to EBITDA but for properties rather than normal companies.

FFO, on the other hand, is calculated at the trust or corporate level.

Since FFO deducts the REIT’s interest expense and corporate overhead, it’s always lower than NOI and more representative of the REIT’s Dividend-paying capacity.

Adjusted Funds from Operations (AFFO) and Other Variations

While Funds from Operations (FFO) is an “improved version of Net Income,” Adjusted Funds from Operations (AFFO) builds on FFO and brings it closer to the REIT’s “true cash flow.”

The exact definition of AFFO varies, but one common calculation method is as follows:

Adjusted Funds from Operations (AFFO) = FFO – Recurring Maintenance CapEx +/- Amortization of Lease Intangibles and Straight-Lining of Rent +/- Other Adjustments.

AFFO subtracts the recurring maintenance CapEx because this represents the ongoing spending the REIT needs to maintain its current properties and continue earning from them.

The Amortization of Lease Intangibles is an acquisition-related item with no cash impact, and the Straight-Lining of Rent is a common adjustment for office/retail/industrial properties related to rent recognized vs. cash payments received.

(Office, retail, and industrial properties usually use multi-year leases where the cash payments increase each year, but they recognize the rent evenly over each year of the lease term, which creates a difference in revenue recognized vs. cash revenue.)

AFFO may also add back or adjust for other non-recurring items in the last part of the formula (“Other Adjustments”).

Here’s an example of the AFFO calculation for Vicinity Centres in Australia:

While AFFO is closer to the “true cash flow” than FFO, it’s still far above actual Free Cash Flow because:

• AFFO does not factor in the Change in Working Capital, but FCF does.
• AFFO does not subtract Growth CapEx (i.e., spending on developing or acquiring new properties), while FCF does.

The other issue is that AFFO is a “non-standard” metric, and each REIT calculates it differently.

This makes a proper comparison difficult unless you go to the REIT’s statements and calculate AFFO manually in the same way for each REIT in your set.

Final Thoughts on Funds from Operations (FFO)

While Funds from Operations (FFO) is a critical metric for REITs that always factors into 3-statement models and valuations, it’s not the only metric you care about.

Free Cash Flow and EBITDA remain important, and other REIT-specific metrics, such as NOI and AFFO, are also useful.

As with any other metric, the key with FFO is to understand its uses, advantages, and disadvantages to interpret it properly.