Funds from operations
Sector Deep DivesNet income adjusted to add back property depreciation and strip out gains on sale, the standard earnings measure for a REIT.
Also written: FFO
Property accounting depreciates buildings, but well maintained real estate in a good location does not generally lose value that way, so net income systematically understates a property company's earnings.
FFO corrects for that: net income plus real estate depreciation and amortisation, less gains from property sales, which are one off and would otherwise flatter recurring earnings.
It is the sector's equivalent of EBITDA, and REITs are quoted on price to FFO in the way industrials are quoted on EV/EBITDA. Dividend capacity is assessed against it too.
It is not a cash figure, which is where AFFO comes in: subtracting maintenance capital expenditure and adjusting for straight lined rent gives a far better measure of what can actually be distributed.
Worked example
Net income 120, real estate depreciation 200, gain on a property sale 45.
FFO is 120 plus 200 less 45, so 275. Depreciation is added back because well maintained buildings do not lose value the way the accounts assume, and the disposal gain is removed because it will not recur.
Subtract 60 of maintenance capex and leasing costs, and reverse 15 of straight lined rent, and AFFO is 200. That is the figure a dividend should be tested against.