What Is Funds From Operations (FFO)?
Funds from operations is the standardized earnings metric for real estate investment trusts, defined by Nareit, the industry's trade association. It adjusts GAAP net income for the quirks of property accounting so investors can see the recurring cash-generating power of a REIT's portfolio. Virtually every US REIT reports FFO and FFO per share alongside its GAAP results each quarter.
The metric exists because depreciation distorts real estate earnings. GAAP requires buildings to be depreciated over decades as if they steadily lose value, yet well-maintained commercial properties often appreciate. A REIT can therefore report thin net income while distributing substantial cash to shareholders, and FFO bridges that gap by stripping the largest non-cash charge out of the earnings picture.
How FFO Is Calculated
The Nareit definition starts with net income, adds back depreciation and amortization related to real estate, excludes gains or losses from selling properties, and excludes impairment charges on real estate. Suppose a REIT reports $200 million of net income, $350 million of real estate depreciation, and a $50 million gain on a property sale. Its FFO would be $200 million plus $350 million minus $50 million, or $500 million.
Analysts often go a step further to adjusted funds from operations, or AFFO, which subtracts recurring capital expenditures and straight-line rent adjustments to approximate distributable cash flow. AFFO gives a stricter view of what a REIT can sustainably pay out, which matters because REITs must distribute at least 90% of taxable income as dividends to keep their tax status.
How Investors Use FFO
FFO per share is the REIT world's answer to EPS, and price-to-FFO is its answer to the P/E ratio. A REIT trading at $60 with $4.00 of FFO per share carries a 15x P/FFO multiple, which investors compare against peers in the same property sector. Dividend safety is also judged against FFO: a payout ratio near or above 100% of FFO signals the distribution may be at risk.
For candidates interviewing with real estate investment banking groups or REIT-focused investors, fluency in FFO is expected. A common question asks why REITs are not valued on P/E, and the strong answer explains that real estate depreciation is a large non-cash charge that bears little relationship to economic reality, making net income an unreliable base while FFO restores comparability.
