Real estate investment trusts (REITs) utilize a metric known as funds from operations (FFO) to measure the cash flow generated from their operations. FFO is a crucial figure for REITs as it provides insight into the financial performance of the company and helps investors make informed decisions.
FFO is calculated by adding depreciation and amortization expenses to net income. Depreciation and amortization are non-cash expenses that are deducted from revenue to account for the decrease in value of assets over time. By adding these expenses back to net income, FFO provides a more accurate representation of the cash flow generated by a REIT’s operations.
FFO is an important metric for REITs because it allows investors to evaluate the company’s ability to generate cash flow from its core operations. Unlike net income, which can be impacted by non-operating expenses such as interest payments and taxes, FFO focuses solely on the cash generated by the company’s real estate holdings.
Furthermore, FFO is used by REITs to determine their dividend payouts. REITs are required by law to distribute at least 90% of their taxable income to shareholders in the form of dividends. Since FFO provides a more accurate measure of a REIT’s cash flow, it is often used as the basis for determining dividend payouts.
It is important to note that FFO is not a standardized accounting metric and can vary depending on the company. Some REITs may choose to adjust FFO to exclude certain expenses or include other items such as gains or losses from property sales. As a result, investors should carefully review a REIT’s financial statements to understand how FFO is calculated and how it compares to other companies in the industry.
Despite its limitations, FFO remains a valuable metric for evaluating REITs. By focusing on cash flow generated from operations, FFO provides a more accurate picture of a company’s financial health and its ability to generate returns for investors. As such, investors should pay close attention to FFO when evaluating REITs as part of their investment strategy.
