Funds from operations (FFO) is a measure of cash flows used in real estate investment trusts (REIT) valuation. It equals net income plus depreciation expense plus deferred tax expense plus any loss on assets minus any gain on assets. AFFO stands for adjusted funds from operations and it equals FFO minus revenue accruals minus capital expenses.

One of the most common method of REIT valuation is the relative valuation using P/FFO and P/AFFO measures. P/FFO and P/AFFO multiples a better measure of an REIT’s profitability than the price to earnings (P/E) multiple.

Funds from operations (FFO)

The general accepted accounting principles (GAAP) measure of income, determined in accordance with US GAAP or IFRS, are not very relevant in case of REITs because an REIT’s value is derived from the value of the underlying real estate. Accounting standards allow such real estate to be accounted based on historical costs model which involves recognizing revenue on straight-line basis and charging depreciation expense which is a non-cash item.

Funds from operations is a proxy for cash flows which is a better indicator of the properties’ economic income.

Funds from operations can be calculated using the following formula:

$$ FFO=NI+D+DT+L-D $$

Where NI is net income, D is depreciation expense, DT is the deferred taxes, L is the loss on properties or debt restructuring and G is any associated gain.

P/FFO is a ratio of share price of an REIT to its funds from operations. P/FFO ratios of comparable properties when multiplied with FFO per share of the REIT under considered gives us an estimate of the intrinsic value of the RIET’s share.

FFO is to an REIT what EBITDA is to a regular industrial entity.

Adjusted funds from operations (AFFO)

Adjusted funds from operations (AFFO) is an even more refined measure of REIT’s cash flows. It equals FFO minus any accruals of revenue minus any capital expenditures which must be incurred to maintain the properties owned and managed by the REIT. It is also called funds available for distribution (FAD) or cash available for distribution (CAD).

AFFO can be calculated using the following formula:

$$ AFFO=FFO\ -\ A\ – C $$

Where AFFO is adjusted funds from operations, FFO is funds from operations, A is the accrued rent and C is the capital expenses.

P/AFFO ratio can be used just like P/FFO ratio to value an REIT.

AFFO is to an REIT what free cash flow (FCF) is to a traditional corporate.

Written by Obaidullah Jan, ACA, CFA and last modified on