A.CRE

Funds from Operations

A widely accepted metric used to analyze the performance of a REIT. Funds from Operations, or FFO, accounts for the fact that net income on a REIT’s income statement may be an inaccurate representation of the REIT’s true performance. As such, net income is adjusted as follows to arrive at FFO:

FFO = Net Income + Depreciation + Amortization – Gain/Loss on Sale of Properties.

Funds from Operations is comparable to the Cash Flow from Operations metric, used in analyzing individual properties.

Putting ‘Funds from Operations’ in Context

Scenario Overview

MidWest Residential REIT, a publicly traded real estate investment trust, has recently acquired a Class B, market-rate multifamily property called Willow Creek Apartments, located in suburban Chicago, Illinois. The 300-unit garden-style property, built in 1995, was purchased for $60 million at a 5.5% cap rate based on the in-place net operating income (NOI). MidWest Residential REIT uses Funds from Operations (FFO) as a key metric to evaluate the performance of its real estate portfolio and communicate results to its investors.

Key Financial Details

  • Acquisition Price: $60 million
  • Net Income: $2.5 million per year
  • Depreciation and Amortization: $800,000 per year
  • Gain on Sale of a Previous Property: $0

Calculating Funds from Operations (FFO)

Funds from Operations adjusts net income to provide a clearer picture of the REIT’s operational performance, eliminating non-cash deductions and excluding one-time gains or losses. For Willow Creek Apartments, the FFO calculation is as follows:

Formula:

  • FFO = Net Income + Depreciation + Amortization – Gain/Loss on Sale of Properties

Plugging in the numbers:

  • FFO = 2,500,000 + 800,000 + 0 – 0; FFO = 3,300,000

Analysis

The FFO for Willow Creek Apartments is $3.3 million. This metric allows MidWest Residential REIT and its investors to understand the property’s contribution to the REIT’s overall cash-generating performance, excluding the effects of non-cash charges (e.g., depreciation) and irregular transactions (e.g., gains from property sales).

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