Funds From Operations (FFO and AFFO)

What it measures

GAAP requires a building to be depreciated over a fixed schedule, so a large non-cash charge runs through net income every year regardless of what is happening to the property's market value or its rent roll. A well-leased office tower in a rising market can carry the same depreciation charge as one losing tenants, because the schedule is set by the tax code and accounting convention, not by the building's actual condition or income.

That charge can push a REIT's net income to a thin number or a loss in a year when it collected full rent, paid its debt service on time, and funded its distribution entirely out of cash. Nareit defined funds from operations in 1991, and has revised the definition since, specifically to strip that distortion out and let REITs be compared against each other rather than against industrial companies whose machinery genuinely wears out on the depreciation schedule it is assigned.

FFO is a property-level operating measure. Unless a company states otherwise, it sits above capital spending, debt principal repayment and preferred dividends, so it is not a measure of free cash left over for common shareholders — it describes operating performance, not what remains to be distributed.

The SEC classifies FFO as a non-GAAP measure. Any REIT that reports it is required to reconcile it back to net income in its filings, and that reconciliation table — not the headline FFO number in a press release — is where the adjustments, and the judgment behind them, are actually visible.

How it is calculated

Written out, FFO equals net income attributable to common shareholders, plus depreciation and amortisation of real property, plus impairment write-downs of depreciable real estate, minus gains on sales of depreciable property, plus losses on sales of depreciable property, plus the REIT's proportional share of the same adjustments from unconsolidated joint ventures. The depreciation add-back is normally the largest single line and is the entire reason the measure exists.

Gains on sale are removed because a REIT that sold a building at a large profit would otherwise look far more profitable in a year when nothing about its ongoing rents actually changed; losses are added back for the mirror-image reason, so that a one-time write-down does not make an otherwise stable operator look like it is failing.

FFO per share divides the result by weighted-average diluted shares, which for a REIT organised as an UPREIT includes operating-partnership units — a share count that can run materially higher than the common share count alone. From there, P/FFO (share price divided by FFO per share) functions as the REIT sector's substitute for a price-to-earnings ratio, and a payout ratio is written as distributions per share divided by FFO per share, or on the stricter basis, by AFFO per share.

FFO, AFFO, and the gap between them

Adjusted funds from operations — also published under the names cash available for distribution or funds available for distribution — starts from FFO and subtracts the spending the base measure ignores. The usual subtractions are recurring maintenance capital expenditure, tenant improvements and leasing commissions needed to re-let space, and the straight-line rent adjustment, which otherwise books a tenant's contracted future rent increases as income today rather than when the cash actually arrives.

The usual add-backs run the other way: non-cash items such as amortisation of deferred financing costs, stock-based compensation, and amortisation of above- or below-market leases acquired with a property. Companies differ on which of these they include, and that difference is exactly why AFFO is not standardised.

The gap between FFO and AFFO is widest where re-leasing space is expensive. An office landlord spends heavily on tenant improvements and commissions every time a lease turns over, so its AFFO can sit well below its FFO; a net-lease or self-storage landlord, with little turnover spending, sees a much smaller gap.

Because there is no published, enforced definition of AFFO, two REITs holding functionally identical properties can report different AFFO simply because one capitalises a cost the other expenses. Any cross-company comparison has to be rebuilt from each filer's own reconciliation, not taken from the headline figure. And because AFFO has already subtracted maintenance capex, an 80% payout ratio measured against AFFO and an 80% payout ratio measured against FFO are different claims about the same company's coverage.

Where it misleads

FFO adds back all depreciation but subtracts no capital spending, so it flatters a landlord with an ageing portfolio and a deferred maintenance backlog — roofs, elevators and HVAC systems are genuinely consumed, whatever the depreciation schedule says. The straight-line rent convention compounds this by converting contracted future rent escalators into current income, so reported FFO can outrun the rent a REIT has actually collected in the period.

Company-defined variants — core FFO, normalised FFO — exclude whatever management labels non-recurring. In some names, the same categories of exclusion appear every single year, which raises the question of how non-recurring they really are.

A REIT that funds its distribution partly by selling buildings is shrinking its asset base, and FFO will not show this directly, because gains on sale are excluded by construction; the effect only appears in the cash-flow statement and the balance sheet, where proceeds and a smaller property count show up.

FFO is silent on leverage, debt maturity schedules and interest-rate resets — the most common actual cause of a distribution cut — and where a REIT is externally managed, management and incentive fees run through FFO without being broken out, blending the landlord's property economics with the manager's compensation.

Where you will meet it on this site

REIT pages and screens use FFO or AFFO, rather than net income, as the denominator for payout ratios, because a REIT payout ratio computed against net income routinely runs past 100% and communicates almost nothing about actual distribution safety.

Commercial real estate pages place FFO alongside net operating income and capitalisation rate, the property-level measures that answer the same underlying question — what is this real estate actually producing — at a different level of the structure.

Distribution-coverage discussions generally use AFFO as the working denominator, since it is the closer approximation of cash actually available to pay a distribution.

Mortgage REIT pages carry a standing caution that FFO is largely irrelevant there: mortgage REITs hold loans, not buildings, and the measures that matter are net interest income and earnings available for distribution instead. Return-of-capital discussions connect back to the same depreciation add-back described here, since it is the reason a meaningful share of many REIT distributions is reported as return of capital on Form 1099-DIV rather than as ordinary income.