REIT Analysis using Funds from Operations (FFO)

Real Estate Investment Trusts (REITs) are a popular way to get real estate exposure without directly owning the physical property.  But as they are equities, how do we go about analyzing if they are good value?

I’ve mentioned numerous times before that I’m cautious over buying income trusts as the bulk of them pay out more in distributions than their reported earnings.   Even though it seems impossible, they still continue to do so.  To me, a strong REIT has recession resistant tenants, low vacancy, a growth strategy,  and most importantly, a sustainable distribution.

In the case of REITs, they often pay out more in distributions than reported earnings mostly because of how earnings/net income is calculated.  Typically, net income (used for earnings) takes into account depreciation/amortization which can reduce net income significantly depending on the business.  In the case of a REIT, buildings are depreciated for accounting purposes, but it doesn’t necessarily mean that the building has decreased in value.  In reality, the building has most likely increased in value.  To account for this and perhaps better represent the cash flow of a REIT, most analysts use Funds from Operations (FFO) per share instead of Net Income/Earnings per share as a measuring stick for REITs.

How is FFO/AFFO Calculated

Funds from operations takes net income, adds back the amortization/depreciation, then subtracts proceeds from property sales.  For those of you who prefer formulas:

FFO = Net Income + Amortization (or depreciation) – Proceeds from Property Sales

AFFO stands for Adjusted Funds from Operation and accounts for the capital expenditures.  Some believe that if amortization expense is added back to the Net Income, then capital expenditures completed on the properties should be accounted for somehow.  The formula is:

AFFO = Net Income + Amortization (or depreciation) – Proceeds from Property Sales – Capital Expenditures

How to DIY

As a do-it-yourselfer, I went on a quest to figure out how to calculate FFO/AFFO on my own.  As I am familiar with reading balance sheets, it wasn’t overly complicated as most of the information can be plucked from company cash flow statements, then calculated manually.

However, for those who couldn’t be bothered with cash flow financial statements, most REITs report FFO/AFFO in their annual/quarterly reports.

If we take a look at a REIT like Calloways, for Q1 2010, we see that their earnings are around $7.4M with distributions of around $39.5M.  Sounds impossible right?  However, if you look at the FFO and AFFO numbers, you’ll see that their distribution is closer to 100% of their actual cash flow.

Final Thoughts

So instead of looking at simple earnings as the way to see if REIT distributions are sustainable, a better way is to take a look at the FFO/AFFO which may show you the real cash flow of the REIT.  Do you have any tips when analyzing REITs?

For more information, Thicken My Wallet also has a few articles on REITs and FFO calculations.

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FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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9 years ago

Is it possible that capital expenditures are higher than FFO?

Best Internet Savings Accounts
10 years ago

Good Information on REIT, but tell me how can I access REIT? Depreciation is a large part of expenses, but in case of real estate it may not apply.

10 years ago

Understood FrugalTrader.

An example of one such investment is a 9% return on a retirement center to be built, once it was 95% occupied.

I would be very interested in a post talking about real estate companies such as League which seems to be a rather prominent and well-established Canadian company. Definitely order the blue book from them which is complementary.

I’m the type that isn’t exactly satisfied with 2% return on RRSPs. I mean, the best thing about the RRSPs is that some of the money you’re using really isn’t yours anyway (Since it’s the governments), so you want to make sure you get as much of a return as possible on it.


Dividend Growth Investor
10 years ago


That’s a great article. It is important to understand what you are buying into with REITS, and as a result you cannot use traditional dividend payout ratios. You could check the trend of the FFO payout however in order to gauge the sustainability of the distribution.

10 years ago


That’s not my take on it. The only reason to buy an investment property is for it to create income for you. If you plug in the numbers on a 5 cap property after paying the mortgage there is almost no cash flow left.

If you compare this to a retail setting it’s like buying an item for a dollar and selling it for 98 cents.

When you’re buying income property especially one this size you can’t acquire it on this basis. Yes potentially it could appreciate due to better management but this is the mechanism that is supposed to add value and equity for your stakeholder not subsidize a bad acquisition.

These REIT’s have been spoiled rotten with too much cheap money. Their house of cards is going to collapse one day.

This is just my personal opinion of course.

Andrew F
10 years ago

Rachelle, I take his point. But, he seems to be suggesting that cash flow from investing activities should not be large outflows. How else do you create a firm? As a firm grows, it spends considerable cash buying assets, which is a cash outflow for investing activity. The only way for this aggregate cash flow to come back to net zero without dissolving the firm would be for these assets to appreciate and then be sold. Another way to look at it: the cash from operations is the return on the cash spent on investing activities. He didn’t specify the duration of these cash flows, but if we assume it’s ~ 7 years, the cash flow yield has been at worst 4.5%. Likely the duration of that investing cash flow is less. If it was, say, 4.5 years, the cash flow yield has been 7.1%. Not at all terrible, since that does not include unrealized increases in asset valuation.

Nonetheless, an interesting article. If the cap rate is far less than the yield on the REIT, they should be buying back units. Unfortunately, managers have an incentive to grow their firm (and hopefully their paycheque) rather than always make investment decisions that maximize shareholder return. The fear is that small players tend to get acquired and while that is often good for shareholders it’s bad for job security for the management.

10 years ago

I just read this interesting article about REITs in the Globe. Basically Fabrice is saying that if you buy a building with a 5% cap rate but pay 7% interest on it that’s a bad buy.

Math 101 is pretty unpopular. Real estate is a sure path to riches – popular.

10 years ago

i come from an accounting/ corporate finance back group and have experience with balance sheets as well but, have not spend significant time with REIT’s i am going to do some research and see what i come up with

Andrew F
10 years ago

REIT distributions are taxed as income, and are not eligible for the dividend tax credit. This is because REITs are eligible for preferred taxation when compared to corporations.