Fund From Operations: What It Means And How It Works

Real estate investing has evolved with the introduction of Real Estate Investment Trusts (REITs), which allow investors to buy units in a professionally managed portfolio of income-generating commercial properties, giving exposure to rental income and potential capital appreciation—without needing to directly own or manage real estate assets.

Investors considering REITs may want to understand how to evaluate their performance. One key metric is Fund From Operations (FFO).

This article will explain what fund from operations means, how it’s calculated, why it’s used for REIT analysis and how to interpret FFO, especially in the Indian context.

We’ll also cover Adjusted Fund from operations (AFFO) and compare FFO with other financial metrics like net income, cash flow from operations, and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation).

Table of contents

• What is Fund From Operations (FFO)?
• How to calculate fund from operations?
• Why use fund from operations?
• What is adjusted fund from operations (AFFO)?
• FFO vs other financial metrics
• How to interpret FFO
• Limitations of FFO and things to watch out for

What is Fund From Operations (FFO)?

Fund From Operations (FFO) meaning: It is a performance measure primarily used by REITs to assess the earnings-generating ability of their real estate operations. Unlike a generic cash flow that tracks all cash in and out, FFO zeroes in on the recurring operating performance from a REIT’s regular rental and property management activities.

Traditional metrics like Earnings Per Share (EPS) or net profit may not accurately capture REIT performance due to heavy non-cash expenses (like depreciation) and occasional property sales. In fact, investors and analysts typically consider FFO the go-to metric for evaluating a REIT’s financial performance.

How to calculate fund from operations?

The basic formula for FFO is:

FFO = Net income + Depreciation + Amortisation + Losses on property sales − Gains (or+Losses) from Property sales

Where,

Net Income: is the profit after all expenses as per the income statement.

+ Depreciation & amortisation: are non-cash expenses related to writing down the value of assets.

– Gains/+ Losses from sales: REITs occasionally sell properties. Any profit from such sale is subtracted, and any loss is added back when computing FFO.

Example

Suppose an REIT has Net Income = Rs. 50 lakh for the year, with Depreciation = Rs. 1 lakh, Amortization = Rs. 0.75 lakh, and a Rs. 4 lakh gain from selling a property.

Using the FFO formula:

FFO = 50 + 1 + 0.75 – 4 = Rs. 47.75 lakh

So, the REIT’s FFO is Rs. 47.75 lakh for that year. Here, Rs. 1.75 lakh of depreciation/amortisation was added back, and the Rs. 4 lakh one-time sale gain was removed to focus on recurring rental operations.

The figures shown are for illustrative purposes only.

Read Also: REIT vs Real Estate Fund: Key Differences Explained

Why use fund from operations?

Real-estate assets may appreciate over time or may not deteriorate in the same way as depreciable plant equipment. Depreciation under standard accounting may understate the value of real-estate assets. FFO adjusts for this by adding back depreciation and amortisation.

Non-recurring gains may distort net income. FFO excludes such items (or adjusts for them) to give a clearer sense of recurring operating performance.

For REITs that distribute a large part of their income to unitholders/shareholders, FFO may prove to be a more suitable gauge of the cash-generating ability of the underlying real-estate operations.

However, investors should note that favorable FFO metrics do not guarantee investment returns, and market conditions can significantly impact actual performance

What is adjusted fund from operations (AFFO)?

AFFO is derived from FFO but further adjusts by subtracting recurring capital expenditures (maintenance capex), straight-lining of rents (the accounting practice of averaging lease rentals over the entire lease term), leasing costs and other recurring items, to present a more reliable estimate of the cash available for distribution to investors.

Its formula is as follows:

AFFO = FFO − Maintenance capex − Straight-lined rent adjustments − Other recurring items
For Indian investors, when assessing an REIT or property trust, looking at AFFO may help in understanding potential wealth creation and dividend sustainability more closely than FFO alone, though investors should consider multiple metrics and associated risks before making investment decisions.

In India, REITs also report Net Distributable Cash Flow (NDCF), which is similar to AFFO.

Read Also: Real Estate vs. Mutual Fund: Which is a Better Investment?

FFO vs other financial metrics

It is useful to distinguish FFO from other familiar metrics:

• Net income: Net income (accounting profit) is reduced by depreciation and may include unusual or non-recurring items. FFO reverses those effects – adding back property depreciation and removing one-time gains or losses – to provide a steadier view of a REIT’s underlying operating performance.
• Cash flow from operations (CFO): CFO (from the cash flow statement) is the actual cash generated by operations, including working capital changes and interest paid. FFO is a standardised figure derived from net income. FFO ignores working capital swings, whereas CFO captures them, which is why the two can differ significantly.
• EBITDA: EBITDA is earnings before interest, tax, depreciation, and amortisation – a broad profitability metric. FFO, by contrast, starts with net income (after interest and tax) and adds back only real estate depreciation (and related adjustments). This makes FFO more aligned with the operating performance attributable to equity holders, whereas EBITDA is less commonly used for REIT evaluation.

How to interpret FFO

In general, higher FFO is considered better for an REIT, as it may mean more cash is being generated from rentals. Key points to consider:

• Trend: Is FFO growing year over year? Growth may suggest improving performance.
• FFO per unit/share: Knowing FFO on a per-unit basis may enable comparison across trusts of different sizes.
• Peer comparison: Comparing FFO across similar REITs may highlight which one has stronger cash generation potential, since FFO standardises earnings by removing accounting distortions.

In the Indian context, when you are considering an REIT or property trust with potential gains, using FFO may give an additional lens beyond just net income.

Read Also: What Are Real Estate Mutual Funds: Meaning and Benefits

Limitations of FFO and things to watch out for

While FFO is a useful metric, there may also be some limitations:

• Ignoring capital expenditures: One of the biggest drawbacks is that FFO does not deduct capital expenditures needed to maintain the properties.
• Non-standard adjustments: FFO is a non-GAAP (Generally Accepted Accounting Principles) measure (in the U.S. and globally) which means there is no absolute standard for how every company computes it.
• One-time events: FFO adjusts for property sale gains/losses, but there could be other one-time or unusual items in operating income that FFO doesn’t automatically remove.
• Not a complete metric: FFO focuses on operating performance. It doesn’t directly tell you about the value of the underlying properties, nor about liquidity or other financial risks.
• Ignores property value changes: FFO focuses only on current rental income, not on changes in the market value of properties. An REIT’s assets might appreciate or depreciate without affecting FFO.

Therefore, while FFO might be a helpful metric, prudent investors may want to use it in conjunction with other financial and operational indicators. You may consult a financial adviser before relying on any single metric.

FAQs

What is Fund from Operations?

Fund from Operations or FFO is a standardized performance metric used by real estate investment trusts (REITs). It adjusts net income by adding back depreciation and amortization of real estate assets, excluding gains or losses from sales of properties, and making other specified adjustments to reflect the recurring cash flow generated from a REIT's core business operations.

Why is FFO important for REITs?

Because REITs typically own income-producing real estate whose accounting depreciation may not reflect economic asset value, and because they often distribute a large portion of their cash flows to investors, FFO gives a clearer view of recurring operational performance, which may help in judging dividend sustainability and valuation.

How is FFO different from net income?

Net income reflects all accounting profits and losses, including depreciation/amortisation, gains/losses from sales, and interest income. FFO modifies net income by adding back depreciation and amortisation, excluding non-recurring gains or losses from property sales and adjusting for interest income, thus giving a different figure more aligned to operating cash generation.