Which metric is commonly used by REITs to measure cash flow by adding back depreciation and excluding gains on property sales?

Which metric is commonly used by REITs to measure cash flow by adding back depreciation and excluding gains on property sales?

• A. Price / NAV
• B. Funds From Operations (FFO)
• C. Price / AFFO
• D. EV / EBITDAR

Answer: (B)

Funds From Operations focuses on cash flow from a REIT’s core operations by starting with net income, adding back non-cash depreciation and amortization, and excluding gains on property sales. Depreciation is added back because it’s a non-cash expense that reduces reported earnings but does not affect cash generated by the business. Gains on property sales are removed because they come from investment activities and can create volatility that doesn’t reflect ongoing operating cash flow. By construction, this metric paints a clearer picture of the cash the REIT can expect to generate to fund dividends and reinvestment. Analysts widely use FFO as the standard cash-flow measure for REITs, making it the best fit for the described calculation. Other metrics either change the focus (valuation ratios like price to NAV) or adjust FFO further (AFFO) or use different cash-flow constructs, but they don’t match the specific approach of adding back depreciation and excluding gains on property sales. For example, if net income is 100, depreciation 40, amortization 10, and gains on sale 20, FFO would be 130.

Funds From Operations focuses on cash flow from a REIT’s core operations by starting with net income, adding back non-cash depreciation and amortization, and excluding gains on property sales. Depreciation is added back because it’s a non-cash expense that reduces reported earnings but does not affect cash generated by the business. Gains on property sales are removed because they come from investment activities and can create volatility that doesn’t reflect ongoing operating cash flow. By construction, this metric paints a clearer picture of the cash the REIT can expect to generate to fund dividends and reinvestment. Analysts widely use FFO as the standard cash-flow measure for REITs, making it the best fit for the described calculation. Other metrics either change the focus (valuation ratios like price to NAV) or adjust FFO further (AFFO) or use different cash-flow constructs, but they don’t match the specific approach of adding back depreciation and excluding gains on property sales. For example, if net income is 100, depreciation 40, amortization 10, and gains on sale 20, FFO would be 130.