The Intelligent REIT Investor Guide by Thomas Brad;

Author:Thomas, Brad; [Thomas, Brad]
Language: eng
Format: epub
Publisher: John Wiley & Sons, Incorporated
Published: 2021-07-14T00:16:52+00:00

The Significance of FFO

Investors in common stock generally use net income as a key measure of profitability, with the term clearly defined under GAAP. Since most REITs are publicly traded companies, they will always list net income and net income per share on their annual audited financial statements. And unaudited net income is reported quarterly.

Yet these net income figures are less meaningful for REITs than they are for other types of companies. The reason for this is that, in accounting, real estate depreciation is always treated as an expense. But in the real world, not only have most competitive properties retained their value over the years, but many have appreciated substantially. This is generally due to a combination of rising land prices due to inflation and increasing construction costs, steadily rising rental and operating income, and property upgrades. That's why REITs tend to report FFO as well, which adds real estate depreciation under GAAP back into net income.

When calculating FFO, there are other adjustments that should be made as well, such as subtracting from net income any capital gain income recorded from the sale of properties. The reason for this is that REITs can't have it both ways. They can't ignore depreciation, which reduces a property's carrying costs on the balance sheet, and then include the capital gain from selling that property above the price at which it's been carried. Furthermore, GAAP net income is normally determined after “straight‐lining,” or smoothing out, contractual rental income over the term of a lease. But in real life, rental income on a multiyear property lease will often rise from year to year.

For this reason, some investors, when examining FFO, adjust reported rent revenues to reflect the actual contractual rental revenues received during the reporting period.

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