How to Calculate FFO in Real Estate: A Comprehensive Step-by-Step Guide

Funds from Operations (FFO) serve as a financial benchmark used to gauge the operational performance of businesses or funds. In the commercial real estate market, FFO plays a role in determining the cash flow stemming from a business's core activities, excluding non-recurring and unrelated elements associated with real estate asset operations. This metric holds particular significance when assessing Real Estate Investment Trusts (REITs), as REITs calculate distributable dividends to shareholders based on their recurring taxable income.

It's essential to note that while FFO offers precise insights into an entity's financial health, it shouldn't be mistaken as an indicator of liquidity or a measure of available cash funds. This is because FFO doesn't encompass all financial and operational aspects that might impact a business's ability to meet its financial obligations. Additionally, it's important to highlight that the exact calculation of FFO can vary due to differing accounting rules, which entail diverse methodologies for computation.

How is FFO Calculated? FFO is derived by summing up the net income generated by a business's core activities, subtracting non-monetary expenses (such as depreciation and amortization), and excluding non-operational or non-recurring gains and losses (like financial costs and property sales). The fundamental formula for this calculation is FFO = Net Income - Depreciation and Amortization - Gains or Losses from Asset Sales.

Let's clarify that: a) net income corresponds to earnings after taxes and operational expenses; b) depreciation signifies a non-monetary expense reflecting the decline in value of tangible assets over time; c) amortization represents a non-monetary expense reflecting the reduction in value of intangible assets over time; d) gains from asset sales occur when the selling price surpasses the original cost (or book value); and e) losses from asset sales happen when the selling price is lower than the original cost.

Example: Imagine managing a real estate company focused on acquiring and leasing commercial properties. Based on last year's operations, the following results were obtained: a) net income or profit = -$20,000; b) depreciation and amortization = -$30,000; c) loss from debt cancellation = -$5,000; d) loss from property sale = -$1,000; and e) gain from capital investment = $10,000.

Applying the formula to compute FFO, the following operations were carried out: FFO = Net Income - Depreciation and Amortization - Loss from Debt Cancellation - Loss from Property Sale - Gain from Capital Investment.

Substituting values into the formula yields: FFO = -$20,000 - (-$30,000) - (-$5,000) - (-$1,000) - ($10,000). This equals: FFO = -$20,000 + $30,000 + $5,000 + $1,000 - $10,000 = $6,000. Thus, the FFO for our company amounted to $6,000 in the past year. This represents the cash flow generated by the core operations of our business.

Now that you grasp FFO calculation, for further insights or to explore additional concepts, visit SiiLA Resource or contact us at contacto@siila.com.mx.