Why earnings don't work for REITs
Real estate companies take large annual depreciation charges against their assets. Under GAAP accounting, a $10 million building might be depreciated over 40 years at $250,000 per year — reducing reported earnings by that amount whether or not the building has actually declined in value.
For most businesses, depreciation is a reasonable proxy for economic reality. For real estate, it often isn't — commercial property can appreciate substantially while generating large depreciation deductions that suppress GAAP earnings.
FFO corrects for this by:
- Adding back real estate depreciation and amortization
- Subtracting gains from property sales (since those are one-time, not recurring)
The result is a cleaner measure of recurring cash generation available for dividends.
Adjusted FFO (AFFO)
Analysts often go further, calculating Adjusted FFO (AFFO), which also subtracts maintenance capital expenditures — the money required to keep properties in good condition. AFFO is often considered the most accurate measure of the cash truly available for REIT distributions.
How to use FFO in REIT analysis
REIT dividends should be compared to FFO (or AFFO), not earnings:
- FFO Payout Ratio = Dividends ÷ FFO
- A healthy REIT typically pays 70–85% of FFO as dividends (legal minimum is 90% of taxable income, which differs from FFO)
- Coverage below 1.0x AFFO signals possible distribution unsustainability
Where to find FFO data
REITs report FFO in their quarterly earnings releases and 10-Q/10-K filings. Most financial data providers (Bloomberg, Seeking Alpha, REIT-specific sites) display FFO alongside traditional financial metrics for REIT coverage.
Related terms
- REIT — the entity type where FFO is the standard valuation metric
- Payout ratio — for REITs, always check against FFO not earnings
- Free cash flow — the equivalent concept for non-REIT companies