The Nareit bridge line by line, the share count to divide by, and what each common error does to the multiple.
To calculate FFO, start from net income, add back depreciation and amortisation of real estate, deduct gains (or add back losses) on the sale of depreciable property, add back impairments of depreciable property, and make the same adjustments for your share of joint ventures. That is the Nareit definition, as restated in its 2018 white paper. On an illustrative REIT, net income of 180.0 million becomes FFO of 461.0 million, $2.744 a share against earnings of $1.125, so a $38.00 share trades on 33.8 times earnings but 13.85 times FFO.
Worked in full in REIT Analysis and Valuation by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The adjustment exists because GAAP depreciation assumes buildings lose value on a straight line, which for well-located real estate is usually not what happens, and because a gain on selling a building is not a recurring part of renting buildings out. FFO removes both so that one year can be compared with the next. The arithmetic is short; the errors come from which lines to include and which share count to divide by.
| Line | Amount |
|---|---|
| Net income attributable to common shareholders | 180.0 |
| Net income attributable to operating partnership (OP) unitholders | 9.0 |
| Real estate depreciation and amortisation | 310.0 |
| Depreciation of corporate office and IT | 4.0 |
| Gains on sale of depreciable real estate | 64.0 |
| Impairment of depreciable real estate | 22.0 |
| Share of real estate D&A in unconsolidated joint ventures | 15.0 |
| Partners' share of D&A in consolidated joint ventures | 11.0 |
| Diluted common shares / OP units, millions | 160.0 / 8.0 |
| Share price | $38.00 |
FFO = net income + real estate D&A − gains on sale of depreciable property + impairment of depreciable property ± joint venture adjustments
FFO per share = FFO ÷ (diluted shares + OP units)
In Excel, with the bridge in B2:B8, =SUM(B2:B8) with gains and the partners' share entered as negatives, then =B9/(B10+B11) for the per-share figure.
| Step | Amount |
|---|---|
| Net income attributable to common shareholders | 180.0 |
| Add net income attributable to OP unitholders | 9.0 |
| Add real estate depreciation and amortisation | 310.0 |
| Less gains on sale of depreciable real estate | -64.0 |
| Add impairment of depreciable real estate | 22.0 |
| Add share of unconsolidated JV real estate D&A | 15.0 |
| Less partners' share of consolidated JV D&A | -11.0 |
| FFO | 461.0 |
| Diluted shares and OP units | 168.0 |
| FFO per share | $2.744 |
Three lines need a word. The OP unitholders' income is added back because their units are counted in the denominator: the units convert one for one into shares, so FFO per share is struck on the whole economic ownership, 168.0 million, not on the 160.0 million listed shares. The 4.0 million of corporate depreciation stays deducted, because a head office and its computers are not the real estate the adjustment is for. And the joint venture lines put depreciation on the REIT's share: add its share of what the unconsolidated ventures charged, remove its partners' share of what the consolidated ventures charged.
FFO of 461.0 million is 2.56 times net income, and real estate depreciation alone is 67.2 per cent of it. That is why earnings per share is close to useless for a REIT: $1.125 against $2.744. The market prices REITs on FFO, and here the $38.00 share sits on 13.85 times.
Many REITs also publish a "core" or "normalised" FFO, which adds back items the company considers non-recurring. Adding back an 8.0 million loss on early repayment of debt and 3.0 million of severance gives 472.0 million, $2.810 a share and 13.53 times. Core FFO has no standard definition, so compare companies on Nareit FFO and read each company's own reconciliation line by line before using its core number.
| Variant | FFO per share | Error | P/FFO |
|---|---|---|---|
| Nareit FFO, correct | $2.744 | 13.85x | |
| Gains on sale left in | $3.125 | +13.9% | 12.16x |
| OP units left out of the share count | $2.881 | +5.0% | 13.19x |
| Impairment not added back | $2.613 | -4.8% | 14.54x |
| Corporate depreciation added back too | $2.768 | +0.9% | 13.73x |
| Joint venture adjustments ignored | $2.720 | -0.9% | 13.97x |
The gain is the dangerous line. A REIT that sold buildings during the year books the profit in net income, and leaving it in overstates FFO per share by 13.9 per cent and cuts the multiple from 13.85x to 12.16x, so the shares look cheaper than they are. The quick version, net income plus all depreciation, gives 503.0 million, 9.1 per cent too high, mostly because the gain is still in it. The share count is the second trap: dividing by listed shares alone overstates FFO per share by 5.0 per cent here, and the error grows with the size of the OP unit base.
The common mistake is to treat FFO as cash flow. It is not: it still includes straight-line rent and other non-cash items, and it deducts none of the capital spent on maintaining the buildings and re-letting the space. That is the step from FFO to AFFO, worked in how to calculate AFFO from FFO, and it is AFFO, not FFO, that tells you whether the dividend is covered. FFO is the comparable earnings measure; it is the starting point of a REIT valuation, as in how to value a REIT using the P/FFO multiple, not the end of it.
REIT Analysis and Valuation rebuilds FFO and AFFO for one industrial REIT on a single definition, carries them to net asset value and the implied cap rate, and corrects the figures its first printing got wrong; the free workbooks for this case keep every step as a live formula.
Mainly because real estate depreciation is added back. GAAP writes buildings down on a straight line, which rarely matches what well-located property does. On the illustrative REIT here, 310.0 million of real estate depreciation is 67.2 per cent of FFO, which is why FFO is 2.56 times net income.
No. Nareit FFO deducts gains on the sale of depreciable real estate, because selling buildings is not part of recurring rental earnings. Leaving a 64.0 million gain in would lift FFO per share by 13.9 per cent, from $2.744 to $3.125, and cut the P/FFO multiple from 13.85x to 12.16x, so the REIT looks cheaper than it is.
FFO follows the Nareit definition; core or normalised FFO is the company's own measure, adding back items it calls non-recurring. Adding an 8.0 million debt prepayment loss and 3.0 million of severance takes FFO here from 461.0 to 472.0 million. Core FFO is not standardised, so compare companies on Nareit FFO.
This article is one calculation from REIT Analysis and Valuation. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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