P/FFO

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P/FFO Meaning

The P/FFO or Price to Funds From Operations ratio is a financial measure that is used in the valuation of a real estate investment trust (REIT). The price is the current market price of each REIT stock, and FFO is the per share monetary value an REIT generates from its business operations.

PFFO

In other words, the FFO multiple determines the value of each outstanding REIT share. It is a crucial valuation metric for investors, shareholders and analysts who deal in real estate investments. Moreover, it helps real estate investment trusts to track their performance by determining the per-share returns generated in a given accounting period.

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  • The P/FFO or Price to Funds From Operations is an operating performance indicator for real estate investment trusts that evaluates the per-share value a REIT generates from its business operations.
  • Its formula is P/FFO = Price Per Share / Funds From Operations Per Share.
  • The investors and analysts use the FFO multiple to evaluate the fair value of the company's outstanding shares. Also, it aids in comparing the values of different REITs.
  • However, it ignores the straight-line rent and recurring costs like maintenance expenses and capex, which are otherwise accounted for in the Price to Adjusted Funds From Operations (P/AFFO).

P/FFO Explained

P/FFO is the ratio of market price to funds from operations (FFO) per share that is used as a metric in REIT valuations. The P/FFO in REIT valuation works similarly to the price-to-earnings ratio for other business entities. Thus, the purpose of both is to determine the current market price of a stock. Since real estate investment trusts (REIT) deal in different kinds of properties whose value often appreciates, unlike the other business assets whose value depreciates.

Thus, they need to be valued differently. P/FFO is more reliable than the other cost accounting procedures, which emphasizes considering the depreciation cost even on real estate. Also, any gains or losses from the sale of properties may artificially raise or decline the trust's profitability, which is also solved by this tool.

FFO is a non-GAAP metric developed by the National Association of Real Estate Investment Trusts (NAREIT). However, it is neither a liquidity measure nor replaces the cash flow from operations. It serves as a REIT's benchmark for operating performance evaluation. The P/FFO ratio is usually high, sometimes even more than 20. However, a ratio below ten is considered low, and therefore, such REITs have a poor dividend-paying ability. Also, the P/FFO ratio is a widely used tool by investors and analysts to compare the values of the various real estate investment trusts and find the cheaper or more expensive ones.

However, the P/FFO has certain shortcomings, of which the primary one is not considering the recurring costs and straight-line rent. The REITs incur routine expenses, such as maintenance and capital expenditures, during their regular course of business. These costs cannot be overlooked and impact the trust's operating performance to a large extent. However, to fix this problem, the adjusted funds from operations were introduced, providing a true residual value of a REIT. Similarly, the P/AFFO is a more accurate and reliable operating performance measure than the P/FFO.

Formula

The price to funds from operations or the FFO multiple helps in determining the per-share value of a REIT. The formula is as follows:

P/FFO = Price Per Share / Funds From Operations Per Share(FFOPS)

Where

FFO = Net Income + (Depreciation + Amortization + Losses on Underlying Properties Sales) - Gains on Underlying Properties Sales - Interest Income

Also,

FFOPS = FFO / Total Outstanding Shares

The price per share is the current market price of each unit of the REIT.

Examples

Check out these examples to get a better idea:

Example #1

Suppose a REIT's financial statements provide the following information:

  1. Net Income = $6,200,000
  2. Sale of Properties = Gain of $930,000 and loss of $150,000
  3. Depreciation = $61,000
  4. Amortization = $57,000
  5. Interest Income = $53,000

Determine the price to funds from operations if the current market price per REIT share is $12 and the outstanding shares are 10,000,000.

Solution:

Step 1: Calculation of funds from operations:

FFO = Net Income + (Depreciation + Amortization + Losses on Underlying Properties Sales) - Gains on Underlying Properties Sales - Interest Income

FFO = $6,200,000+ ($61,000 + $57,000 + $150,000) - $930,000 - $53,000 = $5,485,000

Step 2: Computation of funds from operations per share:

FFOPS = FFO / Total Outstanding Shares = $5,485,000/10,000,000 = $0.55

P/FFO = Price Per Share / Funds From Operations Per Share = $12/$0.55 = 21.81%

Thus, 21.81% is a favorable FFO multiple.

Example #2

Check out this real-world example of the American Tower Corp. (AMT). The REIT's current market price per share is $203.94, while it has booked a $2.55 per share FFO in the first quarter of 2023.

Hence, AMT's Price to Funds From Operations ratio is:

P/FFO = Price Per Share / Funds From Operations Per Share = $203.94/$2.55 = 79.97%

The FFO multiple of AMT is considerably high.

Frequently Asked Questions (FAQs)

1. Where to find a REIT's funds from operations?

A real estate investment trust states its funds from operations figure in the footnotes of its income statement at the end of every accounting period, I.e., quarter or year.

However, FFO can also be evaluated through the above formula using the income statement components - net income, depreciation, amortization, gains or losses on Sales of Underlying properties and interest income.

2. Does FFO include depreciation?

Yes, the Funds From Operations formula suggests adding the depreciation cost to the net income of a REIT since charging depreciation on the properties affects the actual returns of the trust.

3. Is operating cash flow the same as FFO?

The operating cash flow is a cash flow statement item determined using the business's working capital, revenue and expenses. On the other hand, FFO is a performance evaluator of a REIT's operations derived from the net income, depreciation, amortization, and losses on property sales minus the gains on property sales and interest income.

4. Why is FFO a good measure of REIT performance?

The FFO is a true operating performance indicator for the REITs and, therefore, recommended over the other cost accounting methods.