This is the main way to gauge how much money a REIT makes. The main reason is that businesses are allowed to depreciate the value of their assets over time. This is a valuable tax benefit. However, all of a REIT's assets the properties it owns are depreciable.
In fact, the value of real estate tends to go up over time, while most depreciable assets lose value. Instead of using net income or "earnings per share" to gauge how much money a REIT made over a given quarter or year, we use a metric called funds from operations , or FFO. The biggest difference is that we add the depreciation "expense" back in.
Data source: Equity Residential. Numbers may not add perfectly due to rounding. As you can see, FFO is very different from net income. By using FFO, we see that Equity Residential actually made nearly three times what the net income figure suggests. This is how REIT investors compare the valuation of different companies. These generally have some company-specific adjustments, such as taking one-time expenses out of the equation.
They give you a true picture of how much money the company is making. The point is that these measures give you the most accurate picture of how a specific REIT is doing. The amount of a company's dividend payment as a percentage of its earnings. The payout ratio is an important metric for all dividend stocks.
The cost of debt capital is merely the interest expense on the debt incurred. Income tax expense. Depreciation and amortization. Under IRS Revenue Procedure , so long as a REIT provides its shareholders with a choice between cash or stock and so long as at least 10 percent of the total dividend is available in cash , the entire dividend distribution is treated as a distribution of cash for purposes of the tax rules to qualify as a REIT.
Equitization The process by which the economic benefits of ownership of a tangible asset, such as real estate, are divided among numerous investors and represented in the form of publicly-traded securities. Equity Market Cap The market value of all outstanding common stock of a company.
Equal to a REIT's net income, excluding gains or losses from sales of property and adding back real estate depreciation. Gains and losses from the sale of certain real estate assets.
Gains and losses from change in control. Impairment write-downs of certain real estate assets and investments in entities when the impairment is directly attributable to decreases in the value of depreciable real estate held by the entity Learn more.
With the traditional calculation for income, these are deducted to reflect the declining value of these assets over time as business expenses.
However, when it comes to real estate, this really isn't an expense at all. In other words, real estate doesn't have a "shelf life" -- an apartment building, for example, will be just as much of an asset to a REIT in 10 years as it is today. In fact, it will probably increase in value over that time. This is in direct contrast to the depreciation "expense" reflected in REITs' income calculations.
The purpose of FFO is to convey a more accurate measure of a REIT's cash flow, and therefore its ability to keep up with its dividend payments to investors. FFO adds the depreciation expense which doesn't actually cost anything back in and makes a few other adjustments.
The Foolish bottom line It's important to keep in mind that although operating cash flow and FFO are similar metrics, they're not quite the same thing. Cash flow can be a great way to evaluate the financial well-being of a business, but for the purposes of assessing whether a REIT is earning enough to cover its dividends, FFO is the way to go.
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In short, it measures how much cash flow is generated from a company's main business by excluding any other sources of income, such as capital gains from investments.
Investing and financing transactions, such as borrowing, buying capital equipment and making dividend payments, are excluded from operating cash flows and are reported separately. The net operating income calculation can also be referred to simply as operating income when it comes to determining the financial health of a company. Operating income is a company's profit after operating expenses are deducted from total revenue.
Operating income shows the amount of profit a company generates from its operations without interest or tax expenses. Since operating income excludes taxes and interest expenses , it is often referred to as earnings before interest and taxes EBIT. However, there are times when operating income can differ from EBIT. Real Estate Investing.
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