REITs, depreciation and FFO.

The REIT business model is simple. REITs own real estate and they collect rent. For an investor to determine the investment potential of a REIT, one factor he would need to consider is earnings.

Asset value diminishes over time. Real estate is however a special class of assets because land and buildings are not like machines. Their values do not necessarily decline over time but tend to rise or fall depending on market conditions even if they are leasehold properties.

The concept of 'Funds From Operations' (FFO) gets around this problem. FFO excludes historical depreciation costs from net income. FFO has become the industry standard for measuring a REIT's operating performance.

Source: UOB Asset Management.

FFO is calculated by adding depreciation and amortization expenses to earnings, and sometimes quoted on a per share basis. The FFO-per-share ratio should be used in lieu of EPS when evaluating REITs and other similar investment trusts.

Source: Investopedia.

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