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By Selena Maranjian (TMF Selena)
May 2, 2003

Q. I'm interested in REITs, but I don't understand what "FFO" refers to. Can you explain?

A. Think net income or operating income... sort of.

With most companies, net income is a useful number to evaluate, reflecting the profits left over from sales after all expenses have been subtracted. With REITs, though, net income isn't as meaningful. (Remember that REITs are real estate investment trusts, special kinds of corporations that must pay out at least 90% of their taxable income in dividends in order to receive special tax benefits.)

According to accounting rules, the value of REIT properties is decreased over time, with depreciation charged against net income, reducing it. In reality, however, these properties are probably not falling in value, and may even be appreciating. So, a REIT's net income tends to understate its health.

This is why, with REITs, you should look instead at the "funds from operation," or FFO. The FFO ignores the effects of depreciation and other non-cash charges to help you see a REIT's true performance.

To learn more about REITs, read these two Fool articles: "REITs: The Other White Meat" and "Considered REITs? Buffett Has." And drop by the NAREIT website, too.

To learn more about investing Foolishly, visit our Fool's School. Or check out some of our inexpensive and well-regarded online how-to guides (which feature money-back guarantees). You can also learn all about brokerages and find one that's right for you in our Broker Center

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This question and answer is adapted from The Motley Fool Money Guide: Answers to Your Questions About Saving, Spending and Investing. For answers to this and 499 other common money questions, check it out -- it's a handy resource.