What is Funds Available for Distribution?
Funds Available for Distribution (FAD) estimates the capacity of a REIT to generate sufficient cash to distribute dividends to its shareholders, or unit holders.
How to Calculate Funds Available for Distribution?
Funds available for distribution (FAD), also referred to as “cash available for distribution” (or “CAD”), quantifies the cash-on-hand of a real estate investment trust (REIT) that can be distributed to shareholders as dividends.
In practice, the funds available for distribution (FAD) metric is tracked in the REIT industry to understand the amount of cash belonging to the fund that is available to be paid out as dividends to compensate shareholders.
REITs own a portfolio of income-producing real estate assets, such as commercial buildings, offices, residential properties, hotels, self-storage facilities, and communities. Per SEC guidance, part of qualifying as a REIT is that the company must distribute a minimum of 90% of its annual taxable income to shareholders in the form of dividends.
Compared to the funds from operations (FFO) metric, the funds available for distribution is perceived as a more conservative measure because the routine, recurring capital expenditures (Capex) incurred by the REIT are factored in.
The calculation of a REIT’s funds available for distribution (FAD) is a three-step process.
- Calculate Funds from Operations (FFO)
- Subtract Recurring Capital Expenditures (Capex)
- Adjust for Non-Cash Items
However, it is worth noting that there is no standardized method to compute the FAD metric.
The lack of standardization in the FAD metric is one reason that the metric receives less attention than other more standardized real estate metrics, such as funds from operations (FFO), especially when it comes to comparisons between different REITs.
Funds Available for Distribution Formula (FAD)
While there may be no standardized formula to calculate the funds available for distribution (FAD) metric, the core components of the formula are the same across most variations, for the most part.
- Funds from Operations (FFO) → The funds from operations (FFO) metric measures the cash flow from operations (CFO) of a REIT. The FFO calculation starts with net income – i.e. the “bottom line” of the GAAP-based income statement – before adding back non-cash expenses, such as depreciation and amortization (D&A), and adjusting for gains and losses on sales of assets, like properties.
- Recurring Capital Expenditures (Capex) → The recurring capital expenditures of a REIT refer to the recurring, maintenance Capex spend necessary to maintain the current quality of the portfolio’s real estate assets. The spending is deducted because it is a recurring expenditure with an integral role in maintaining the quality of the assets belonging to the REIT (and thus continues to generate income).
The formula to calculate the funds from operations, the starting point of the funds available for distribution calculation, is as follows.
Two other common adjustments to the FAD calculation are straight-line rent and non-recurring item adjustments.
- Straight-Line Rent Adjustments → REITs often use straight-line accounting for rental income, where the expected rental income is distributed evenly across the lease term. However, the actual receipt of cash proceeds from the rental income can differ in a given period, resulting in adjustments to fix the discrepancy.
- Non-Recurring Items → Non-recurring items describe sources of income and incurred expenses that are unusual, one-time events and not part of the core operations of the REIT. More specifically, these sorts of items are not expected to continue into the foreseeable future and do not reflect long-term performance. Common examples include gains or losses from the sale of real estate assets or impairment charges (i.e. write-down).
Funds Available for Distribution Calculator (FAD)
We’ll now move on to a modeling exercise, which you can access by filling out the form below.
Funds Available for Distribution Calculation Example (FAD)
Suppose you’re tasked with calculating the funds available for distribution (FAD) for a REIT that reported the following financials for the fiscal year ending 2022.
Fiscal Year 2022 – Selected Financial Data
- Net Income = $4.6 million
- Depreciation = $1.2 million
- Gain on Sale of Property = $200k
Upon adding depreciation to net income and subtracting the gain on the sale of the property (i.e. “cash outflow”), the funds from operations (FFO) amounts to $5.6 million.
- Funds from Operations (FFO) = $4.6 million + $1.2 million – $200k = $5.6 million
For our assumption regarding recurring capital expenditures, we’ll assume the REIT’s routine spending on maintenance Capex was $1.4 million in 2022.
- Recurring Capital Expenditures (Capex) = $1.4 million
In conclusion, we arrive at a funds available for distribution (FAD) of $4.2 million after subtracting our hypothetical REIT’s recurring capital expenditures (Capex) from its funds from operations (FFO).
- Funds Available for Distribution (FAD) = $5.6 million – $1.4 million = $4.2 million