Adjusted Funds From Operations (AFFO) is a financial performance measure primarily used in analyzing real estate investment trusts (REITs). AFFO generally equals the trust’s Funds From Operations (FFO) after adjustments for recurring capital expenditures, aligning the measure more closely with the REIT’s true residual cash flow. This calculation considers GAAP rent adjustments, leasing costs, and other essential factors.
Key Insights
- AFFO Defined: Adjusted funds from operations (AFFO) estimates the value and sustainability of a real estate investment trust (REIT).
- An Enhanced Metric: While FFO lays the groundwork, AFFO accounts for costs, giving a clearer picture of present values and dividend potential.
- Typical Formula: Although methods vary, a general AFFO formula is: AFFO = FFO + rent increases - capital expenditures - routine maintenance expenses.
Understanding AFFO: Beyond Basic Metrics
AFFO is esteemed among analysts as a more accurate residual cash flow measure for shareholders than FFO. Although FFO is widely used, it omits crucial capital expenditure deductions, making it less reflective of true residual cash flow. By taking into account additional costs (like maintenance) and income sources (such as rent hikes), AFFO delivers a precise estimate of present day values and a more reliable forecast of a REIT’s future dividend-paying capacity—making it a favored, non-GAAP measure among professionals.
Calculating AFFO: A Step-By-Step Guide
Before delving into AFFO, one must first calculate Funds From Operations (FFO). FFO gauges cash flow stemming from specific activities such as leasing and acquisitions, excluding capital gains from property sales due to their non-recurring implications.
The FFO formula: FFO = net income + amortization + depreciation - capital gains from property sales
Having determined FFO, we can compute AFFO. Although unofficial and prone to variations, an exemplary formula for AFFO is: AFFO = FFO + rent increases - capital expenditures - routine maintenance expenses. Traditional metrics like earnings-per-share (EPS) and price-to-earnings ratio (P/E) fall short in accurately valuing a REIT.
AFFO in Action: A Calculation Example
To elucidate the AFFO calculation, consider a hypothetical REIT scenario: Over the last reporting period, the REIT achieved $2 million in net income, garnered $400,000 from the sale of one property, and incurred a $100,000 loss from another sale. It reported $35,000 in amortization and $50,000 in depreciation, witnessed net rent increases of $40,000, spent $75,000 on capital expenditures, and incurred $30,000 in routine maintenance costs.
First, calculate the FFO: FFO = $2,000,000 + $35,000 + $50,000 - ($400,000 - $100,000) = $1,785,000
Then, proceed with AFFO calculation: AFFO = FFO + $40,000 - $75,000 - $30,000 = $1,720,000
This AFFO formula demonstrates how adjustments refine the FFO figure to more accurately reflect the REIT’s holistic financial standing and operational capabilities.
Related Terms: Funds From Operations, capital expenditures, net income, depreciation, amortization, dividends.
References
- Nareit. “Glossary of REIT Terms”.
- Stephanie Krewson-Kelly, R. Brad Thomas. “The Intelligent REIT Investor,” Pages 133, 139-140. Wiley, 2016.
- Nareit. “Nareit Funds From Operations White Paper - 2018 Restatement”. Pages 1, 4-5.
- CFI: “Adjusted Funds From Operations (AFFO)”.
