What is Adjusted Funds from Operations (AFFO)
Adjusted Funds from Operations (AFFO) is a financial measure often used by real estate investment trusts (REITs) to better represent the actual cash flow generated by their operations. AFFO adjusts the traditional Funds from Operations (FFO) metric by deducting recurring capital expenditures and leasing commissions, which are necessary to maintain the quality and earning capacity of a REIT’s assets. Additionally, AFFO may be adjusted for rent increases, straight-lining of rents, and non-cash components of income and expenses.
Importance in REITs
AFFO is considered a more accurate reflection of a REIT’s operational performance than net income or FFO because it takes into account the costs associated with maintaining property portfolio quality. This metric provides investors with a clearer picture of the REIT’s cash flow available for distribution as dividends. Given the income-focused nature of REIT investments, AFFO is a critical measure for assessing a REIT’s ability to sustain and grow its dividend payouts over time.
Calculating AFFO for REITs
AFFO=FFO−Recurring Maintenance CapEx−Leasing Commissions+Rent Increases Adjustments−Straight-lining of Rents Adjustments.
Suppose a REIT reports the following in a fiscal year:
- Funds from Operations (FFO): $150 million
- Recurring Maintenance Capital Expenditures: $20 million
- Leasing Commissions: $5 million
- Rent Increases Adjustments: $10 million
- Straight-lining of Rents Adjustments: $3 million
Using the AFFO calculation formula:
AFFO=$150M−$20M−$5M+$10M−$3M
AFFO=$132M
In this example, the REIT’s Adjusted Funds from Operations (AFFO) for the fiscal year would be $132 million, indicating the amount of cash flow available for distribution to shareholders after accounting for expenses necessary to maintain the portfolio’s income-generating potential
Why AFFO Matters
For investors, AFFO is a key determinant of a REIT’s dividend-paying capacity. A stable or growing AFFO indicates a healthy, cash-generating real estate portfolio with potential for steady or increasing dividends. Conversely, declining AFFO may signal upcoming challenges in maintaining dividend levels. Investors often compare the AFFO payout ratio (dividends divided by AFFO) among different REITs to assess their investment’s sustainability and growth prospects.
Conclusion
Understanding AFFO and its implications allows investors to make more informed decisions when investing in REITs. It serves as a vital tool for evaluating the quality of a REIT’s earnings, the potential for dividend growth, and the overall health of its property portfolio.
