What are 'Adjusted Funds From Operations - AFFO'

Adjusted funds from operations (AFFO) refers to the financial performance measure primarily used in the analysis of real estate investment trusts (REITs). The AFFO of a REIT, though subject to varying methods of computation, is generally equal to the trust's funds from operations (FFO) with adjustments made for recurring capital expenditures used to maintain the quality of the REIT's underlying assets. The calculation takes in the adjustment to GAAP straight-lining of rent, leasing costs and other material factors.

BREAKING DOWN 'Adjusted Funds From Operations - AFFO'

Regardless of how industry professionals choose to compute AFFO, it is considered to be a more accurate measure of residual cash flow for shareholders than simple FFO. This provides for a more accurate base number when estimating present values and a better predictor of the REIT's future ability to pay dividends. This is a non-GAAP measure.

Calculating Adjusted Funds From Operations

Before calculating the AFFO, an analyst must first determine the REIT's funds from operations (FFO). The FFO measures cash flow from a specified list of activities. FFO reflects the impact from the REIT's trend in operations from leasing and acquisition activity, as well as interest costs. FFO takes into account the REIT's net income including amortization and depreciation, but it excludes the capital gains from property sales. The reasons these gains are not included is that they are one-time events and generally do not have long-term effects on the REIT's future earnings potential. The formula is:

FFO = Net Income + Amortization + Depreciation - capital gains from property sales

Once the FFO is determined, the AFFO can be calculated. To calculate the AFFO, an analyst should take the FFO and make the following adjustments:

1) Add in rent increases

2) Subtract capital expenditures

3) Subtract routine maintenance amounts

Example

As an example of the AFFO calculation, assume the following: a REIT had $2 million in net income over the last reporting period. During that time, it earned $400,000 from the sale of one of its properties and lost $100,000 from the sale of another. It reported $35,000 of amortization and $50,000 of depreciation. During the period, net rent increases were $40,000, capital expenditures were $75,000 and routine maintenance amounted to $30,000.

Given this information the FFO can be calculated as:

FFO = $2,000,000 + $35,000 + $50,000 - ($400,000 - $100,000) = $1,785,000

From this, the AFFO is calculated as:

AFFO = FFO + $40,000 - $75,000 - $30,000 = $1,785,000 - $65,000 = $1,720,000

The resulting figure is a more accurate estimate of the REIT's earning potential than the FFO.

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