What is AFFO (Adjusted Funds From Operations)?
– AFFO stands for Adjusted Funds From Operations. It is a non-GAAP (not defined by official accounting standards) cash‑flow measure used by real estate investment trusts (REITs) to estimate the cash available to pay dividends after taking into account maintenance spending and other recurring adjustments.
– Purpose: AFFO refines Funds From Operations (FFO) by removing items that inflate accounting earnings but do not reflect ongoing cash needs (for example, depreciation) and then deducting recurring capital and maintenance outlays that reduce distributable cash.
Key definitions
– REIT: A company that owns, operates, or finances income-producing real estate and that typically distributes most of its taxable income to shareholders as dividends.
– FFO (Funds From Operations): A common REIT metric that adjusts net income by adding back depreciation and amortization and excluding gains or losses on property sales.
– Non‑GAAP measure: A financial metric that is not defined by Generally Accepted Accounting Principles (GAAP); it can vary by issuer.
Why AFFO is often considered more informative than GAAP EPS or FFO
– GAAP earnings (such as earnings-per-share) include depreciation, which for real estate often understates ongoing cash generation because buildings may not lose economic value like other assets.
– FFO corrects for depreciation and one‑time gains or losses, but it typically still ignores recurring capital expenditures (capex) needed to keep properties rentable.
– AFFO goes further: it subtracts recurring maintenance capex, adjusts for straight‑lining of rent (an accounting timing effect), and can add recurring rent escalations—providing a closer proxy for actual distributable cash.
How to calculate AFFO — step-by-step
1. Start with net income (GAAP).
2. Compute FFO:
FFO = Net income + Depreciation + Amortization − Gains (net) from property sales
(Exclude one‑time property sale gains because they are not part of ongoing operations.)
3. Make AFFO adjustments (examples of common adjustments):
– Subtract recurring capital expenditures needed to maintain properties.
– Subtract routine maintenance and leasing costs (if management treats them as recurring).
– Add back or adjust for recurring rent increases (including reversal of GAAP straight‑lining of rent, which spreads tenant incentives or stepped rents over the lease term).
– Adjust for other recurring non‑cash or non‑core items as appropriate (variable by REIT).
4. Optionally, compute AFFO per share:
AFFO per share = AFFO / Diluted weighted‑average shares outstanding
A representative formula (industry variants exist)
– FFO = Net income + Amortization + Depreciation − Capital gains on property sales
– AFFO ≈ FFO + Recurring rent increases − Recurring capital expenditures − Routine maintenance costs
Note: There is no single industry standard for AFFO; different REITs and analysts may include slightly different items.
Checklist for calculating or evaluating reported AFFO
– Obtain the REIT’s consolidated income statement and cash-flow footnotes.
– Identify net income and amounts for depreciation and amortization.
– Find gains and losses on property disposals.
– Determine recurring (maintenance) capex versus expansion/acquisition capex.
– Review lease schedules for straight‑line rent adjustments and tenant‑incentive accounting.
– Check management’s reconciliation from GAAP to FFO and from FFO to AFFO (should be disclosed).
– Note any one-time or extraordinary items that should be excluded.
– If comparing REITs, ensure each uses similar definitions or normalize to a consistent approach.
– When computing per‑share metrics, use diluted weighted‑average shares.
Worked numeric example (step-by-step)
Assumptions for a reporting period:
– Net income: $2,000,000
– Gain on property sale A: $400,000 (gain)
– Loss on property sale B: $100,000 (loss)
– Amortization: $35,000
– Depreciation: $50,000
– Net rent increases (recurring): $40,000
– Recurring capital expenditures (maintenance capex): $75,000
– Routine maintenance expense: $30,000
Step 1 — compute net gain (or loss) from property sales:
– Net gains = $400,000 − $100,000 = $300,000
Step 2 — compute FFO:
– FFO = Net income + Amortization + Depreciation − Net gains on property sales
– FFO = $2,000,000 + $35,000 + $50,000 − $300,000 = $1,785,000
Step 3 — compute AFFO with typical adjustments:
– AFFO = FFO + Net rent increases − Maintenance capex − Routine maintenance
– AFFO = $1,785,000 + $40,000 − $75,000 − $30,000 = $1,720,000
Interpretation:
– In this example, AFFO ($1,720,000) represents the analyst’s estimate of recurring cash available after maintaining the property portfolio—useful for assessing dividend coverage. Different practitioners might make slightly different adjustments, so always check the REIT’s reconciliation.
Caveats and practical notes
– Because AFFO is not standardized, compare apples to apples: if you compare two REITs, confirm that each uses the same rules for adjustments.
– Pay attention to how a REIT classifies capex (maintenance vs. growth) and whether management’s “recurring” descriptions line up with cash flow reality.
– AFFO is a tool for analyzing dividend sustainability and valuation models, but it should be used alongside balance sheet and cash-flow analysis, occupancy and leasing metrics, and market conditions.
Sources for further reading
– Investopedia — Adjusted Funds From Operations (AFFO): https://www.investopedia.com/terms/a/affo.asp
– Corporate Finance Institute — Adjusted Funds From Operations (AFFO): https://corporatefinanceinstitute.com/resources/knowledge/finance/affo-adjusted-funds-from-operations/
– Nareit — Real Estate Glossary and REIT resources: https://www.reit.com/what-reit/real-estate-glossary
– U.S. Securities and Exchange Commission (SEC) — REITs overview: https://www.sec.gov/answers/reits.htm
Educational disclaimer
This explainer is for educational purposes only and does not constitute investment advice or recommendations. Always perform your own analysis or consult a licensed professional before making investment decisions.