When it comes to investing in Real Estate Investment Trusts, it is important to finally familiarize yourself with the related terms. There is a volume of REIT language, but one of the most important to understand is Adjusted Funds from Operations, also known by its acronym AFFO. While the definition is helpful, it is even better to have a broader understanding of its uses and implications for all stakeholders. Here you will find everything you need to know about the Adjusted Funds from Operations line.
Adjusted funds from the definition of operations
AFFO is, by definition, a calculation performed by investors and analysts to measure the recurring or normalized FFO of a real estate company, after deduction of the financing of capital improvements. The process to reach the AFFO is generally carried out by obtaining the Operating Funds, which are the standardized expenses that are capitalized by the REIT, are repeated and then amortized. These, by definition, are necessary for the maintenance of the properties and the income stream of the Trust. Expenses include purchases of tangible assets such as floors and other construction-related materials and assets, lease expenses and allowances for tenant improvements, as well as GAAP income for straight-line rent adjustments. The AFFO is subtracted from the FFO. A quick summary to describe this process is that it is the adjusted fund balance after all other eligible expenses are incurred from the Operations Funds, but it is not that simple.
The definition of AFFO is not standardized
Although there is a basic formula for creating an AFFO, it is a measure that is defined by each individual company. There may be differences in approach from one REIT to another. This makes it imperative that investors and any other stakeholders who routinely use financial statements familiarize themselves with the specific definition to which the company subscribes.
Why is there no standard definition?
The reason for variations in the definition of AFFO from one company to another is because there are likely to be variations in the way one company conducts its operations to another. While there are similar elements, there are other factors that influence the best focus to obtain an accurate AFFO. However, the formula is similar, but it has not yet been translated into an official definition for the business world that is widely accepted for REITs.
A simple formula to determine AFFO
If one were to put the formula in easy-to-understand terms, it would be AFFO equal to FFO plus rent increases minus capital expenditures and routine maintenance amounts. This frames the process in easy-to-understand terms for stakeholder audiences who are only interested in a rudimentary explanation of the process.
The basic FFO formula looks like this. FFO equals net income plus amortization plus depreciation minus capital gains from the sale of properties. It’s a tremendous simplification that sounds easy, but there is so much more to finding the facts involved than collecting current data for each of the items.
Advantages / Benefits of AFFO
The AFFO is a figure that can be provided to stakeholders that offers a more accurate representation of the value of a REIT.
- -Accurate measure of residual cash flow
- -More information than an FFO closer to the full financial picture
- -Preference of professional analysts
- -AFFO helps better in predicting the future ability of a REIT to pay dividends
- -More accurate than traditional metrics for stock evaluations, including EPS and PE
Additional information on adjusted funds of the operation
We can go one step further in expanding the definition of Adjusted Operating Funds. It measures the financial performance of a REIT, it is used as an alternative to FFO, because it includes more other factors that affect the overall value of a REIT at a given snapshot in time. This makes it a superior measure to the FFO, which does not give a complete account of the other relevant financial activities. In short, as a stakeholder viewing or considering financial statements, the AFFO is the best tool for making decisions that affect investments or planning for the future.
It is not difficult to understand that the AFFO is an important figure when it comes to REIT-related investments. Understanding precisely what it is can be a bit tricky, and a full explanation is needed to get even to the heart of what an AFFO actually is and how it is obtained. As an analyst, this is the tool that will allow you to make additional estimates …