Understanding Adjusted Funds From Operations (AFFO)
Adjusted Funds From Operations (AFFO) extends the concept of Funds From Operations (FFO), introducing adjustments to better reflect the true economic performance of real estate investment trusts (REITs). It’s like giving FFO a reality check, subtracting the costs of being fabulous—or at least, maintaining property fabulousness.
AFFO fine-tunes the raw data provided by FFO by including costs such as rent increases and subtracting capital expenditures and routine maintenance, offering a sharper image of a REIT’s operational cash flow. It’s the financial equivalent of Photoshop for REITs’ earnings portraits—enhancing the features you need to focus on and smoothing out the misleading bumps.
The Formal Calculation Dance: AFFO Style
The choreography for calculating AFFO starts with the FFO as its opening step:
- FFO = Net Income + Amortization + Depreciation - Gains on Property Sales
From there, AFFO tangoes in with:
- AFFO = FFO + Rent Increases - Capital Expenditures - Routine Maintenance Costs
Unlike the more laissez-faire EPS and P/E ratios, AFFO adds a layer of meticulousness to the financial evaluation of REITs, making it a darling measure among analysts who prefer their data well-coiffed.
Example: Crafting AFFO
Consider a hypothetical REIT jig. Here’s the breakdown:
- Net Income: $2 million
- Amortization: $35,000
- Depreciation: $50,000
- Gain from High-Flying Property Sale: $400,000
- Loss from Not-So-Great Sale: $100,000
- Net Rent Increases: $40,000
- Capital Expenditures: $75,000
- Routine Maintenance: $30,000
Calculating FFO:
- $2,000,000 + $35,000 + $50,000 - ($400,000 - $100,000) = $1,785,000
Then, hitting the AFFO:
- $1,785,000 + $40,000 - $75,000 - $30,000 = $1,720,000
Relative Terms Packed with Insights
- Net Income: It starts the party but doesn’t bring all the fun.
- Capital Expenditures: Necessary evils to keep the assets looking sharp.
- FFO: Brings more friends (metrics) to the party, starting the real analysis.
- GAAP: The rulebook that everyone agrees to ignore when FFO and AFFO come into play.
Suggested Readings for the Budding Real Estate Baron
- “REITs: Real Estate Investment Trusts” by Richard T. Garrigan & John B. Parsons - A comprehensive guide on why and how to invest in REITs.
- “Investing in REITs” by Ralph L. Block - Offers practical advice for both seasoned and novice investors in the realm of real estate trusts.
Understanding and calculating AFFO adds a high-resolution lens to your investment overview, ensuring that what you see is less of an illusion and more of the hardcore fiscal reality—keeping your investments smart and your dividends smarter!
