When dealing with Real Estate Investment Trust investments it's important to at last have a familiarity with the related terms. There is a volume of REIT language, but one of the more important to understand is the Adjusted Funds From Operations, or also known by its acronym AFFO. While the definition is useful, it's even better to have an expanded knowledge of its uses and implications for all stakeholders. Here is everything you need to know about the Adjusted Funds From Operations line.
Adjusted Funds From Operations Definition
AFFO is by definition a computation that is made by investors and analysts for the measurement of the recurring or normalized FFO of a real estate company, after the deduction of capital improvement funding. The process for arriving at the AFFO is generally made by obtaining the Funds From Operations which are the normalized expenditures which are capitalized by the REIT, they recur, and they are then amortized. These by definition, are necessary for the maintenance of the Trust's properties and revenue stream. The expenses include purchases of tangible goods such as flooring, and other building related materials and goods, expenses for leasing, and allowances made for tenant improvements, as well as GAAP revenue to straight-line rents adjustments. The AFFO is subtracted from the FFO. A quick summary to describe this process is that it's the adjusted funds balance after all other eligible expenditures are made from the Funds From Operations, but it's not that simple.
The definition of AFFO is not standardized
Although a basic formula exists for creating an AFFO, it is a measure that is defined by each individual company. There may be differences in the approach from one REIT to another. This makes it imperative for investors and any other stakeholders who routinely use financial statements to become familiar with the specific definition by which the company subscribes.
Why isn't there a standard definition?
The reason for the variances in AFFO definition from one company to another is because there are likely to be variances from the way that one business conducts their operations to another. While there are similar elements, there are other factors that influence the best approach to obtaining an accurate AFFO. The formula is similar though, but it has not yet been translated into an official definition for the business world that is widely accepted for REITs.
A simple formula for determining AFFO
If one were to put the formula into easy to understand terms, it would be AFFO equals the FFO plus rent increases minus capital expenditures and routine maintenance amounts. This frames the process in easy to understand terms for audiences of stakeholders who are only interested in a rudimentary explanation of the process.
The basic formula for FFO looks like this. FFO equals the net income plus amortization, plus depreciation, minus capital gains from property sales. It's a tremendous simplification that sounds easy, but there is a lot more fact finding involved to gather current data for each of thee items.
Advantages/Benefits of the AFFO
The AFFO is a figure that can be provided to stakeholders that offers a more accurate representation of the value of an REIT.
- -Accurate measure of residual cash flow
- -More information than an FFO closer to the full financial picture
- -Preference of professional analysts
- -The AFFO best helps in the prediction of the future ability of an REIT to pay dividends
- -More accurate than traditional metrics for equities evaluations including EPS, and PE
Additional information about Adjusted Funds From Operation
We can go one step further in expanding on the definition of Adjusted Funds From Operation. It measures the financial performance of a REIT, it is used as an alternative to the FFO, because it is more inclusive of other factors affecting the overall value at of an REIT at a certain snapshot in time. This makes it a superior measurement to the FFO, which doesn't give a full account for the other relevant financial activities. In short, as a stakeholder who views or considers financial statements, the AFFO is the better tool for making decisions affecting investments or planning for the future.
It's not difficult to understand that the AFFO is an important figure when dealing with REIT related investments. Understanding precisely what it is can be a bit tricky, and it does take a thorough explanation to arrive at even the gist of what an AFFO truly is, and how it is obtained. As an analyst, this is the tool that will allow you to make further estimates on how the REIT is likely to perform in the future, and it will impact the overall value of the trust, and when analyzed periodically, it can point to emerging trends within the trust. It is useful in planning for future investments for the REIT, as well as for the investors.
If you're a shareholder, then this information will help you to understand more about the nature, performance, and overall value of the trust you've invested in. This can help you in decision making for future investments in the REIT, and it can also give you an idea of the REIT's ability to pay out dividends, with indications about when this may occur if the REIT isn't currently paying out to shareholders. It's useful information to practically all stakeholders, including the owners of the trust. It's far better to have a more clear picture of the performance, value and trends than it is to make important and potentially impactful decisions on information that gives you an approximation that is based on only some of the available information. Although it's a long and drawn out explanation of what an AFFO is, the few moments that it takes to digest the complexities can help you in making the best possible decisions for investment in REITs.
Written by Allen Lee
Read more posts by Allen Lee