Adjusted funds from operations (AFFO) is a commercial real estate company’s Funds from operations (FFO) after
capital expenditures. AFFO portrays a better economic reality than FFO because
it includes non-operating expenses. And in practice, dividend distribution by a
REIT is dependent on earnings after the deduction of non-operating expenses.
Alas, AFFO is key to understanding a dividend distribution policy.
National Association of Real Estate Investments
Trusts (NAREIT) calculates AFFO by subtracting from FFO both normalized non-recurring and recurring expenditures that are not capitalized,
but which are necessary to maintain its properties and its revenue. Recurring expenditures are new carpeting,
leasing expenses and tenant improvement allowance
The trouble is that AFFO is often defined
differently. Green Street Advisors, a REIT analysis company, determines
AFFO by deducting from FFO normalized capital expenditure, straight line rent,
gains on land sales, merchant-building gains and gains on debt prepayments.
Other firms adjust FFO by items such as acquisition expenses, equity based
compensation and costs that are unrelated to the operating performance of
the real estate.
It is a murky situation because reported AFFO
differs from one REIT to the other. As a result, AFFO is often incomparable across real estate companies, notes Ramin Kamfar, boss of Bluerock
Residential Growth. Also, within the REIT itself, AFFO may fluctuate widely from one year
to next. And because the year-over-year variance is substantial, it is often
futile to compare AFFO over time. To project AFFO is even a tougher challenge.
AFFO multiple may underestimate a REIT’s market
capitalization. For example, AFFO will not capture value from land or
development projects, non-income producing assets. Also, the annual provisions
required to maintain a property are difficult to predict, so AFFO often
includes assumptions that can only be described as art rather than science.
Yet with all its drawbacks, AFFO provides benefits. First, it is widely used. Analysts at financial institutions often
comment on AFFO trends. Second, by adding interest expense and other items to
AFFO, it can be compared to EBITDA, a performance metric used by companies that
operate outside of real estate. Third, a ratio such as AFFO to debt service
allows rating agencies and credit analysts to estimate the expected solvency of