Adjusted Funds from Operations (AFFO): What Is It, Calculation, Applications & More

Adjusted Funds from Operations (AFFO) is a critical metric for evaluating the financial health and performance of Real Estate Investment Trusts (REITs). It builds upon the traditional Funds from Operations (FFO) metric by incorporating adjustments for recurring capital expenditures and other non-cash items, offering investors a more accurate picture of cash flow available for distribution as dividends.

While the exact calculation may vary across REITs, the general formula for AFFO is:

AFFO = Funds From Operations (FFO) – Recurring Capital Expenditures – Straight-line Rent Adjustment

Breaking down the formula:

• FFO (Funds from Operations): Starts with net income and adds back depreciation and amortization while excluding gains or losses from property sales.
• Recurring Capital Expenditures: Includes costs for property maintenance and upgrades necessary for sustained operations.
• Straight-line Rent Adjustments: Normalizes rental income to account for tenant incentives or lease agreements with varying payments over time.
• Other Adjustments (if applicable): Non-cash items such as stock-based compensation or certain amortized costs may also be adjusted depending on the REIT’s reporting methodology.

Consider a REIT, ‘XYZ Realty’ reported the following figures for its most recent reporting period:

• Net Income: $3,000,000
• Depreciation Costs: $80,000
• Amortization Costs: $120,000
• Profit from Property Sales: $600,000
• Loss from Property Sales: $150,000
• Straight-Line Rent Adjustments: $200,000
• Recurring Capital Expenditures: $250,000

Using this data, we will calculate XYZ Realty’s Funds from Operations (FFO) and Adjusted Funds from Operations (AFFO).

The FFO formula adjusts net income by adding back non-cash charges like depreciation and amortization while excluding gains or losses from property sales.

FFO = Net Income + Depreciation + Amortization − (Profit from Property Sales − Loss from Property Sales)

Calculation:

FFO = 3,000,000 + 80,000 + 120,000 − (600,000 − 150,000)

FFO = 3,200,000 − 450,000 = 2,750,000

XYZ Realty’s Funds from Operations (FFO) is $2,750,000.

To calculate AFFO, we deduct recurring capital expenditures and adjust for straight-line rents from the FFO.

Formula:

AFFO = FFO − Capital Expenditures − Straight-Line Rent Adjustments

Calculation:

AFFO = 2,750,000 − 250,000 − 200,000

AFFO = 2,300,000

XYZ Realty’s Adjusted Funds from Operations (AFFO) is $2,300,000.

This calculation reveals that XYZ Realty has $2,300,000 in cash flow available for potential distribution to shareholders. The AFFO metric demonstrates how recurring costs and rent adjustments can significantly impact distributable cash flow, providing a clearer picture of the REIT’s financial health.

Adjusted Funds from Operations (AFFO) provides insight into the actual cash flow generated by a REIT after accounting for costs necessary to maintain properties. Unlike net income, AFFO excludes non-cash items like depreciation but adjusts for recurring expenses that impact cash flow. 

Investors value AFFO because it bridges the gap between accounting profits and actual cash flows that can be paid out as dividends, aligning with REITs’ primary investment appeal: steady income generation. It offers them insights into the sustainability of dividends and the operational efficiency of a REIT.

By incorporating recurring expenses, it delivers a more accurate measure of the cash flow that can be distributed, making it a vital tool for income-focused investors. For deeper analysis, investors may consider AFFO trends over time, comparing these figures across multiple reporting periods or within the REIT’s peer group to benchmark performance.

While both metrics are widely used in REIT analysis, their purposes differ significantly:

• FFO primarily measures operating performance by excluding non-cash expenses like depreciation. It focuses on core operations without adjusting for necessary expenditures.
• AFFO refines FFO by deducting ongoing capital expenditures and other cash-flow-related items, making it a more accurate gauge of distributable income.

Illustrative Example:

Imagine a REIT reports the following:

• Net income: $10 million
• Depreciation and amortization: $3 million
• Gains from property sales: $2 million
• Recurring capital expenditures: $1 million

FFO:
10+3−2=11 million

AFFO:
11−1=10 million

In this case, AFFO provides a more conservative and realistic estimate of cash available for dividends.

REITs are required to distribute at least 90% of their taxable income to maintain tax-advantaged status. AFFO helps investors assess whether a REIT generates sufficient cash flow to meet and sustain its dividend commitments.

AFFO is often used in price-to-AFFO ratios, similar to price-to-earnings (P/E) ratios, to evaluate whether a REIT’s stock price is aligned with its cash flow generation capabilities.

AFFO enables investors to benchmark REITs within the same sector by standardizing the impact of recurring expenditures, offering an apples-to-apples comparison.

High-dividend-paying REITs often use AFFO as a benchmark to demonstrate the sustainability of their payouts. Investors can compare AFFO per share growth with dividend payouts to ensure alignment.

REITs reinvesting in property development or acquisitions may show lower AFFO due to higher capital expenditures. However, AFFO can still reflect cash flow improvements from long-term investments.

AFFO is a cornerstone metric for REIT analysis, offering transparency into a REIT’s ability to generate cash for dividends. Understanding AFFO equips investors with the tools to make informed decisions, whether assessing dividend sustainability or comparing REITs within a competitive market.

Here are some limitations of the financial metric.

While AFFO offers a refined view of cash flow, there is no universal standard for calculating adjustments. Investors must carefully review the methodology disclosed by each REIT.

AFFO excludes one-time costs, which may sometimes impact future performance. For instance, significant tenant improvement costs may not be reflected in AFFO, leading to an overly optimistic picture.

High variability in recurring capital expenditures can make AFFO volatile, requiring investors to analyze trends over multiple periods.

InvestingPro offers detailed insights into companies’ Adjusted Funds from Operations (AFFO) including sector benchmarks and competitor analysis.

AFFO adjusts FFO by subtracting recurring capital expenditures and accounting for other cash-flow-related adjustments, making it a more refined measure of distributable income.

AFFO provides a clearer view of cash flow available for dividend payments, ensuring that distributions are sustainable over time.

While most REITs disclose AFFO in their financial reports, calculations may vary slightly, so investors should review the methodology used.

Consistent AFFO growth indicates effective management and property performance, which are positive signals for investors. However, growth should align with broader industry trends.

Yes, negative AFFO can occur if a REIT incurs high capital expenditures or experiences declining property income, signaling potential risks for dividend sustainability.