What are adjusted operating funds?
Adjusted operating funds (AFFO) refer to the measure of financial performance mainly used in the analysis of real estate investment trusts (REITs). A REIT’s AFFO, although subject to different calculation methods, is generally equal to the Trust’s Operating Funds (FFO) with adjustments made to recurring capital expenditures used to maintain the quality of the assets under- of the REIT. The calculation takes into account the adjustment to GAAP of the linear alignment of rents, rental costs and other important factors.
Understanding adjusted transaction funds
Regardless of how industry professionals choose to calculate adjusted operating funds (AFFO), it is considered a more accurate measure of residual cash flow to shareholders than the simple FFO because it takes into account rent increases and additional costs incurred by the REIT. It provides a more accurate base number when estimating current values and a better predictor of the REIT’s future ability to pay dividends. This is a non-GAAP measure.
Calculation of adjusted funds from transactions
Before calculating the AFFO, an analyst must first determine the operating funds of the REIT (FFO). The FFO measures the cash flows of a specified list of activities. FFOs reflect the impact of rental and acquisition activities of the REIT, as well as interest costs. The FFO considers the REIT’s net income, including amortization and depreciation, but excludes capital gains from the sale of properties. The reason these gains are not included is that these are unique events and generally do not affect the REIT’s future earnings potential in the long term.
The formula for FFO is:
FFO = net profit + depreciation + depreciation – capital gains on the sale of real estate
Once the FFO has been determined, the AFFO can be calculated. The formula for AFFO is:
AFFO = FFO + rent increases – capital expenditure – current maintenance amounts
AFFO calculation example
As an example of the AFFO calculation, assume the following: a REIT had net earnings of $ 2 million in the last reporting period. During this time, she earned $ 400,000 from the sale of one of her properties and $ 100,000 from the sale of another. He reported $ 35,000 in amortization and $ 50,000 in amortization. During the period, net rent increases were $ 40,000; capital expenditures were $ 75,000 and routine maintenance was $ 30,000.
Based on this information, the FFO can be calculated as follows:
FFO = $ 2,000,000 + $ 35,000 + $ 50,000 – ($ 400,000 – $ 100,000) = $ 1,785,000
From this, the AFFO is calculated as follows:
AFFO = FFO + $ 40,000 – $ 75,000 – $ 30,000 = $ 1,785,000 – $ 65,000 = $ 1,720,000