Adjusted Funds from Operations (AFFO)

What are Adjusted Funds from Operations (AFFO)?

Adjusted Funds from Operations (AFFO) is a financial performance measure primarily used in the real estate investment trust (REIT) industry. It begins with Funds from Operations (FFO) and makes several adjustments to provide a more accurate reflection of a company’s cash flow and its ability to pay dividends. AFFO accounts for maintenance capital expenditures (CapEx), amortization of leasing commissions, tenant improvements, straight-line rent adjustments, and financing costs.

How to Calculate Adjusted Funds From Operations

To calculate AFFO, start with the Funds from Operations and then make the following adjustments:

1. Subtract maintenance capital expenditures (CapEx).
2. Subtract the amortization of leasing commissions or tenant improvements.
3. Adjust for straight-line rent expenses by adding or subtracting them.
4. Make adjustments for financing costs and gains or losses on the early retirement of debt.

Practical Example of AFFO

Let’s consider a practical example of calculating AFFO for a REIT. The AFFO excel template file from Financial Edge’s free downloads to follow along.

Here we have a typical income statement for a REIT showing the Income Statement, Supplemental data and the Funds from Operations calculation. To calculate the AFFO in this problem, we first must calculate the Funds from Operations (FFO).

Step 1: Adjust for Loss on the Early Retirement of Debt

After taking the FFO, the first thing that we have to do is adjust for the loss on the early retirement of debt which is detailed in the income statement. This loss is showing as a positive – it is important to check if the convention for a loss is shown as a positive or negative for each company’s financials. In this case all financials are shown to be positive, but it is described as a loss. Therefore, the 11.1 loss will need to be added back onto FFO.

The calculation for Year –2 in the template would be:

• Total FFO + Loss on early retirement of Debt
• 1,239.6 + 11.1 = 1,250.7

Step 2: Adjust for Supplemental Data

There’s nothing else on the income statement that needs to be adjusted for. However, we are given some supplemental data and in that supplemental data, there are a number of things that need to be adjusted for as a result:

1. The first is the recurring CapEx – this is always going to be a deduction from FFO, so this needs to be linked to the AFFO calculation (and must be a negative, or minus calculation of –88.6).
2. The next piece supplemental data is the accrued rental income from straight line rents. These have to be subtracted because these reflect the accrual amounts that are over and above the economic reality of the lease. Subtract the accrued rental from straight line rents and that’s going to be done by using a minus sign (link –22.5 to the calculation as shown below).

Step 3: Amortization of Lease Commissions

The next line item is amortization of lease commissions. This has been included in the amortization expense. (These are lease commissions that have been paid out to brokers to close the deal on a new lease, and they are being amortized over the life of the lease.) However, because originally the lease commission was paid up front as a cash outflow, we want to adjust our AFFO to reflect the reality that cash has been spent here. The 7.2 was included in the amortization expense, which was added back to get to FFO. Now this 7.2 will need taking out of the AFFO calculation as shown below.

Step 4: Amortization of Financing Fees

There is one last item in the Supplemental data – the amortization of financing fees. While this is another kind of amortization expense, we don’t treat it like the lease commissions because the lease commissions were actually included in the amortization expense in the D&A line. Therefore, subtracting them out is the correct thing to do.

The amortization of financing fees is an expense that was paid upfront in cash and then essentially broken up each year over the life of the piece of debt that it is associated with. For calculating AFFO, we know that this amortization is generally included in the interest expense line. Since interest expense has already been deducted from our AFFO in the sense that it came out of net income, if we were to deduct it again, we would be double counting it. We are actually always going to ignore this amortization of financing fees.

Step 5: Total AFFO

Once all the adjustments have been made the cells can be summed up and the template will show the AFFO in row 38.

Once these steps have been completed, the template model can be cleaned and used for other AFFO calculations for REIT companies.

FFO vs. AFFO

Funds from Operations (FFO) and Adjusted Funds from Operations (AFFO) are both financial performance measures used in the real estate investment trust (REIT) industry, but they have some key differences:

Funds from Operations (FFO)

FFO is a measure of the cash generated by a REIT’s operations. It starts with net income and adds back depreciation and amortization, as well as gains and losses on the sale of properties. FFO is intended to provide a more accurate measure of a REIT’s operating performance than net income, as it excludes non-cash expenses and gains or losses that are not related to the core operations of the REIT.

Adjusted Funds from Operations (AFFO)

AFFO takes FFO a step further by making additional adjustments to provide a more accurate reflection of a REIT’s cash flow and its ability to pay dividends. AFFO accounts for maintenance capital expenditures (CapEx), amortization of leasing commissions, tenant improvements, straight-line rent adjustments, and financing costs.

These adjustments help to address some of the limitations of FFO and provide a more comprehensive measure of a REIT’s financial performance.

Conclusion

Adjusted Funds from Operations (AFFO) is a crucial financial measure for REITs as it provides a more accurate reflection of a company’s cash flow and its ability to pay dividends by making several adjustments to Funds from Operations (FFO). Understanding and calculating AFFO helps investors make informed decisions about the financial health and performance of a REIT.

Free Resources

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