Adjusted Funds from Operations
A superior metric compared to FFO when evaluating a REIT’s performance. AFFO is used in order to account for any additional expenses the landlord is expected to incur over the life of the asset (such as TIs, CAPEX, leasing commissions etc.). The measure is calculated as follows:
AFFO = FFO – Maintenance Costs – CAPEX – Straight Line Rent Adjustments.
Adjusted Funds from Operations is comparable to the Net Operating Income metric, used in analyzing individual properties.
Putting ‘Adjusted Funds from Operations (AFFO)’ in Context
Scenario:
Great Lakes REIT, a public real estate investment trust specializing in core-plus acquisition investments, recently acquired Glenwood Plaza, a grocery-anchored retail center located in suburban Chicago, Illinois. Glenwood Plaza is a well-maintained property with a mix of national and regional tenants, anchored by a major grocery store. The acquisition aligns with Great Lakes REIT’s strategy of investing in stable properties with potential for moderate value appreciation through strategic asset management.
Property Overview:
- Property Name: Glenwood Plaza
- Location: Suburban Chicago, Illinois
- Size: 150,000 square feet
- Tenants: 20, including a major grocery anchor, several national retail chains, and local businesses
- Purchase Price: $45 million
- Net Operating Income (NOI): $3 million per year
- Occupancy Rate: 95%
AFFO Calculation Context:
In evaluating the performance of Glenwood Plaza, Great Lakes REIT utilizes Adjusted Funds from Operations (AFFO) as a key metric. AFFO provides a more accurate picture of the property’s financial health by accounting for ongoing capital expenditures and other necessary costs that are not reflected in Funds from Operations (FFO).
AFFO Formula:
AFFO = FFO – Maintenance Costs – CAPEX – Straight Line Rent Adjustments
Hypothetical Financial Details:
- Funds from Operations (FFO): $3.5 million per year
- Maintenance Costs: $200,000 per year
- Capital Expenditures (CAPEX): $300,000 per year
- Straight Line Rent Adjustments: $50,000 per year
AFFO Calculation for Glenwood Plaza:
- Start with FFO: FFO = $3,500,000
- Subtract Maintenance Costs: Maintenance Costs = $200,000
- Subtract CAPEX: CAPEX = $300,000
- Subtract Straight Line Rent Adjustments: Straight Line Rent Adjustments = $50,000
- Calculate AFFO: AFFO = $3,500,000 – $200,000 – $300,000 – $50,000 = $2,950,000
By using AFFO, Great Lakes REIT can provide its investors with a more comprehensive understanding of the property’s performance, reflecting the true cash flow available after accounting for essential ongoing costs. This is particularly important for a public REIT, as it ensures that the reported earnings are not overly optimistic and consider the necessary expenditures to maintain and enhance the value of their properties.
This detailed approach helps Great Lakes REIT make informed decisions about future investments and asset management strategies, ensuring sustainable long-term returns for their investors.
Frequently Asked Questions about Adjusted Funds from Operations (AFFO)
What is Adjusted Funds from Operations (AFFO)?
AFFO is a superior performance metric for REITs that adjusts Funds from Operations (FFO) by subtracting maintenance costs, capital expenditures (CAPEX), and straight line rent adjustments. It provides a clearer picture of true cash flow.
Why is AFFO considered more accurate than FFO?
AFFO accounts for ongoing expenses such as TIs, CAPEX, and leasing commissions that FFO does not. This makes it a more realistic measure of the cash available to a REIT for distributions and reinvestment.
How is AFFO calculated?
AFFO is calculated as follows:
AFFO = FFO – Maintenance Costs – CAPEX – Straight Line Rent Adjustments
How did Great Lakes REIT apply AFFO to Glenwood Plaza?
Great Lakes REIT used AFFO to evaluate Glenwood Plaza by adjusting its FFO to reflect ongoing costs. They subtracted $200,000 in maintenance, $300,000 in CAPEX, and $50,000 in rent adjustments from $3.5 million in FFO, resulting in an AFFO of $2.95 million.
What is the significance of using AFFO in public REITs?
AFFO provides a more comprehensive view of a REIT’s financial health by incorporating recurring costs. This helps investors make informed decisions and ensures reported earnings reflect the true sustainability of returns.
How does AFFO compare to Net Operating Income (NOI)?
AFFO is comparable to Net Operating Income (NOI) in that both metrics aim to reflect the actual cash performance of a property. However, AFFO is used at the REIT level, whereas NOI typically evaluates individual properties.
Why did Great Lakes REIT use AFFO instead of just NOI or FFO?
AFFO offers a more complete financial picture by adjusting for essential costs that NOI and FFO might exclude. It enables Great Lakes REIT to assess the sustainability of income after accounting for real-world expenditures.
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