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FFO amends reported earnings and is a popular measure of the ongoing operating income of a REIT or REOC. It is calculated as follows:
$$ {\begin{array}{l|r} \text{Accounting Net Earnings} & XX \\ \hline\text{Add: Depreciation expense} & XX \\ \hline\text{Add: Deferred tax expenses } & XX \\
\hline {\text{Add: Losses in respect to sales of} \\ \text{property and debt restructuring}} & XX \\ \hline {\text{Less: Sales of property and debt} \\ \text{restructuring }}& (XX) \\ \hline & \textbf {FFOXXX}\\ \end{array}} $$
Note:
AFFO is an extension of FFO but is proposed to be a more useful illustration depicting the income in the current economy. AFFO can also be referred to as cash available for distribution (CAD) or funds available for distribution (FAD) and is calculated as follows:
$$ {\begin{array}{l|r} \text{Funds from operations (FFO)} & XX \\ \hline\text{Less: Non-cash (straight line) rent adjustments} & (XX) \\ \hline {\text{Less: Recurring maintenance type capital} \\ \text{expenses/leasing commissions} }& (XX) \\ \hline & \textbf{AFOXXX} \\ \end{array}}$$
Note:
AFFO is argued to be a better measure of economic income than FFO. This is because AFFO considers the capital expenditures incurred to sustain the property’s economic income. Consequentially, FFO is more often mentioned in practice since AFFO relies more on estimates and is considered more subjective.
An investor in a property REIT has consolidated the following information for a REIT:
$$ {\begin{array}{l|r} \text{Non-cash (straight-line) rent} & $305,450 \\ \hline\text{Depreciation } & $720,250 \\ \hline {\text{Recurring maintenance-type capital} \\ \text{expenditures and leasing commission}} & $605,750 \\ \hline\text{Adjusted funds from operations } & $3,525,000 \\ \hline \text{AFFO per share }& $4.55 \\ \end{array}}$$
The REIT’s fund from operations (FFO) per share is closest to:
Step 1: Calculate the FFO:
$$ {\begin{array}{l|r} \text{Adjusted funds from operations} & $3,525,000 \\ \hline\text{Add: Non-cash (straight-line) rent} & $305,450 \\ \hline \text{Add: Recurring maintenance-type capital expense }& $605,750 \\ \hline\text{}& \bf $4,436,200 \\ \end{array}}$$
Step 2: Calculate the number of outstanding shares:
$$ \begin{align*} \text{Outstanding shares} & =\frac{\text{Adjusted funds from operations}}{\text{AFFO per share}} \\ & =\frac{$3,525,000}{$ 4.55} \\ & = 774,725 \text{ shares} \end{align*} $$
Step 3: Calculate the FFO per share as follows:
$$ \text{FFO per share}=\frac{\text{Total FFO}}{\text{Outstanding shares}}=\frac{$4,436,200}{774,725}= $5.73 $$
Question
When calculating adjusted funds from operations (AFFO) from funds from operations (FFO), an analyst is most likely to:
- Add depreciation and amortization.
- Deduct non-cash rent.
- Add frequent maintenance-type capital expenditures and leasing commissions.
Solution
The correct answer is B.
Non-cash rent, maintenance-type capital expenditures, and leasing commissions are deducted from FFO when calculating AFFO.
A is incorrect. Addition of depreciation and amortization only applies when calculating funds from operation.
C is incorrect. Recurring maintenance-type capital expenditures and leasing commission is deducted when calculating AFFO.
Reading 37: Investments in Real Estate Through Publicly Traded Securities
LOS 37 (c) Describe the use of funds from operations (FFO) and adjusted funds from operations (AFFO) in REIT valuation.