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REIT Valuation Using Funds From Operations (FFO) and Adjusted Funds from Operations (AFFO).

REIT Valuation Using Funds From Operations (FFO) and Adjusted Funds from Operations (AFFO).

Funds from Operation (FFO)

FFO amends reported earnings and is a popular measure of the ongoing operating income of a REIT or REOC. It is calculated as follows:

$$\small{\begin{array}{l|l|l|l|l|l}\textbf{}&{\textbf{}\\ \textbf{}_{\textbf{}}}& \\ \hline\text{Accounting Net Earnings} & XX \\ \hline\text{Add:Depreciation expense} & XX \\ \hline\text{Add:Deferred tax expenses } & XX \\
\hline\text{Add:Losses in respect to sales of property and debt restructuring} & XX \\ \hline \text{Less:Sales of property and debt restructuring }& (XX) \\ \hline\textbf{FFO} & \bf XXX\\ \end{array}}$$


  1. Depreciation expense is added back because real estate maintains its value to a more considerable extent than other business assets. In fact, the value of real estate often appreciates during the real estate property’s useful life. That depreciation deduction is provided for under IFRS, and US GAAP doesn’t represent the economic reality.
  2. Gains and losses from property sales and debt restructuring are factored in because they don’t represent sustainable expected income.
  3. Deferred tax expenses are added back. This is done on the pretext that a taxable REOC that uses a moderate degree of leverage and chooses to reinvest most of its income in its business is usually able to defer its annual tax liability. In this scenario, income will be low as a result of accelerated depreciation rates for tax purposes.

Adjusted Funds from Operation (AFFO)

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:

$$\small{\begin{array}{l|l|l|l|l|l}\textbf{}&{\textbf{}\\ \textbf{}_{\textbf{}}}& \\\hline\text{Funds from Operations (FFO)} & XX \\ \hline\text{Less: Non-cash (straight line) rent adjustments} & (XX) \\ \hline \text{Less: Recurring maintenance type capital expenses/ leasing commissions }& (XX) \\ \hline\textbf{AFO} & \bf XXX\\ \end{array}}$$


  1. Straight-line rent refers to average contractual rent over a lease period and no cash rent is paid during the lease. The non-cash rent reflects contractually increasing rental rates.
  2. Maintenance capital expenditures and expenses related to leasing the properties are deducted since they are related to costs incurred to maintain the property value.

There is a reason for making adjustments to net earnings when calculating FFO and AFFO. It aims at obtaining a more tangible, cash-focused measure of viable economic income that decreases dependence on non-cash accounting estimates and excludes non-economic, non-cash charges.

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:

$$\small{\begin{array}{l|l|l|l|l|l}\textbf{}&{\textbf{}\\ \textbf{}_{\textbf{}}}& \\ \hline\text{Non-cash (straight-line) rent} & $305,450 \\ \hline\text{Depreciation } & $720,250 \\ \hline\text{Recurring maintenance-type capital expenditures and leasing commission} & $605,750 \\ \hline\text{Adjusted funds from operations } & $3,525,000 \\ \hline \text{AFFO per share }& $4.55 \\ \hline\end{array}}$$

Calculate the REIT’s fund from operations (FFO) per share.

  1. $6.65.
  2. $4.55.
  3. $5.73.


The correct answer is C:

Step 1: Calculate the FFO as follows:

$$\small{\begin{array}{l|l|l|l|l|l}\textbf{}&{\textbf{}\\ \textbf{}_{\textbf{}}}& \\ \hline\text{Adjusted Funds From Operations} & $3,525,000 \\ \hline\text{Add: Non-cash (straight-line) rent} & $305,450 \\ \hline \text{Add: Recurring maintenance-type capital expense }& $605,750 \\ \hline\text{}& \bf $4,436,200 \\ \hline\end{array}}$$

Step 2: Calculate the number of outstanding shares as follows:

\(\text{Outstanding Shares}=\frac{\text{Adjusted funds from operations}}{\text{AFFO per share}}\)

\(\text{Outstanding Shares}=\frac{$3,525,000}{$ 4.55}= 774,725 \text{ shares}\)

Step 3: Calculate the FFO per share as follows:

\(\text{FFO per share}=\frac{\text{Total FFO}}{\text{Outstanding shares}}\)
\(\text{FFO per share}=\frac{$4,436,200}{774,725}= $5.73\)

A is incorrect: This is because the amount is arrived at when depreciation is added back when calculating total FFO (which is incorrect) as follows:

$$\small{\begin{array}{l|l|l|l|l|l}\textbf{}&{\textbf{}\\ \textbf{}_{\textbf{}}}& \\ \hline\text{Adjusted Funds From Operations} & $3,525,000 \\ \hline\text{Add: Depreciation}&$720,250\\\hline\text{Add: Non-cash (straight-line) rent} & $305,450 \\ \hline \text{Add: Recurring maintenance-type capital expense }& $605,750 \\ \hline\text{}& \bf $5,156,450 \\ \hline\end{array}}$$

The incorrect FFO per share then becomes:

\(\text{FFO per share}=\frac{$5,156,450}{774,725}= $ 6.65\)

B is incorrect: The AFFO price per share cannot equal the FFO price per share.


When calculating adjusted funds from operations (AFFO) from funds from operations (FFO), an analyst is most likely to:

  1. Add depreciation and amortization.
  2. Deduct non-cash rent.
  3. Add frequent maintenance-type capital expenditures and leasing commissions.


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 35: Real Estate Investments

LOS 35 (m) Describe the use of funds from operations (FFO) and adjusted funds from operations (AFFO) in REIT valuation.

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