FFO measures earnings before the cost of keeping the buildings let; AFFO deducts it, and the dividend that looked comfortable on one is tight on the other.
Start from FFO, reverse the non-cash items that remain in it (straight-line rent, lease intangible amortisation, stock compensation, amortised financing costs), then deduct the capital the buildings consume every year: maintenance capex, leasing commissions and tenant improvements. On an illustrative REIT, FFO of 410 ($ millions) becomes AFFO of 300, $1.50 a share against $2.05, and a $1.32 dividend moves from a 64.4 per cent payout on FFO to 88.0 per cent on AFFO.
Worked in full in REIT Analysis and Valuation by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
FFO is the industry's standard earnings measure: net income with real estate depreciation added back and gains on property sales removed, on the argument that buildings do not lose value the way the accounts depreciate them. That argument holds only if the buildings are maintained and re-let, which costs cash every year. AFFO, adjusted funds from operations, deducts that cost. It is the better guide to what a REIT can pay, and the one with no standard definition, so it has to be rebuilt.
| Item | Amount |
|---|---|
| Net income attributable to common shareholders | 180 |
| Real estate depreciation and amortisation | 260 |
| Gains on sale of property | 40 |
| Impairment of real estate | 10 |
| Straight-line rent included in revenue | 20 |
| Above and below-market lease amortisation, net income effect | 6 |
| Non-cash stock compensation | 12 |
| Amortisation of deferred financing costs | 8 |
| Maintenance capex / leasing commissions / tenant improvements | 45 / 25 / 34 |
| Shares, millions / dividend per share | 200 / $1.32 |
FFO = net income + real estate D&A − gains on sale + impairment of real estate
AFFO = FFO − straight-line rent − lease intangible income + stock compensation + financing cost amortisation − maintenance capex − leasing commissions − tenant improvements
In Excel, keep each adjustment on its own row with its sign, and compute the payout both ways: =DPS/(FFO/Shares) and =DPS/(AFFO/Shares).
| Line | $ m |
|---|---|
| Net income | 180 |
| + real estate depreciation and amortisation | 260 |
| − gains on sale | −40 |
| + impairment | 10 |
| FFO | 410 |
| − straight-line rent | −20 |
| − lease intangible amortisation | −6 |
| + stock compensation | 12 |
| + financing cost amortisation | 8 |
| − maintenance capex | −45 |
| − leasing commissions | −25 |
| − tenant improvements | −34 |
| AFFO | 300 |
The non-cash items nearly cancel, a net 6. The recurring capital is the large deduction: 104, or 25.4 per cent of FFO. AFFO is 73.2 per cent of FFO, and per share $1.50 against $2.05.
None of the inputs requires management's own AFFO. Net income, depreciation, gains and impairment are in the income statement and the FFO reconciliation every REIT publishes. Straight-line rent, lease intangible amortisation, stock compensation and financing cost amortisation are adjustments in the cash flow statement, reconciling net income to operating cash flow. The capital lines are the hardest: maintenance capex, leasing commissions and tenant improvements are usually disclosed in the supplemental package, split between recurring spend on the existing portfolio and first-generation spend on developments and acquisitions. Take the recurring split, check it against the investing section of the cash flow statement, and if the company does not disclose one, ask for it on the call. A REIT that cannot say what it spends to keep its buildings let has told you something about its AFFO.
The dividend is $1.32 a share, 264 in total. On FFO the payout is 64.4 per cent, which reads as a generous cushion. On AFFO it is 88.0 per cent: the company retains 36 a year after paying the dividend and maintaining its buildings, which is what it has for growth and debt reduction before raising new capital. Both ratios are arithmetically correct. Only the second describes the cash.
| Recurring capital | AFFO | Per share | Payout | Retained |
|---|---|---|---|---|
| 70 | 334 | $1.67 | 79.0% | 70 |
| 104 | 300 | $1.50 | 88.0% | 36 |
| 140 | 264 | $1.32 | 100.0% | 0 |
Recurring capital is the line that differs most between property types. An industrial or net-lease portfolio may need little; an office portfolio with a heavy lease expiry year needs far more, because tenant improvements and commissions are paid when space is re-let. At 140 of recurring capital the dividend absorbs all of AFFO while the FFO payout still reads 64.4 per cent. A one-year spike is normal; a payout above 100 per cent of AFFO year after year means the dividend is being funded by asset sales, debt or new equity.
AFFO is FFO less its non-cash income and less the capital the buildings need to stay let: here 300 against 410, $1.50 a share. Judge the dividend on it, at 88.0 per cent, not on the 64.4 per cent FFO payout. The FFO and AFFO bridges in the free workbooks for REIT Analysis and Valuation are built on one definition for exactly this reason, and the implied cap rate article applies the same discipline to valuation.
No. Nareit defines FFO; AFFO is each company's own measure, so the adjustments differ between REITs. Rebuild it on one definition before comparing. In the illustrative case, deducting maintenance capex only gives AFFO of 359 instead of 300, $1.79 a share against $1.50, and a payout of 73.5 instead of 88.0 per cent.
There is no universal threshold, but below 100 per cent of AFFO the dividend is funded from recurring cash, and the margin below it is what the company retains to grow. At an 88.0 per cent payout the illustrative REIT retains 36 a year; if its recurring capital rose from 104 to 140 the payout would reach 100.0 per cent and retention would be nil.
Because GAAP spreads fixed rent increases evenly over the lease, so early years report more rent than tenants actually pay. The difference is income that has not been received in cash. In the illustrative REIT it is 20 a year; leaving it in raises AFFO from 300 to 320 and flatters the payout, 82.5 instead of 88.0 per cent.
This article is one calculation from REIT Analysis and Valuation. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: real estate investing, finance and fund management → · All 324 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.