Definition
Adjusted Funds From Operations (AFFO) is a financial performance measure often used in the real estate sector. It is more refined than the Funds from Operations (FFO) by taking into account the capital expenditures required for maintaining the quality of underlying investment properties. Essentially, AFFO represents the cash available to be distributed to investors, providing a more accurate picture of a company’s ongoing profitability.
Phonetic
The phonetics of the keyword, Adjusted Funds From Operations (AFFO), would be: ah-just-ed funds from operations (A-F-F-O).
Key Takeaways
1. Definition: Adjusted Funds From Operations (AFFO) refers to a financial performance measure primarily used in the Real Estate Investment Trusts (REITs) industry. It offers a more precise estimate of residual or distributable cash flows than the other measures like Funds From Operations (FFO).
2. Calculation: AFFO is derived by deducting capital expenditures necessary to maintain current rental income from FFO. It also includes adjustments for recurring capital expenditures and straight-lining of rents.
3. Importance: AFFO is considered a crucial measure of a REIT’s recurring operational performance. It provides investors with insights about the REIT’s ability to sustain or raise its dividends. A consistent or growing AFFO usually indicates a promising REIT investment.
Importance
Adjusted Funds From Operations (AFFO) is a paramount financial term within business and finance as it offers a more precise measure of the financial performance and viability of a real estate investment trust (REIT) or similar type of investment vehicle beyond just assessing net income. AFFO takes into account the significant costs of sustaining capital expenditures and leasing commissions that are crucial to maintaining the income generating real estate portfolio of a REIT. Therefore, by determining AFFO, investors acquire a more accurate depiction of the entity’s ongoing operational productivity and cash flow position – enabling more informed decisions concerning potential investments, dividend payouts, and overall long-term strategic planning.
Explanation
Adjusted Funds From Operations (AFFO) is a financial performance measure primarily used in the analysis of real estate investment trusts (REITs). The main purpose of AFFO is to provide a more accurate measure of the recurring income that a REIT is expected to generate. Traditional measures like Net Income or Funds From Operations (FFO) may not adequately reflect the financial performance of a REIT due to the unique nature of real estate investments, which often include heavy depreciations and non-cash expenses. AFFO, by making certain adjustments to FFO, seeks to mitigate these inconsistencies, thus presenting a more realistic assessment of sustainable operational performance.AFFO is commonly used to calculate the payout ratio of a REIT, helping investors determine if the REIT can support its dividends from its operational cash flow. Furthermore, by comparing AFFO across periods, investors can track changes in the REIT’s operational efficiency over time. In valuing a REIT, analysts also use the price to AFFO ratio, which is similar to the price to earnings ratio used in traditional equity valuation. Therefore, AFFO is an essential tool for investors and analysts in making informed decisions about investment in real estate properties and trusts.
Examples
1. Real Estate Investment Trusts (REITs): Real Estate Investment Trusts commonly use AFFO to demonstrate their financial performance. For example, Simon Property Group, one of the largest REITs in the U.S., reported an AFFO of over $3 billion in 2019. This indicated that they have a significant income from their operations after deducting the necessary expenditures, which should be attractive to investors considering dividend payments.2. Industrial Companies: Companies in sectors such as manufacturing tend to have high capital expenditures due to the nature of their operations. Therefore, these type of businesses might use AFFO to provide a clearer picture of how much cash flow they can actually use for dividends, acquisitions, or paying down debt. For instance, General Motors reported an AFFO of $13.6 billion in 2019, post subtracting expenses necessary to maintain and grow the business, demonstrating strong financial health to its shareholders.3. Energy Companies: Energy companies, particularly oil and gas, have significant property, plant, and equipment costs. ConocoPhillips, a leading energy company, provided an AFFO figure in their report as a way to highlight their ability to yield profits and still cover these mandatory operating costs. This critical figure helped the company in attracting investment by showing a more accurate representation of their free cash flow relative to standard accounting measures.
Frequently Asked Questions(FAQ)
What is Adjusted Funds From Operations (AFFO)?
Adjusted Funds From Operations (AFFO) is a financial performance measurement used in real estate industries, especially in Real Estate Investment Trusts (REITs). It represents the amount of cash flow that a property will generate after accounting for capital expenditures that are necessary to maintain the property.
How is AFFO calculated?
The standard formula to calculate AFFO is: AFFO = Funds From Operations (FFO) – normalized recurring real estate maintenance expenditures. But the calculation may vary slightly among different REITs.
How is AFFO different from FFO (Funds from Operations)?
While FFO provides a measure of total cash generated, AFFO further deducts capital expenditures and is considered a more accurate measure of a REIT’s ongoing cash-flow capacity.
Why is AFFO considered a better measure than Net Income for REITs?
AFFO takes into account the necessary capital expenditures needed for property maintenance, which Net Income does not. This makes AFFO a more accurate representation of the cash flow available to shareholders.
What can an investor deduce from a rising AFFO?
An increasing AFFO generally signals good financial health for the company as it indicates that the company is generating more cash after subtracting the costs needed to maintain their assets.
How does one use AFFO to evaluate the performance of a REITs?
Investors often look at the AFFO per share and compare it to the purchase price to determine if the REIT can generate a reasonable return on investment. They may also use AFFO to compare the performance of different REITs.
What is the relation between AFFO and dividend payments?
The AFFO of a company can be utilized to evaluate its ability to sustain or increase dividend payments. Higher AFFO typically means the company has a greater potential to pay dividends.
Is a low AFFO a bad sign?
A consistently low or decreasing AFFO may raise concerns about a company’s profitability and it’s ability to maintain its property, which could affect its long-term growth. However, like most financial metrics, it should be considered in the context of overall performance.
Related Finance Terms
- Real Estate Investment Trusts (REITs)
- Net Operating Income (NOI)
- Non-cash Expenses
- Capital Expenditures (CapEx)
- Funds From Operations (FFO)
Sources for More Information
