FFO and AFFO: what do they mean for your REIT shares?

Why property depreciation changes the earnings picture#

A building usually stays on the balance sheet at its accounting cost, reduced by depreciation and any impairment. Depreciation spreads part of that cost over its useful life and reduces reported profit. The depreciation charge itself creates no new cash payment in that period.

Property prices and rental income can move differently from that accounting charge. Nareit's FFO measure adds back real-estate depreciation and amortisation, removes gains or losses on certain property sales and makes other defined adjustments. It gives you an additional measure of operating performance alongside the financial statements.

The property still needs upkeep. Adding depreciation back to earnings leaves you with a question about what repairs and replacements actually cost. Those cash outlays appear elsewhere in the accounts.

Follow one REIT from a loss to FFO#

Suppose a hypothetical REIT reports the following annual figures. It has 10.000 million common shares throughout the year, with no preferred shares, outside ownership interests or other adjustments in this example.

GAAP is the accounting framework used for these financial statements. The loss already includes the depreciation expense and the sale gain. Reversing those two items gives FFO of −$2.000 million + $12.000 million − $1.000 million = $9.000 million.

The $1.000 million sale gain is the accounting profit on the sale, separate from the cash proceeds. You would find the proceeds in investing activities. Removing that gain helps you examine the property operation without treating a sale profit as recurring rental earnings.

FFO per share is $9.000 million divided by 10.000 million shares, or $0.90. Read the company's reconciliation to see which earnings belong to common shareholders and which share or unit count it uses. A change in total FFO may reach each share differently if the denominator changes.

What AFFO changes, and why the definition matters#

AFFO starts with FFO and applies further adjustments. Companies choose their definitions, so compare the actual reconciliation lines before comparing two reported AFFO figures.

Our example REIT deducts $1.000 million of straight-line rent that was recognised in earnings without current-period cash, and $2.000 million of maintenance capital spending. Straight-line rent spreads rental income across a lease; the amount recognised in a particular year can differ from the rent collected that year. Maintenance spending pays for work needed to keep existing properties operating.

Its AFFO is $0.60 per share. If you hold 100 shares, those shares correspond to $60 of this adjusted annual performance measure. The amount does not appear in your account; a declared dividend determines your payment.

Check whether a real REIT deducts recurring property spending, leasing costs and tenant improvements, and whether it adds back expenses that recur. A company can use a different adjustment list from this example. Keep its definition beside the numbers you are comparing.

Does AFFO cover your dividend?#

Suppose the same REIT pays $0.50 per share for the year, a total of $5.000 million. That is 83.333% of its $6.000 million AFFO. Your 100 shares receive $50 before any tax or fees.

The ratio tells you how the distribution compares with the reported adjusted measure. To see how it was funded, read the same year's cash-flow statement. In our example, ordinary receivables and payables movements use another $3.000 million of cash, separate from the straight-line-rent adjustment.

Operations leave $3.000 million after maintenance, while the dividend uses $5.000 million. The remaining $2.000 million comes from another source, such as existing cash, property-sale proceeds or financing. Read investing and financing activities and the change in the cash balance to find it.

A temporary working-capital outflow may reverse. A repeated shortfall asks a different question: what keeps funding the distribution? Also check borrowing repayments and committed spending that this simplified calculation leaves out. Profit and cash-flow checks explain those account movements in more detail.

Compare what belongs to each share#

Keep the period and ownership basis consistent. Use common-shareholder FFO or AFFO with its corresponding share count. Check the reconciliation for preferred dividends, joint ventures, noncontrolling interests and any operating-partnership units included in the measure.

If more shares are issued, total AFFO can increase while AFFO per share grows less or falls. Compare the per-share measure and the share-count explanation across periods. Revenue, profit and EPS walks through the same ownership problem using ordinary company earnings.

For valuation, use the same version of the measure in both parts of a comparison. A price divided by annual AFFO per share is a multiple of that company's adjusted earnings definition. It leaves the definition, property outlook and financing assumptions for you to assess. Stock valuation checks explain how a multiple fits into that wider research.

Find the adjustment that needs another look#

Start with the reported financial statements and the FFO/AFFO reconciliation for the same period. Trace a large add-back to its note, then check the cash-flow statement and property-spending disclosure. Record which items are recurring and whether the company changed its definition.

That gives you a specific next question: are rents being collected, is upkeep fully reflected, or is the dividend drawing on another cash source? Carry that question into the next report and compare the answer using a consistent definition.