REIT Valuation by FFO and AFFO
Real estate is different from equipment assets. This is because the property loses value gradually occasionally and often appreciates. You can't always rely on net income, so it's good to judge REITs by FFO.last updated Friday, January 19, 2024
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CONTENTS
Investors in the REIT valuation process will likely find that traditional metrics like earnings-per-share and price-to-earnings do not apply to such investments. Traditional metrics like these are unreliable sources for estimating a REIT's value. A better metric to use is FFO or Funds From Operations. It makes adjustments for depreciation, preferred dividends, and distributions.
Depreciation is an acceptable non-charge that marks the cost of investing before investing in businesses. But real estate is different from fixed-plant or equipment assets. This is because the property loses value gradually occasionally and often appreciates. You can't always rely on net income, so it's good to judge REITs by FFO.
What is AFFO in real estate?
What does affo mean?
Companies adjust Funds From Operations (FFO) with the net income. The general calculation includes adding the depreciation to the net income while subtracting gains on the property sales. However, the inability to deduct capital expenditures might be considered a weakness. Shareholders' real estate should be maintained well.
Professional analysts estimate the REIT's value using adjusted funds from operations (AFFO). AFFO is used for two reasons:
- It is a more elaborate measure of residual cash flow available to shareholders and a better method for estimating value.
- Residual cash flow better predicts REIT's future capacity for paying dividends.
What is a good FFO for a REIT?
The standard FFO for REIT is 70-80%, higher than average. A dividend cut could be on the horizon when FFO is close to or higher than 100%.
AFFO Calculation
The next will help you to answer the question: How to calculate affo? AFFO Formula:
- Step one, Calculate FFO.
The formula to calculate FFO takes net income and adds back the depreciation and amortization, subtracting any one-time gains from the sale of assets.
FFO = Net Income + Depreciation + Amortization – Gains on Sales of Property, net - Step two, normalize the FFO.
AFFO = FFO + Non-Recurring Items – Capital Expenditures
Only maintenance CAPEX must be deducted, as opposed to the entirety of a REIT's CAPEX, i.e., maintenance and growth CAPEX.
Reit valuation model Excel.
Growth in FFO and AFFO
The REIT's value can be more accurately estimated when the FFO and AFFO seek expected growth using one or more metrics. Investors need to observe the prospects of the REIT very carefully. A few things to consider before evaluating the growth of REIT:
- The probability of an increase in rent
- The possibility of improving occupancy rates
- Upgrading properties to attract tenants
- External growth prospects
REIT evaluation provides clarity when dealing with FFO rather than net income. Prospective investors should also calculate AFFO, which cuts expenses to maintain a stable real estate portfolio. AFFO also provides excellent tools for gauging the REIT's dividend and growth.
Applying a Multiple to FFO/AFFO
The total REIT's return is dividends paid plus price appreciation.
Total Return (REIT) = Dividents + Price Appreciation
Next, price appreciation can be broken into two components: growth in FFO/AFFO and expansion in the price-to-FFO or price-to-AFFO multiple.
Price Appriciation = Growth in FFO/AFFO + price-to-FFO
Let's look at multiples for Paperfree Residential. Note that we are showing price/market capitalization divided by FFO. Paperfree Residencial's market cap* in this example is $8M.
*where market cap is the number of shares multiplied by the price per share.
FAQ
What is affo formula CFA?
The CFA version of the AFFO formula is next.
AFFO = FFO - CAPEX
where:
- CAPEX is Recurring Capital Expenditures
- AFFO means Adjusted Funds From Operations
- FFO means Funds From Operations
- FFO=Net Income+Depreciation −Gains/Losses from property sales
What is Affo vs FFO?
The primary and single difference between ffo vs affo is Capex.
In detail - If we take funds from operations (FFO) and minus Recurring Capital Expenditures (Capex) we will have adjusted funds from operations (AFFO).
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