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Assessing A Real Estate Investment Trust (FFO and AFFO)

Real Estate Investment Trust

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last update Tuesday, August 25, 2020
  

 



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Investors who estimate the value of a REIT are likely to find that traditional metrics like earnings-per-share and price-to-earnings do not apply to such investments. Traditional metrics like these are not reliable sources to estimate the value of a REIT. 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 earmarks the cost of investing before an investment is made for businesses. But real estate is different from fixed-plant or equipment investments. This is because the property loses value gradually occasionally and often appreciates. You can’t always rely on net income, and therefore, it’s good to judge REITs by FFO.

Funds From Operations (FFO)

Companies work by adjusting 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 for capital expenditures might be considered a weakness. Shareholder’s real estate should be maintained well.

Professional analysts use a stratagem called adjusted funds from operations (AFFO) to estimate the REIT’s value. AFFO is used for 2 reasons:

  1. It is a more elaborate measure of residual cash flow available to shareholders and, therefore, a better method for estimating value.
  2. Residual cash flow is a better predictor of REIT’s future capacity for paying dividends.

Growth in FFO and AFFO

The REIT’s value can be estimated with higher accuracy when the FFO and AFFO are looking for 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 prospect of improving occupancy rates
  • Upgrading properties for attracting tenants
  • External growth prospects

REIT evaluation provides clarity when you are dealing with FFO rather than net income. Prospective investors should also calculate AFFO, which cuts the expense to maintain a stable real estate portfolio. AFFO also provides excellent tools for gauging the REIT’s dividend and growth.



       
 

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