What does 'AFFO' mean when talking about REITs?

I apologize for adding this term to my REIT Tracker without providing a good explanation of what it means and how I’m using it. AFFO stands for “adjusted funds from operations”, and is thought of as one of the best (though still imperfect) tools to estimate a REIT’s earnings potential. It’s sort of like a net income measure that is special to the REIT industry; the funds from operations (FFO) calculation is used to account for the non-cash expenses like depreciation and amortization that are usually charged against a company’s income (by adding these expenses back into income), and then removing gains (or losses) on the sale of assets and interest income.

The “adjusted” part is thought to make the measure even more accurate, as it subtracts recurring capital expenditures from the FFO total. I like to represent a REIT’s AFFO relative to its stock price, first by dividing AFFO by the number of common shares (to get a “AFFO per share” amount), and then by dividing the stock price by the “AFFO per share”. This gives an easy-to-understand multiple.

MB BOTTOM-LINE

There’s no perfect measure of a REIT, but I like to use the Price-to-AFFO multiple to compare the “price” of REITs. You can quickly go down the rabbit hole in terms of the forward-looking subjective values of the properties within each REIT, comparing locations, tenant mixes, occupancy rates, churn, and building age, but the Price-to-AFFO multiple (again, for me) helps me get a very high-level feel for whether or not a certain REIT is commanding a premium for a slice of its revenues.

It’s like using a special REIT version of a “price to earnings per share” multiple to compare how the market values different REITs. The higher the multiple, the more the market is willing to pay for that REIT’s income. That’s where all the rabbit-hole stuff comes in. If the multiple looks high, it’s possible (but not necessarily true) that the stock might be overpriced. For me, it’s a jumping-off point to a whole range of deeper investigations that help me sift through the data and take actions (or not) that will help my particular investment thesis and situation. REITs aren’t for everyone, and they aren’t all (by default) a good investment.

A REIT can be overpriced, and it’s entirely possible to lose money investing in REITs (just ask any DDMP [DDMPR 1.82 2.82%] IPO investors). The REIT Tracker (and price-to-affo stat) are merely there to help in case you determine REIT investments are something that is right for you.

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