What are Adjusted Funds From Operations

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Many Real Estate Investment Trusts fail to calculate FFO in a uniform manner. Some of them include short-term capital expenditures, such as the cost of replacing apartment curtains. Therefore, to obtain a truer picture of a REIT's financial performance, such items should be subtracted from Funds From Operations, producing Adjusted Funds From Operations, or AFFO.

To calculate the AFFO of a real estate investment trust, you must subtract all items that, although capitalized (which means spreading their expense out over years), don't really add to the value of a property. (For instance, a new roof is a necessary expense and usually capitalized, but the building had a roof before, and now it still does, so its overall value has not been increased.

With Adjusted Funds From Operations, Eliminate the Accounting Convention of Straight-Lining Rents

The straight-lining of rent refers to a practice of Generally Accepted Accounted Principles (GAAP) where rent over multi-year properties is averaged so it's the same over the life of a contract. In reality, however, rents usually don't remain the same over the life of a contract. They often start out low and then go up through the years.

Therefore, straight-lining rents in the early years of such a contract makes it appear that the REIT is collecting more money in rent than it actually is. Using actual rents collected in a year is more realistic and accurate.

The term AFFO was invented by the REIT research firm Green Street Advisors, Inc.

However, Real Estate Investment Trusts usually don't report their AFFO, and those that do, do so in different ways, so it's still difficult to compare them.

Sometimes REITs use other terms to refer to the cash they can pay out to shareholders.

Cash Available for Distribution (CAD).

Funds Available for Distribution (FAD).

Next: What is the Price to Funds From Operations Ratio -- one way to evaluate REIT fundamental financial information

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