The FFO & AFFO are probably the most useful tools to analyze a REIT. Since REITs main reason for existing is the distribution of its revenue, you must look at how healthy this distribution is, right? This is a similar thinking to dividend stock analysis, but with different data.
The main problem when looking at a REIT financial statement is the inclusion of amortization in the calculation of its earning. The amortization concept is a GAAP that allows a company to reduce its income by applying a virtual loss in value to its equipment or buildings. Since REIT’s are in the business of owning and managing properties, they show an important amount in amortization that reduces their earnings on paper.
On top of that, in January 2011, the application of International Financial Reporting Standards (IFRS) modified the known definition of net income. In fact, IFRS requires REITs to consider their buildings as “investment properties” in their financial statements. Investment properties allow accountants to use the Fair Market Value model (FMV) in order to reflect the true value of the assets instead of a falsely depreciated asset according to amortization rules. This will help bring ratios closer to the business reality. However, there is already a measure existing that avoids any confusion among investors.
In reality, most properties will gain in value instead of losing value over time. Therefore, this GAAP is mixing your analysis. This is why we are using a different approach by looking at the FFO & AFFO. The AFFO will give you hints on the sustainability of future distributions. In other words, looking at the AFFO is like looking at the company’s real profit.
The difference in the FFO and AFFO is the consideration of the capital expenditure. The FFO will consider the company’s earnings and add the amortization to have a real look at the company’s income flow. It will withdraw the proceeds from property sales in order to show a net income flow. A new approach with the AFFO will go a little bit further by withdrawing capital expenditure to the ladder. This is to ensure the true net income flow from the REITs operations. Since each company will have to spend money in order to maintain and manage its property, it makes sense to include capital expenditures in your calculation. Therefore;
Before you let a big sigh out of your mouth I would ask you to hold your breath a few more seconds. I told you that the AFFO can’t be found with a free stock screener such as the TMX. However, REITs are giving the AFFO in their quarterly financial statements. Even though it’s not a GAAP and you would technically have to calculate it yourself, REITs management teams are well aware that you are looking for this info and therefore provide it to you on a quarterly basis. You can surely waste a few hours trying to calculate AFFO for each REIT yourself… or you can simply get the financial statement and read a few pages to find the information you are looking for .