Funds From Operations (FFO) and Adjusted Funds From Operations (AFFO) are the core non-GAAP measures used to evaluate equity REITs. FFO strips out accounting noise like noncash real estate depreciation and gains on sales, while AFFO goes further by subtracting recurring cash outlays needed to maintain properties. Used together, they provide a cleaner line of sight into dividend capacity than GAAP earnings.
Investors center valuation on FFO and AFFO because these metrics align more closely with a REIT’s ability to pay and grow dividends. GAAP earnings can make healthy hotel, apartment, and retail landlords look unprofitable on paper due to depreciation, even when property values are stable or rising. If a REIT trades at 12x GAAP EPS but 16x FFO, that spread signals depreciation is suppressing reported earnings while cash generation is stronger.
FFO exists because two GAAP items obscure operating performance: noncash real estate depreciation and episodic gains from property sales. A steady apartment REIT might show $2.00 in GAAP EPS but $4.00 in FFO, simply because accounting assumes buildings decline in value on a straight-line schedule. Nevertheless, FFO is not cash flow from operations, not EBITDA, and not REIT taxable income. It ignores maintenance capital expenditures and leasing costs, so it can overstate recurring free cash in capex-heavy sectors. It also excludes gains on sale, which understates earnings for portfolios that routinely recycle assets.
Nareit provides the baseline FFO definition used by the equity market. At a high level, FFO equals GAAP net income attributable to common shareholders, plus real estate depreciation and amortization, plus the REIT’s pro rata share of those items from unconsolidated joint ventures, minus gains or losses from sales of depreciable property, and plus impairment charges of depreciable real estate. Depreciation of corporate-level assets such as computers and vehicles is not added back.
Many issuers also present “Nareit FFO” alongside “Normalized FFO” or “Core FFO,” which remove items like transaction costs, storm damage, or early debt extinguishment. These additional adjustments fall outside Nareit’s definition and deserve careful scrutiny because they can make recurring expenses look temporary.
AFFO aims to approximate recurring free cash flow after the ongoing capital needed to preserve Net Operating Income (NOI). There is no single formula, but common practice starts with FFO and adjusts for timing differences and recurring cash burdens. Typical adjustments include:
Critically, issuers should reconcile AFFO to GAAP with transparent labels. When management uses averaging methods or normalized reserves for recurring capex, they should explain the methodology and why it suits the portfolio’s lease terms and property mix.
Building a reliable bridge is straightforward if you tie each step to account-level line items. The typical sequence is:
When the reconciliation is built from the general ledger and cash flow statement, it becomes repeatable across periods and comparable across peers.
Straight-line rent recognition front-loads revenue when leases contain rent steps or free rent. For newer leases with long concession periods, GAAP revenue can sit well above cash collections for years. AFFO typically removes straight-line rent so the result better approximates cash rent in the current period.
The SEC often challenges bespoke revenue constructs presented as a replacement for GAAP. To stay compliant, show the specific noncash components removed, rather than rebranding an alternative topline like “cash rent” without a reconciliation.
Many REITs own properties through joint ventures for tax, capital, or operational reasons. GAAP equity method accounting collapses all JV activity into a single line. To keep FFO comparable, include the REIT’s pro rata share of JV-level real estate depreciation add-backs and the removal of JV-level gains on sales.
For AFFO, pro rate JV maintenance capex, tenant improvements, and leasing commissions. If you omit JV shares, reported growth rates, margins, and payout ratios can look healthier than the economic reality, especially in retail and industrial sectors where JVs are common.
FFO is not a cash flow measure. Working capital swings, property tax payment timing, and semiannual interest schedules can move cash flow from operations, while FFO remains unchanged. It is also not NOI, which is property-level income before corporate overhead and capital structure and is the primary base for asset valuation and the income capitalization approach. Finally, it is not comparable across mortgage REITs and equity REITs, and it is not standardized globally where IFRS reporters often use EPRA Earnings with different fair value and leasing rules.
Price-to-FFO and price-to-AFFO map more directly to dividend-paying capacity than P/E for equity REITs. Most issuers target dividends as a percentage of AFFO, so P/AFFO is a clean shorthand for the cash yield you are underwriting. EV/EBITDA can work, but EBITDA for REITs adds back real estate depreciation while ignoring recurring property-level capex, which is crucial for retail, office, and lodging. For those sectors, AFFO captures the maintenance burden better than EBITDA.
When you see a large gap between implied property values from P/FFO and a NAV derived from NOI, you are observing the market’s view on future rent growth, capex intensity, and capital allocation. Cross-check your equity view with a discounted cash flow (DCF) and a property-by-property NAV to ensure the equity multiple aligns with asset-level economics.
Credit practitioners and rating agencies define FFO differently from equity investors. Agencies often begin with operating cash flow or adjust EBITDA for cash taxes and interest to analyze leverage and coverage on a cash basis. Methodology differences around lease-adjusted debt, treatment of perpetual preferreds, and capitalized interest on development can move ratios materially. To avoid mixing bases, reconcile company-presented AFFO to your preferred credit-centric FFO before computing leverage and coverage.
Triple-net REITs with long leases and tenant-responsible maintenance often show FFO and AFFO converging. The major risks there are tenant credit concentration and lease rollover cliffs. Office REITs, by contrast, carry heavy leasing and tenant improvement costs that push AFFO well below FFO, particularly when demand is weak. Retail REITs face lumpy re-tenanting spend and differing practices around smoothing AFFO. Lodging REITs have significant maintenance burdens and variable cash flows, making AFFO more informative than FFO but harder to compare across cycles.
FFO is harder to massage because Nareit’s adjustments are prescriptive. AFFO invites more judgment, and problems typically appear in three places:
Also watch for overreliance on JVs that keeps capex and leverage off consolidated statements while reported FFO remains high. Demand pro rata JV disclosures. If you see aggressive “other adjustments,” treat them as suspicious, similar to how you would evaluate EBITDA add-backs in leveraged finance.
Use this quick checklist to test the quality of a company’s FFO and AFFO and its dividend safety:
Start with Nareit FFO using prescriptive adjustments. Then layer AFFO with explicit, separately labeled lines for straight-line rent, intangible amortization, deferred financing amortization, and each category of maintenance capex. Avoid a single “other adjustments” bucket that obscures recurring costs. Tie maintenance capex to multi-year schedules. For stable portfolios, a trailing three-year average works. For portfolios in transition, build property-by-property assumptions informed by lease expirations.
Set peer groups by lease duration and capex intensity, not just property type. Apply P/FFO or P/AFFO ranges based on relative organic growth, balance sheet strength, and external growth visibility. Always reconcile the equity story with property-level NOI and a NAV that uses the income capitalization approach.
Two simple heuristics can save time and flag where to dig deeper:
These rules of thumb do not replace full analysis, but they quickly highlight where capital intensity or accounting choices are driving headline numbers.
Higher interest rates compress AFFO through interest expense and reduce NAV through higher cap rates, which pressures both multiples and implied asset values. When acquisition cap rates exceed a company’s weighted average cost of capital, external acquisitions can drive FFO per share growth and win premium multiples. When those spreads compress, multiples tend to converge toward organic growth profiles. Lower net debt to EBITDA earns higher multiples, particularly when unsecured debt platforms diversify maturities and reduce refinancing risk. Sectors with durable rent growth and low obsolescence risk typically support higher P/FFO, while those with heavy capex and structural demand risk trade at discounts.
To maintain REIT status, companies must distribute at least 90 percent of taxable income, which can diverge substantially from both GAAP net income and FFO due to depreciation methods and gain recognition. In steady state, book depreciation often exceeds economic depreciation, so FFO commonly exceeds taxable income. The 90 percent requirement rarely sets dividend policy for stabilized equity REITs. More often, dividends are constrained by AFFO coverage, debt covenants, and targeted leverage. Remember that tax classifications of dividends, including return of capital, are driven by taxable income, not FFO, so a dividend can be labeled return of capital even when fully covered by AFFO.
FFO and AFFO are non-GAAP measures subject to SEC Regulation G. Companies must present comparable GAAP measures with equal prominence, reconcile non-GAAP measures to GAAP, explain why management finds them useful, and apply definitions consistently. They cannot present “individually tailored” accounting that replaces GAAP with bespoke recognition rules. Recasting revenue as “cash rent” without a clear reconciliation invites SEC scrutiny.
FFO gives REIT investors a common operating earnings language by neutralizing depreciation and one-off gains. AFFO turns that into a closer cash proxy by charging the capital needed to preserve NOI. The real work is consistency in definitions, pro rata inclusion of joint ventures, transparent maintenance capex, and discipline around nonrecurring items. Price-to-FFO and price-to-AFFO guide valuation only when the “F” is comparable and the “A” does not bury recurring cash costs. Tie the metrics to property-level NOI, credit ratios, and dividend payouts, and FFO becomes an anchor for decision-making rather than a marketing label.
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