What is P/AFFO?
The P/AFFO is calculated by adding the P/FFO to any rent increases and subtracting capital expenditures and the routine maintenance costs. The P/AFFO is a measure of the financial performance of a REIT (Real Estate Investment Trust). It is equal to the P/FFO adjusted to consider capital expenditures and regular maintenance costs, making it a more accurate REIT valuation tool than P/FFO.
It is also a more precise predictor of dividends that a company will pay in the future, and it can help potential investors make a decision on whether or not to buy shares of the company. The P/AFFO is also known as the Funds Available for Distribution.
- P/AFFO is an adjusted version of Funds from Operations (FFO), which takes into account capital expenditures of a company.
- The P/AFFO metric is not standardized, making it impossible to compare one REIT from the other since there are no standard procedures for the P/AFFO between companies.
- The P/AFFO takes into account the capital expenditures of the portfolio, such as an increase in rent, repaint of the premises, and roof replacement.
How to Calculate P/AFFO
The calculation of the P/AFFO requires that we first determine the P/FFO, and then deduct other forms of expenditures from the P/FFO to get the P/AFFO. The P/FFO is used to evaluate cash flow from real estate investments. It is calculated by first getting the net income of the company and then adding back any depreciation and amortization costs during the period. The depreciation is added back to the equation because real estate properties appreciate in value, and deducting depreciation would distort the value of a property.
The P/AFFO is obtained from taking the P/FFO value and then deducting capital expenditures like maintenance costs and any capital gains on the sale of the property. The capital gains on the property sale are deducted since it’s a one-time event and does not result in any long-term effect on the property.
P/AFFO Payout Ratio
The P/AFFO ratio measures a REIT’s ability to pay dividends to shareholders in the long term. The payout ratio is calculated by taking a REIT’s yearly dividend rate and dividing it by the estimated P/AFFO per share. It helps evaluate the REIT’s operations cash flow after taking into account the capital expenditures and other routine maintenance costs.
If a calculated ratio is over 100%, it means that the dividends of that REIT are higher than income projected for future operations. As a result, the REIT can be obliged to pay dividends from its cash reserve. However, such a scenario is not a cause for alarm if it prevails in the short term. It can, however, be a cause for alarm if it extends to the long term, which will be unsustainable for the business and will require swift action for the adjustment of dividends payout.
P/AFFO vs. P/FFO
The P/AFFO is more preferred than P/FFO when measuring the REITs performance since the former deducts expenses incurred by the business in detail, including capital expenditures and routine maintenance costs. The P/FFO only considers the depreciation and amortization costs, while excluding other important costs that affect a company’s value.
Another point of contention between the two metrics is that the P/FFO is more standardized than the P/AFFO for most companies. There are guidelines that companies can use when calculating the P/FFO, but there is no standard method for calculating the P/AFFO.
It means that every company can use its preferred way to determine its P/AFFO; the values obtained by companies may not be comparable with other values across the industry. Comparison is an important aspect in the real estate industry since it enables experts to determine how different companies are performing.
Debt (Leverage Ratio)
For a steady growth of per-share P/AFFO and an increase in the dividends payable to shareholders, companies are required to maintain lower costs of capital than cash yields. Debt is a key aspect for most companies since they can take on debt to boost their growth or cover a deficit in the financing of their operations. However, the cost of debt varies, and companies should obtain the cheapest debts that are flexible and with manageable terms of repayment.
Companies use leverage ratios to evaluate the risk associated with a given debt offer. The ratio is also used by credit rating bureaus in assessing the viability of REITs in terms of credit. Creditors use the data obtained by the rating agencies to prove the creditworthiness of a borrowing firm.
The data elaborates on the cash flow and ability of a REIT to comfortably repay the debt and whether they have other outstanding debts with other creditors. A company’s credit rating is essential to their creditworthiness since creditors consult such records to gauge the repayment ability and the default risk. Low credit rates, therefore, limits a company’s growth opportunity.
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