FFO vs AFFO: What's the Difference and Why It Matters

Why FFO and AFFO Matter More Than Net Income

A REIT’s net income tells you very little about what it can afford to pay you. Accounting depreciation writes the buildings down every year on a fixed schedule, whether or not they have lost any value, and a well-maintained property in a decent location usually has not. That charge is large enough to swamp the income statement, so reported earnings understate what the portfolio actually generates.

Nareit created Funds From Operations in 1991 to close that gap. FFO adds the real estate depreciation back and strips out the gains and losses from selling buildings, so one year’s disposals do not flatter the trend. For the asset-value view of the same portfolio, see our guide on how to calculate NAV.

FFO has a blind spot of its own: it ignores what the landlord has to spend to keep the buildings occupied. AFFO is the attempt to put that back. But the two metrics are not equal citizens. FFO is a defined measure with a published rulebook. AFFO is whatever the company reporting it says it is. Knowing which is which is most of the value of this page.

The Nareit FFO Definition

Nareit publishes the definition, and that is what makes FFO comparable from one company to the next:

FFO = net income + real estate depreciation and amortisation - gains on sales of property + losses on sales of property + impairments of depreciable real estate

A REIT also adds its share of FFO from joint ventures it does not consolidate, calculated the same way. Nareit asks any company that adjusts the figure to reconcile back to the standard one, so a REIT reporting something else is reporting something else, not a different flavour of FFO.

Consider a mid-sized office REIT, “Urban Properties Inc.”:

• Net Income: $42 million
• Depreciation & Amortisation: $85 million
• Gain on property sales: $8 million
• Shares outstanding: 18.5 million

The FFO calculation:

• $42M + $85M - $8M = $119 million
• FFO per share: $119M / 18.5M = $6.43

That $119 million is operating earnings with the accounting depreciation stripped out. It is struck after interest expense, because it starts from net income, but before any of the cash the portfolio consumes to stay let.

AFFO: The Number Nobody Defines

AFFO tries to reach the cash left after keeping the portfolio in a lettable state. Nareit deliberately did not standardise it. When it restated the FFO rulebook it said there was no consensus among companies and investors on what the adjustments should be, and no single measure of distributable cash that fits every REIT.

So what follows is convention, not rule. Most analysts make these four adjustments, but the company you are reading may draw them differently, and it is allowed to.

1. Capital Expenditures (Maintenance CapEx)

Every property requires ongoing maintenance: parking lot resurfacing, HVAC replacement, roof repairs, structural updates. These are legitimate costs that reduce distributable cash, yet they don’t appear in FFO.

Companies rarely separate maintenance from growth capital in the accounts, so most analysts apply an estimated rate to the property base instead. The rates in common use, as a percentage of property value each year:

• Industrial: 0.8–1.2%
• Office: 1.0–1.5%
• Retail: 1.2–1.8%
• Residential: 1.0–1.4%

They are rules of thumb, not measurements, and a portfolio’s age and location move it around within its band. The same intensity difference shows up in the pricing of the buildings themselves, which the cap rates guide covers.

For Urban Properties, take 1.1% of its $4.2 billion property portfolio: $46.2 million a year.

2. Straight-Line Rent

Most leases step the rent up over time, say 2% a year. Accounting spreads the total contractual rent evenly across the lease term rather than following the cash, so in the early years the REIT books more rent than the tenant actually pays. That difference is income sitting in FFO with no cash behind it.

Urban Properties has $8 million of straight-line rent in this year’s FFO that nobody has yet paid. AFFO takes it back out.

3. Leasing Commissions and TI Costs

When a lease renews or a new tenant is signed, the REIT typically covers leasing agent commissions (4–6% of total lease value) and tenant improvement (TI) costs. These are immediate cash outflows that offset FFO.

Urban Properties estimates $12 million in normalised annual leasing costs across its portfolio.

4. Other Adjustments

Some analysts also strip out non-recurring items such as litigation settlements, and add back stock-based compensation, which costs no cash but dilutes the shares the AFFO is divided by.

Where the discretion sits

Maintenance capital is the line to watch, because the split between maintenance and growth is the company’s own call and no auditor rules on it. Money spent replacing a roof is maintenance. The same roof, replaced as part of repositioning the building, can be booked as growth capital, and growth capital never reaches AFFO. A REIT that classifies generously reports a higher AFFO and a safer-looking dividend without a thing changing on the ground. So a higher AFFO is not automatically a better one, and the first question about any AFFO figure is where the company drew that line.

The Full AFFO Calculation

Here’s the complete picture for Urban Properties:

AFFO per share: $50.3M / 18.5M = $2.72

FFO says $6.43 a share. After paying to keep the buildings occupied, $2.72 is left, a gap of 58%.

Office sits at the painful end of that spread, because the landlord funds the fit-out every time a tenant moves and office leases turn over often enough for it to hurt. Where the tenant pays for the building, as in net lease, or where there is barely a building to maintain, as on a cell tower, the gap narrows to a modest haircut. How wide the gap runs is a fact about the property type before it is a fact about the company.

Why This Matters: The Dividend Sustainability Test

Urban Properties pays $0.62 a quarter, $2.48 a year, against AFFO of $2.72. That is a 91% payout: covered, with 24 cents a share to spare, though already past the 90% line most screens treat as a warning.

Now remember where AFFO came from. The maintenance capital figure was an estimate, 1.1% of the property base. Move it to 1.5%, still inside the office band above, and the deduction rises to $63 million, AFFO falls to $1.81 a share, and the payout goes to 137%. The dividend’s safety rests on a number the analyst chose, not one the company filed.

On FFO the same dividend looks like a 39% payout ($2.48 / $6.43), with room to double it. That is how analysts miss dividend cuts.

Common Pitfalls When Comparing FFO to AFFO

1. Taking Two AFFO Figures as Comparable Because nobody defines AFFO, two REITs can report it on genuinely different bases and neither is wrong. Before ranking AFFO across a peer group, read each company’s reconciliation and check they deduct the same things, particularly whether recurring tenant improvements sit inside maintenance capital or outside it.

2. Trusting the Maintenance CapEx Rate A company guiding maintenance capital at 0.8% while its own history runs at 1.2% is telling you something, and it is usually about how it splits maintenance from growth rather than about the buildings. Check the guided rate against the spend the company has actually made over a cycle.

3. Ignoring Rent Growth Embedded in Straight-Line Rent A REIT with fast-rising rents carries a large straight-line adjustment. As leases mature and the cash rent catches up with the accounting rent, that adjustment unwinds, and AFFO grows faster than the underlying rent roll for reasons that have nothing to do with the properties.

4. Assuming AFFO Equals Distributable Cash It doesn’t. AFFO sits before debt principal repayment and before any development spending, so a REIT building out a pipeline can cover its dividend on AFFO and still be issuing shares to fund itself. AFFO is a good proxy for operating-level cash, not a cash flow statement.

Which Metric to Use When

Use FFO for peer valuation and growth comparisons, because it is standardised and therefore comparable. P/FFO is the sector’s multiple for exactly that reason.

Use AFFO for dividend safety, because it is the one that reflects the cash the buildings consume. Accept that you are working with an estimate: the maintenance capital rate drives the answer, and a modest change in it moves the payout ratio further than most people expect. Check the rate you are using against what the REIT has historically spent, and if they diverge, find out why before trusting either number. Our screening checklist sets out the threshold ranges for both.