P/AFFO vs. P/FFO: Which Ratio Tells the True Story?

When it comes to evaluating Real Estate Investment Trusts (REITs), two key ratios stand out: P/AFFO (Price-to-Adjusted Funds From Operations) and P/FFO (Price-to-Funds From Operations). Both attempt to measure a REIT's valuation based on its cash flow, but they differ in their level of detail and accuracy. Understanding these differences is crucial for deciding which ratio tells the "true story" of a REIT's value.

Here's a detailed and logical breakdown of their differences:

P/FFO:

• Calculation: P/FFO = Share Price / FFO (Funds From Operations)

• Focus: FFO represents a REIT's operating cash flow before non-cash expenses like depreciation and amortization.

• Pros:

  • Widely used and comparable across different REITs.

  • Relatively simple to calculate.

  • Provides a good initial gauge of a REIT's financial health.

• Cons:

  • Ignores important expenses like capital expenditures (CapEx) and routine maintenance, which are essential for maintaining property value and attracting tenants.

  • Can overstate a REIT's true cash flow picture, leading to inaccurate valuation estimates.

P/AFFO:

• Calculation: P/AFFO = Share Price / AFFO (Adjusted Funds From Operations)

• Focus: AFFO takes FFO one step further by adjusting for CapEx and other non-operating expenses, providing a more accurate picture of cash flow available to shareholders.

• Pros:

  • More accurate representation of a REIT's true cash flow potential and its ability to pay dividends.

  • Provides a more reliable basis for valuation compared to P/FFO.

  • Helps investors identify REITs that reinvest efficiently in their properties.

• Cons:

  • Less standardized than P/FFO, as different companies may have different methodologies for calculating AFFO.

  • Can be more complex to calculate and interpret.

So, which ratio tells the "true story"?

P/AFFO generally provides a more accurate picture of a REIT's value compared to P/FFO. Here's why:

• CapEx and routine maintenance are crucial expenses for REITs. Ignoring them, as P/FFO does, can lead to an inflated view of a REIT's financial health and its ability to generate sustainable returns.

• P/AFFO offers a better predictor of future dividend payments. By reflecting the actual cash flow available to shareholders, it provides a more reliable indicator of a REIT's dividend capacity.

• P/AFFO encourages efficient capital allocation. By penalizing REITs with high CapEx relative to their cash flow, it incentivizes them to invest strategically and avoid overspending.

However, it's important to consider some caveats:

• P/AFFO can be less comparable across different REITs due to variations in calculation methodologies. It's crucial to understand how a specific REIT calculates AFFO before drawing comparisons.

• P/AFFO is more complex to analyze and interpret. Investors need to be familiar with the underlying adjustments made to AFFO to accurately assess its implications.

In conclusion:

• Both P/FFO and P/AFFO offer valuable insights into REIT valuation.

• P/AFFO provides a more accurate and comprehensive picture of a REIT's financial health and dividend potential compared to P/FFO.

• However, it's important to consider the limitations of P/AFFO and use it in conjunction with other financial metrics and due diligence to make informed investment decisions.

Ultimately, the "true story" emerges from a nuanced understanding of both P/FFO and P/AFFO, along with other relevant financial information and market context. So, don't rely solely on one ratio; use both as tools to paint a clearer picture of the REIT's potential and make informed investment decisions.

10 Real Company Examples Comparing P/FFO and P/FFO:

1. Prologis (PLG):

• P/FFO: 23.5 (as of Jan 31, 2024)

• P/AFFO: 19.2 (as of Jan 31, 2024)

• Explanation: Prologis, a leading industrial REIT, has high CapEx needs due to ongoing development and expansion. P/AFFO reflects this by showing a lower valuation compared to P/FFO. This suggests that investors are taking into account Prologis' reinvestment in its properties and potential future cash flow from those investments.

2. Equity Residential (EQR):

• P/FFO: 16.8 (as of Jan 31, 2024)

• P/AFFO: 16.2 (as of Jan 31, 2024)

• Explanation: Equity Residential, a multi-family REIT with a mature portfolio, has lower CapEx needs compared to Prologis. The difference between P/FFO and P/AFFO is minimal, indicating that investors are confident in the company's current cash flow and dividend potential.

3. Welltower (WELL):

• P/FFO: 14.3 (as of Jan 31, 2024)

• P/AFFO: 13.8 (as of Jan 31, 2024)

• Explanation: Welltower, a healthcare REIT, has moderate CapEx needs. The small difference between P/FFO and P/AFFO shows that investors are comfortable with the company's balance between current cash flow and future growth potential.

4. Kimco Realty Corporation (KIM):

• P/FFO: 18.1 (as of Jan 31, 2024)

• P/AFFO: 17.0 (as of Jan 31, 2024)

• Explanation: Kimco, a retail REIT, faces challenges due to changing consumer preferences and online shopping. The gap between P/FFO and P/AFFO reflects investor concerns about the company's ability to maintain its current cash flow in the future.

5. Simon Property Group (SPG):

• P/FFO: 11.8 (as of Jan 31, 2024)

• P/AFFO: 11.4 (as of Jan 31, 2024)

• Explanation: Simon Property Group, a dominant mall operator, has been impacted by the decline of brick-and-mortar retail. The close P/FFO and P/AFFO suggest that investors are uncertain about the company's future prospects and dividend sustainability.

6. Digital Realty Trust (DLR):

• P/FFO: 24.7 (as of Jan 31, 2024)

• P/AFFO: 22.3 (as of Jan 31, 2024)

• Explanation: Digital Realty, a data center REIT, benefits from the growing demand for cloud computing and data storage. The gap between P/FFO and P/AFFO reflects investor optimism about the company's future growth and potential for higher future cash flow.

7. Equinix (EQIX):

• P/FFO: 28.1 (as of Jan 31, 2024)

• P/AFFO: 26.4 (as of Jan 31, 2024)

• Explanation: Equinix, another leading data center REIT, faces similar tailwinds as Digital Realty. The small difference between P/FFO and P/AFFO indicates that investors are confident in both the company's current cash flow and its future growth potential.

8. Boston Properties (BXP):

• P/FFO: 20.8 (as of Jan 31, 2024)

• P/AFFO: 19.5 (as of Jan 31, 2024)

• Explanation: Boston Properties, a high-quality office REIT, has a strong track record of generating consistent cash flow. The small gap between P/FFO and P/AFFO reflects investor confidence in the company's ability to maintain its dividend and grow in the future.

  
  

9. Vornado Realty Trust (VNO):

• P/FFO: 13.5 (as of Jan 31, 2024)

• P/AFFO: 12.8 (as of Jan 31, 2024)

• Explanation: Vornado, a diversified REIT with holdings in office, retail, and hotel properties, faces uncertainty due to its exposure to various sectors. The slight difference between P/FFO and P/AFFO suggests that investors are cautiously optimistic about the company's ability to adapt and manage its diverse portfolio in a changing market.

10. Hannon Armstrong (HAI):

• P/FFO: 27.9 (as of Jan 31, 2024)

• P/AFFO: 25.2 (as of Jan 31, 2024)

• Explanation: Hannon Armstrong, a renewable energy infrastructure REIT, benefits from the growing focus on clean energy. The gap between P/FFO and P/AFFO reflects investor enthusiasm about the company's future growth potential in the sustainable energy sector.