Adjusted Funds From Operations (AFFO) is a financial measure used to evaluate the financial performance, value, and ability to pay dividend distributions of a Real Estate Investment Trust (REIT). AFFO is closely related to Funds from Operation (FFO), however, AFFO is considered to be a more accurate financial indicator due to its ability to factor in real estate operations costs.

FFO is defined as all income earned by a REIT with the exception of depreciation and amortization. It is generally calculated as the net income of a REIT plus all gains on the sale of property and securities less either impairment losses or gains. The FFO calculation provides investors with an estimate of the net income of a REIT.

AFFO, however, adjusts the FFO calculation by including expenses related to the operations of a REIT's real estate properties and provides a less volatile metric that is more closely related to the actual cash flow of a REIT. As such, AFFO has become an actionable metric for investors looking to determine the fair market value of a REIT.

An AFFO formula typically includes FFO, rent increases, capital expenditures, and routine maintenance amounts. These four components are added and subtracted from the FFO calculation to generate a more precise measure of REIT performance and income potential.

For example, rent increases need to be factored into the AFFO calculation as one of the main drivers of revenue for a REIT portfolio. In addition, capital expenditures such as property upgrades and maintenance need to be factored in to provide a fuller picture of AFFO. Routine maintenance is also added to the AFFO calculation in order to account for expenses related to the upkeep of a REIT’s real estate portfolio.

By combining both revenue and expense drivers into one metric, AFFO provides investors with an accurate measure of a REIT’s performance, financial health, and potential. A positive AFFO indicates that a REIT is generating sufficient revenue to cover its income needs, meaning it is in a strong financial position and can continue to pay its dividend distributions.

In addition to helping investors understand a REIT’s ability to pay dividends, AFFO can also be used as a tool to compare different REITs in a given sector. Comparing AFFO gives investors a clear understanding of which REITs are making the best decisions with their income and have the greatest potential for growth.

Given its importance in evaluating the performance, value, and ability to pay dividend of a REIT, Adjusted Funds From Operations (AFFO) should be monitored closely by investors when assessing their portfolios.