Chartered Financial Analyst Level 2
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- For an investor interested in evaluating a REIT's dividend-paying capacity, it is most appropriate to use:
Exam-Like
A
net income.
B
funds from operations.
C
adjusted funds from operations.
Explanation:
Explanation
For evaluating a REIT's dividend-paying capacity, adjusted funds from operations (AFFO) is the most appropriate metric because:
- Net income (Option A) is not suitable due to accounting treatments like depreciation, which doesn't reflect the actual cash flow from real estate operations
- Funds from operations (FFO) (Option B) is better than net income but still includes maintenance capital expenditures that are necessary for property upkeep
- Adjusted funds from operations (AFFO) (Option C) is the best measure as it:
- Starts with FFO
- Subtracts recurring capital expenditures needed to maintain the property portfolio
- Adjusts for straight-line rents and other non-cash items
- Provides a more accurate picture of the cash available for dividend distribution
AFFO better reflects the sustainable dividend-paying capacity of a REIT by accounting for the ongoing capital requirements to maintain the quality and income-generating ability of the real estate portfolio.
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