Why did the sector need its own earnings measure? GAAP/Ind AS net income charges depreciation on buildings as if they wasted away like machine tools, yet well-maintained Grade-A real estate often appreciates. So accounting profit dramatically understates a REIT's cash-generating power. That's the mirror image of most industries, where your forensics training taught you to distrust add-backs. The fix comes in two steps, and the second one is where the hard thinking happens.
How are FFO and AFFO calculated?
Step 1. FFO (Funds From Operations), the Nareit standard:
FFO = Net income + real-estate depreciation & amortization − gains on sale of properties (+ impairments of depreciable real estate) ± JV adjustments
Add back the non-cash depreciation, and remove one-off sale gains so the run-rate reflects rents instead of disposals.
Step 2. AFFO (Adjusted FFO): subtract the money that keeps the rent flowing. Buildings don't depreciate like trucks, but they aren't free to own either. Lobbies get refurbished and chillers replaced, and every tenant turnover costs tenant improvements (TI) and leasing commissions (LC). Accounting also straight-lines contracted rent escalations, booking year-5 rent partly in year 1, and that's cash that hasn't arrived. So:
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AFFO = FFO − recurring/maintenance capex − TI & LC − straight-line rent adjustment ± other non-cash items
AFFO ≈ the REIT's owner earnings, in valuation language: the cash available to distribute while keeping the portfolio competitive. There's no standardized AFFO definition. Each REIT defines its own, so the maintenance-capex line is the first place managements flatter distributable cash. Classifying recurring refurbishment as "growth capex" is this sector's improper-capitalization shenanigan, and your forensic instincts on capitalization apply word for word.
Worked, Horizon Business Parks REIT (synthetic, Embassy-scale, 38 msf, 95 cr units):
| Line | ₹ cr |
|---|---|
| Net income (post SPV taxes) | 850 |
| + Real-estate D&A | 950 |
| − Gain on sale of an asset | (40) |
| FFO | 1,760 |
| − Maintenance capex (building systems) | (140) |
| − Tenant improvements | (70) |
| − Leasing commissions | (45) |
| − Straight-line rent adjustment | (85) |
| AFFO | 1,420 |
AFFO/unit = 1,420 ÷ 95 cr = ₹14.9. The declared distribution is ₹13.0/unit, so AFFO payout = 87%.
What is a healthy AFFO payout?
Reading the payout: <80% healthy, >90% cut risk. Below 80%, the REIT keeps a cushion for capex surprises, vacancy shocks and deleveraging. Above 90%, the distribution is one bad quarter from a cut, and REIT investors came for the yield, so they punish cuts brutally. Horizon at 87% is in the amber zone. It's sustainable only if occupancy and spreads hold.
There's an India nuance here. SEBI mandates ≥90%, but of NDCF, a bottom-up cash definition (SPV cash flows after tax, debt service and reserves), and AFFO doesn't enter into it. So Indian REITs run structurally high payouts, and your health test moves one level down. Ask how NDCF is manufactured. If a meaningful slice of the distribution is return of capital or funded by refinancing, and post-maintenance rental cash flow isn't paying for it, the "yield" is partly your own money coming back. Indian REIT distributions are explicitly split into interest, dividend and repayment-of-debt components, each taxed differently in your hands, so read the split every quarter.