Calculation of FFO/AFFO

in the CFAI text, it says you can calculate FFO by starting with NET earnings (adding back depreciation, deferred taxes and gains/losses on sales).

but they also say you can obtain FFO by simply subtracting interest expense from EBITDA.

2 problems I have here…1. in first scenario, taxes are subtracted, in second, they are not. not sure how these 2 methods are equal. 2. would you not have to add the DEPRECIATION * TAX shield to EBITDA for proper addition of depreciation??

confused here.


REITs aren’t taxed. REIT shareholders are though.

yeah i figured that afterwards, thanks!

If they are not taxed at all how they have deferred taxes? The REITs pay taxes and then authorities return the money back or what?

i could be wrong, but i believe the deferred taxes element only applies to REOCs. the text IMO does a bad job of explaining this topic b/c they don’t specify the exact calculations of both REOC and REIT, which should be different I would think b/c one is taxed and one isn’t?

i think they make it sound like REOCs usually have small cash taxes and they are deferred, and essentially excluded from the calculation (or added back if starting from NI). again though, bad job by CFAI explaining this…

REITs are wonky, because they’re called trusts but are really corporations. Basically Reagan’s second tax cut in 1986 created the main benefits of even pursuing a REIT, which is run kind of like a holding company where 90% of normal GAAP style net income could be distributed and the corporation would be exempt from corporate taxes, assuming they did X, Y, Z list of steps. He was big on property tax changes. This is why REITs aren’t usually levered up… there’s no tax shield on the debt, and the equity shares pay decent yields, so they can raise capital with them assuming they don’t dilute AFFO too much. Most states allow the REIT structure to bypass corporate taxes, but some might not, which could cause a DTA/L? There was a law in 2001, called RMA, which allowed for a TRS, taxable REIT subsidiary, where the REIT owns up to 100% of the subsidiary, as long it doesn’t make up +25% of parent (REIT) assets, and the subsidiary can have a little more freedom to do things (manage property for office tenants, for example), but this sub is subjected to corporate taxes like a normal company. The idea was to make REITs more competitive vs. something like private equity, etc., etc. This is outside of the scope of this CFA exam, but might help you understand the full picture.

Also, there’s potentially something called depreciation recapture tax if you depreciate a property and then sell it for a gain above cost after converting your property set into a REIT. Also, when converting properties to the REIT election, there’s a ten-year window on capital gains taxes after the conversion.

Analysts consider the 90% distribution to be its own “tax burden,” even if the company is corp tax free. It can be a strain on managment. (This is why REIT depreciation matters even though there’s no US corporate tax, which is why I few months ago I started looking into the whole thing about the structure… The books didn’t mention this at all. Ironic, assuming you’ve read the MM stuff in the corporate finance section). I think thats the key tax issue for Level II. If you see a soft tax charge, obviously reverse it, but I doubt that will be tested since it could be pretty controversial unless super explicit.