This means that the company must have more cash than the equity value, debt, and preferred equity combined together. Cash is subtracted from the enterprise value, so the larger cash is, the lower the enterprise value. The company also likely has a suppressed equity value due to negative investor sentiment. Investors are expecting the company to perform so poorly such that the company is not even worth the cash it holds. It’s possible that the company is expected to pay a large lawsuit, absorb a large expense, or simply burn cash at an unsustainable rate.

Adjusted Funds From Operations (AFFO) is calculated as:

AFFO = FFO + rent increases – capital expenditures – routine maintenance amounts

For reference, the formula for Funds from Operations (FFO) is:
FFO = net income + depreciation & amortization + property sales losses – property sales gains – interest income

Compared to FFO, AFFO provides a more accurate measurement of cash flows generated from a real estate company’s core operations. AFFO accounts for routine maintenance to maintain the quality of the assets as well as capital expenditures to renovate the assets or to purchase new assets. AFFO also accounts for the additional income from rent increases. As a result, AFFO provides a more accurate cash flow number that can be used to calculate present value and forecast a REIT’s ability to pay dividends.

Funds From Operations (FFO) is calculated as:

FFO = net income + depreciation & amortization + property sales losses – property sales gains – interest income

FFO measures the cash flows generated from a real estate company’s core operations. Unlike net operating income, FFO is levered metric which is after the effects of debt, which is why we start with net income as it is after-interest. Mortgages are core to real estate investments, which is why we look at this on an after-debt basis.

Similar to the cash flow statement, we add back depreciation & amortization since it is a non-cash exense.

We also reverse property sale losses and gains since they are not part of a real estate company’s core operations, and are often driven by market factors outside of the company’s control. Instead, a real estate company’s core operations is driven by rental income and ancillary revenues like parking.

Finally, we reverse interest income from cash since this is not part of the core real estate operations, but rather a financial benefit of having a positive cash balance deposited in the bank.

Net operating income (NOI) measures the core profitability of real estate properties. It’s calculated as:

NOI = revenue generated from property – operating expenses

NOI is before any cost of financing (such as debt or mortgage interest expense) as well as income taxes. It focuses only on the core revenues and expenses directly related to operating the property.

The revenue generated from the property represents the rental revenue the property generates, including parking fees, laundry income, etc. It is also known as gross operating income, and can be calculated as:

Gross operating income = gross potential income – vacancy and credit losses

Gross potential income refers to the rental revenue that could be potentially generated if the property was rented out every day of the year and all tenants paid the rent due. To get to the actual rental revenue (gross potential income), we need to subtract vacancy and credit losses.

Operating expenses include any expenses needed to operate the property. These include property management fees, utilities, maintenance and repairs, property taxes, and insurance.

The write-down of existing goodwill on the balance sheet increases the excess purchase price. Sometimes, a % of the excess purchase price can be allocated to a PP&E and / or intangible asset write-up. In this scenario, it would be important to write-down existing goodwill since it would impact the amount of the write-up.

Excess purchase price = equity purchase price + transaction fees – seller’s shareholder’s equity + write-down of existing goodwill

By writing down existing goodwill, we are looking at the LBO on a “clean slate” and analyzing only the premium paid on the original assets, without the noise of other past acquisitions made by the seller.

Existing goodwill represents the premium that the seller had previously paid to acquire other companies, and so we write this existing goodwill down to find the “true” excess purchase price over the original book value of the assets. Since we are comparing the purchase price to the original book value of the acquired assets – which would be lower without the existing goodwill – the write-down of existing goodwill increases excess purchase price.

The write-down of existing goodwill will not make an impact on the ending balance sheet values if we are not allocating a % of the excess purchase price to asset write-ups, as goodwill just ends up being the plug to make the balance sheet balance.

Using rule of 72, we can find the approximate IRR to double an investment for a given # of years.

$100M growing to $400M equity in year 6 is similar to $100M doubling to $200M equity in year 3, and then doubling again to $400M in year 6.

So by finding out what IRR is for $100M equity doubling to $200M equity by year 3, we essentially find out the IRR is for $100M growing to $400M by year 6; they are the same.

Here is the rule of 72 formula.

IRR = 72 / # of years to double
IRR = 72 / 3
IRR = 24%

Therefore, the approximate IRR is 24%.