I've written before that when looking at American Financial Realty Trust (NYSE: AFR ) , it's necessary to look at the company's funds from operations (FFO) and include additions for gains from property sales. However, in its first-quarter results, the company is throwing some extra curveballs at investors by adjusting how it calculates adjusted funds from operations (AFFO) and changing its AFFO guidance.
First, let's dig into the company's standard FFO performance. For the quarter, the company reported $0.074 per diluted share in FFO, in comparison to $0.10 in the first quarter of 2005 and $0.055 in the fourth quarter of 2005. While the first quarter showed sequential quarterly improvement, I had expected the company's performance to be closer to what it reported in the prior year's first quarter.
The company is still focused on improving its FFO performance from core properties, and it expects to see a ramp up in this metric in its third and fourth quarters. The company is also looking at a number of ways of getting to the FFO promised land. The most obvious way is to increase occupancy or to use some of the cash generated from dispositions to acquire fully leased buildings. The company will also self-manage larger core-portfolio buildings going forward, and terminate contracts with third-party building managers (as contracts expire) in an effort to reduce operating expenses.
American Financial Realty's sale of five buildings to Resnick Development closed after the quarter ended, and will be reported in second-quarter results. The sale creates a taxable gain for the company and it appears -- from the company's acquisition goals for the rest of the year -- that American Financial will reinvest the proceeds from the sale. These properties were 100% leased, and the company's stated purpose of the sale was to invest the funds in properties with greater potential for growth.
In its earnings press release, the company announced that it is changing its definition of AFFO. The change is a subtle one, relating to recurring capital expenditures. Some of these expenditures are reimbursable under its leases, and some are not, but there is a lag between when the company makes the expenditure and when it's reimbursed. To compensate for that lag, the company is setting up a financing facility to allow it to recoup the cash more quickly and show something closer to its cash capital expenditures. While the mechanics make sense, I am questioning why the company feels the need to adjust its definition of AFFO now.
There's also a change in AFFO guidance, partly to reflect the change in calculation, and also because of the lower expected revenue after the closing with Resnick. Previous AFFO guidance was $149 million-$164 million, and the updated guidance is for AFFO of $137 million-$149 million (without the sale to Resnick), and $183 million-$195 million (with the sale to Resnick). As AFFO is primarily a measurement of cash generation from operations, and the Resnick sale is beyond what is normal, I recommend investors go with the lower figure. Assuming the company's dividend runs $36 million a quarter on average for the year, it should total $144 million, which puts the dividend payment smack dab in the middle of the updated AFFO guidance.
The real problem I see for American Financial is its ability to lease up the properties that it intends to retain. With its current tenants, the lease revenue is of high quality, and there is little worry that companies like Bank of America (NYSE: BAC ) , State Street (NYSE: STT ) , Citigroup (NYSE: C ) , and Regions Financial (NYSE: RF ) will fail to pay the bills. Just like baseball teams need to get butts in the seats to cover fixed costs, American Financial needs to get more tenants in its buildings and unload the buildings that it doesn't intend to hold in order to reduce its operating expenses.
All this brings us back to the company's dividend, which, after today's 11% drop in share price, is providing a yield in the ballpark of 10.5%. Given the company's AFFO guidance, the dividend should be safe in the near term, but there is a question of whether the company can maintain its dividend and reinvest in higher-quality assets to drive growth in FFO. To get around this hurdle, the company may take on more debt, which is a concern since the company is already about 70% leveraged. In the future I'll revisit some of my investment assumptions for American Financial Realty -- and see whether the company is likely to live up to them.
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American Financial Realty Trust and Bank of America are bothMotley Fool Income Investorselections.