How do you value a REIT using NAV and FFO approaches?
I'm studying alternative investments for CFA Level I and REITs have their own valuation metrics — NAV and FFO. Why can't we just use regular P/E ratios? Can someone explain both approaches with an example?
REITs require special valuation methods because traditional earnings metrics are distorted by depreciation — real estate assets often appreciate in value, but accounting rules still depreciate them, making reported earnings misleadingly low.
Funds From Operations (FFO):
FFO = Net Income + Depreciation + Amortization - Gains on Property Sales
FFO adds back non-cash depreciation and removes one-time gains to show recurring cash-generating ability.
Adjusted Funds From Operations (AFFO):
AFFO = FFO - Recurring Capital Expenditures - Straight-line Rent Adjustments
AFFO is considered a better measure of sustainable cash flow because it accounts for maintenance capex needed to keep properties in good shape.
Net Asset Value (NAV) Approach:
NAV = (Market Value of Properties - Total Liabilities)
This is similar to book value, but uses market values for the real estate portfolio rather than depreciated book values.
Example — Pinnacle REIT:
| Item | Amount |
|---|---|
| Net income | $45M |
| Depreciation & amortization | $30M |
| Gain on property sale | $5M |
| FFO | $70M |
| Maintenance capex | ($8M) |
| Straight-line rent adjustment | ($2M) |
| AFFO | $60M |
| Shares outstanding | 20M |
| FFO per share | $3.50 |
| AFFO per share | $3.00 |
If comparable REITs trade at 18x FFO, Pinnacle's estimated value = 63/share**.
NAV calculation:
| Item | Amount |
|---|---|
| Market value of properties | $1,200M |
| Other assets | $50M |
| Total debt | ($500M) |
| Other liabilities | ($30M) |
| NAV | $720M |
| NAV per share | $36.00 |
If the stock trades at $33, it's at a 8.3% discount to NAV — potentially undervalued.
Which approach to use?
- FFO/AFFO multiples: Best for comparing REITs within the same sector
- NAV: Best for assessing whether the market is pricing properties correctly
- Price/AFFO is generally preferred over Price/FFO because it captures maintenance costs
Exam tip: Know the FFO calculation cold — adding back depreciation and removing property sale gains. The CFA exam loves testing whether you can compute FFO from a given income statement.
Check out our alternative investments module on AcadiFi.
Master Level I with our CFA Course
107 lessons · 200+ hours· Expert instruction
Related Questions
Why does an early retirement provision lower risk tolerance but high turnover does not — both reduce liabilities, right?
Why does it matter if the pension fund is invested in stocks similar to the sponsor's business?
What is the rule about active vs retired lives and pension plan duration?
Why does the textbook recommend 100% equities for a young employee? That sounds extremely aggressive.
I run my own startup. My income is volatile and tied to my industry. Should I hold ZERO equities in my financial accounts?
Join the Discussion
Ask questions and get expert answers.