How do you value a REIT using NAV and FFO approaches?

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:

If comparable REITs trade at 18x FFO, Pinnacle's estimated value = $3.50 × 18 = $63/share.

NAV calculation:

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.

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