REIT Valuation Explained: FFO, AFFO and NAV (With a Worked Example)

If you're interviewing for a real estate group, or just landed a REIT question in a generalist interview, you need three acronyms down cold: FFO, AFFO and NAV. These replace net income, EPS and book value as the metrics that actually matter for real estate investment trusts.

The good news: once you understand why they exist, the math is simple. Below, we'll walk through each one, build them from scratch for a single example REIT, and cover the interview questions you're most likely to get.

Why REITs Need Their Own Metrics

A REIT owns income-producing property: apartments, offices, warehouses, malls, data centers. Under US rules, a REIT must distribute at least 90% of its taxable income to shareholders as dividends. That makes cash flow and dividend capacity the center of every conversation.

The problem is that standard accounting makes REITs look worse than they are. Here's why:

• Depreciation is huge. Buildings are depreciated over decades, which crushes net income.
• But real estate doesn't really lose value like a machine does. Well-located property often holds or grows in value over time.
• Gains on property sales are lumpy. Selling a building can spike net income in one quarter without saying anything about recurring performance.

So net income and EPS are misleading for REITs. FFO, AFFO and NAV fix that.

FFO: Funds From Operations

FFO is the industry's standard measure of operating performance. The definition comes from Nareit, the REIT industry association, which is why you'll see it reported consistently across companies.

The FFO Formula

The simplified version:

FFO = Net Income + Real Estate Depreciation & Amortization − Gains on Sale of Property + Losses on Sale of Property + Impairments on Depreciable Real Estate

(Adjustments for unconsolidated joint ventures are also included, but you rarely need those in an interview.)

What Each Adjustment Does

• Add back real estate D&A: it's a non-cash charge that doesn't reflect the property's real economic value.
• Remove gains (add back losses) on property sales: these are one-off, not part of recurring operations.
• Add back impairments on depreciable real estate: also non-cash and non-recurring.

One detail interviewers love: only real estate depreciation gets added back. Depreciation on things like corporate office equipment stays in.

FFO's Big Blind Spot

FFO assumes buildings don't wear out at all. That's not true. Roofs need replacing, HVAC systems break, and new tenants want their space renovated before moving in. FFO ignores all of that spending, which is exactly why AFFO exists.

AFFO: Adjusted Funds From Operations

AFFO tries to get closer to the actual recurring cash flow available to shareholders. Think of it as FFO with a reality check.

The AFFO Formula

AFFO = FFO − Recurring (Maintenance) Capex − Tenant Improvements − Leasing Commissions − Straight-Line Rent Adjustment ± Other Non-Cash Items

What Each Adjustment Does

• Recurring capex: the spending needed just to keep properties in shape (not expansions or development).
• Tenant improvements (TIs) and leasing commissions (LCs): the real cost of signing and keeping tenants.
• Straight-line rent adjustment: accounting rules spread rent escalations evenly over a lease, so reported revenue in early years can exceed cash actually received. AFFO removes that excess.
• Other non-cash items: commonly stock-based compensation (added back) and amortization of above- or below-market leases.

The Catch With AFFO

AFFO is not standardized. Each REIT defines it a bit differently, and some don't report it at all. When comparing REITs, always check the company's reconciliation table so you're comparing apples to apples.

NAV: Net Asset Value

FFO and AFFO are cash flow metrics. NAV is an asset-based valuation: what would the REIT's properties be worth if you marked them to market today, after paying off all obligations?

Book value is useless here because properties sit on the balance sheet at historical cost minus years of depreciation. NAV replaces that with current market value.

The NAV Formula

The core step is valuing the property portfolio with a cap rate:

Property Value = Forward Net Operating Income (NOI) ÷ Cap Rate

Then:

NAV = Property Value + Other Assets (cash, land, development pipeline) − Debt − Preferred Equity − Other Liabilities

NAV per Share = NAV ÷ Diluted Shares Outstanding

A quick refresher: NOI is property-level revenue minus property operating expenses. It excludes interest, corporate G&A, depreciation and taxes. The cap rate is the yield buyers are paying for similar properties in the private market.

Worked Example: One REIT, Three Metrics

Let's build everything for a hypothetical REIT with 100 million shares trading at $35.00. All figures below are in millions except per-share numbers.

Step 1: The Income Statement

That's EPS of $1.00, which makes the stock look expensive at 35x earnings. Let's see what FFO says.

Step 2: Calculate FFO

• Net income: $100
• Add real estate D&A: +$150
• Remove gain on sale: −$20
• Add back impairment: +$10

FFO = $240, or $2.40 per share

P/FFO = $35.00 ÷ $2.40 ≈ 14.6x

Step 3: Calculate AFFO

• FFO: $240
• Straight-line rent adjustment: −$15
• Recurring capex: −$30
• TIs and leasing commissions: −$25
• Stock-based compensation: +$5

AFFO = $175, or $1.75 per share

P/AFFO = $35.00 ÷ $1.75 = 20.0x

Now say the REIT pays a $1.40 annual dividend. The AFFO payout ratio = $1.40 ÷ $1.75 = 80%. That's a useful signal: the dividend is covered by recurring cash flow with some cushion left over. A payout ratio above 100% would suggest the dividend is being funded by debt, asset sales or new equity, which isn't sustainable forever.

Step 4: Calculate NAV

Assume the market cap rate for comparable properties is 6.0%.

• Property value: $400 ÷ 6.0% = $6,667
• Plus cash: $100
• Plus land and construction in progress: $233
• Gross asset value: $7,000
• Less debt: ($3,000)
• Less preferred equity: ($200)

NAV = $3,800, or $38.00 per share

At $35.00, the stock trades at roughly an 8% discount to NAV ($35 ÷ $38 ≈ 0.92x).

Step 5: Bonus, the Implied Cap Rate

You can also flip NAV around and ask: what cap rate is the stock market paying?

• Equity value: $3,500
• Plus debt and preferred: $3,200
• Less cash and non-income-producing assets: ($333)
• Implied value of operating properties: $6,367

Implied cap rate = $400 ÷ $6,367 ≈ 6.3%

The public market is valuing these properties at a higher cap rate (lower price) than the private market's 6.0%. That gap is the same story as the NAV discount, told a different way.

How to Interpret the Numbers

Here's how to think about each metric in practice:

• P/FFO: the closest REIT equivalent to a P/E multiple. Good for quick comparisons within the same property type.
• P/AFFO: a better gauge of what you're paying for actual distributable cash flow. Also the base for judging dividend safety.
• Price to NAV: tells you whether the stock is cheap or expensive relative to the private market value of its buildings.

A discount to NAV isn't automatically a buy signal. It can reflect worries about management, leverage, a weak property type or expectations that cap rates will rise. Likewise, REITs with strong growth prospects or top-tier management can trade at persistent premiums.

Also, always compare within a sector. Industrial, data center, office and retail REITs trade at very different multiples because their growth outlooks and capex needs differ a lot. Comparing an office REIT's P/FFO to a data center REIT's tells you very little.

Common Interview Questions (and How to Answer Them)

"Why do we add back depreciation for REITs but not for most companies?"

Depreciation assumes assets lose value over time. For most companies' equipment, that's roughly true. For real estate, buildings often hold or gain value, so depreciation understates true earnings. Adding it back gives a cleaner view of operating performance.

"What's the difference between FFO and AFFO?"

FFO adjusts net income for real estate depreciation and one-off property gains, losses and impairments. AFFO goes further by subtracting the real recurring costs of maintaining properties and tenants (capex, TIs, leasing commissions) and stripping out non-cash revenue like straight-line rent. AFFO is closer to true distributable cash flow, but it isn't standardized.

"Walk me through a NAV calculation."

Take forward NOI, divide by a market cap rate to value the property portfolio, add cash and other assets like land or development projects, subtract debt, preferred equity and other liabilities, then divide by diluted shares.

"If cap rates rise, what happens to NAV?"

NAV falls. Since property value equals NOI divided by the cap rate, a higher cap rate means a lower property value, and with debt fixed, equity value drops even faster in percentage terms. In our example, moving the cap rate from 6.0% to 6.5% cuts property value from about $6,667 to about $6,154, and NAV per share falls from $38.00 to roughly $32.87.

"Why not just use a DCF for a REIT?"

You can, and analysts sometimes do. But REITs distribute most of their cash and constantly buy, sell and develop properties, which makes long-term projections tricky. FFO and AFFO multiples, NAV and dividend yield are the standard toolkit because they're easier to compare across companies. EV/EBITDA is also commonly used alongside them.

The Bottom Line

Here's the one-sentence version of each metric to lock in before your interview:

• FFO: net income with real estate depreciation and one-off property items stripped out. The REIT version of earnings.
• AFFO: FFO minus the real recurring costs of keeping buildings leased and maintained. The REIT version of distributable cash flow.
• NAV: the market value of the properties (NOI ÷ cap rate) plus other assets, minus all debt and preferred. The REIT version of a mark-to-market book value.

Practice the worked example above once or twice on paper. If you can rebuild FFO, AFFO and NAV from a blank page and explain why each adjustment exists, you'll handle almost any REIT question an interviewer throws at you.