Introduction
Real estate investment trusts (REITs) and real estate operating companies require specialized valuation metrics because the standard tools produce misleading results. The core issue is depreciation: US GAAP requires REITs to depreciate their real estate assets over 27.5-39 years, creating large non-cash charges that significantly understate earnings and free cash flow. Since the underlying real estate may actually be appreciating in value (or at minimum maintaining its value with proper maintenance), the depreciation charge does not reflect economic reality.
Why Standard Metrics Fail for REITs
EPS is depressed by depreciation. A REIT with significant real estate holdings may report low or negative EPS due to large depreciation charges, even though the underlying cash flow from rents is substantial and growing.
EV/EBITDA is less meaningful. While EBITDA partially corrects for depreciation, it does not capture the unique economics of real estate (property-level net operating income, cap rates, occupancy dynamics) and does not distinguish between property types, locations, or lease structures.
Standard DCF misses the asset value. A DCF based on projected cash flows does not directly value the underlying real estate, which may be worth more or less than the cash flows it generates.
The Three Core REIT Metrics
Net Asset Value (NAV)
NAV estimates the fair value of the REIT's real estate portfolio minus all liabilities:
The fair value of properties is estimated using capitalization rates (cap rates): each property's net operating income (NOI) is divided by the applicable cap rate to derive its value:
- Capitalization Rate (Cap Rate)
The rate of return on a real estate investment, calculated as the property's annual net operating income (NOI) divided by its current market value or purchase price. A property generating $5 million in NOI valued at $100 million has a 5% cap rate. Lower cap rates indicate higher valuations (and lower expected returns); higher cap rates indicate lower valuations. Cap rates vary by property type, location, quality, and market conditions, typically ranging from 3-5% for prime urban office to 6-9% for suburban retail.
NAV provides an asset-based valuation that reflects the market value of the REIT's holdings. A REIT trading above NAV is valued at a premium (investors pay more than the sum of its parts, reflecting franchise value, management quality, or growth expectations). A REIT trading below NAV trades at a discount (investors can buy the real estate portfolio for less than its estimated fair value). As of Q3 2025, the median implied cap rate across the REIT sector was 7.7%, down 48 basis points year-over-year, reflecting both moderating interest rates and strong fundamentals.
P/FFO multiples vary dramatically by property type, reflecting different growth trajectories and market dynamics. In late 2025, data center REITs like Equinix (operating 260 data centers across 33 countries) traded at approximately 24.6x forward FFO, the highest of any REIT sub-sector, driven by explosive AI-related demand. Industrial/logistics REITs like Prologis traded at approximately 19-20x FFO, buoyed by e-commerce growth and Prologis's expansion into $8 billion of data center development. At the other end, office REITs traded at single-digit multiples, reflecting persistent post-pandemic headwinds. The average P/FFO across all REITs was approximately 13.7x forward FFO in November 2025.
Funds from Operations (FFO)
FFO is the REIT industry's standard earnings metric, designed to replace EPS:
By adding back depreciation and removing one-time gains from property dispositions, FFO provides a cleaner measure of the REIT's recurring earning power from its real estate operations. P/FFO is the REIT equivalent of P/E and is the primary relative valuation multiple.
Adjusted Funds from Operations (AFFO)
AFFO goes one step further by subtracting maintenance capex (the capital expenditures required to maintain the properties' current condition and earning power):
AFFO is the closest approximation to sustainable, distributable cash flow and is the most relevant metric for assessing the REIT's ability to maintain and grow its dividend. P/AFFO is analogous to P/FCF for operating companies.
| Metric | What It Measures | Adjustment vs. Net Income | Valuation Multiple |
|---|---|---|---|
| Net Income (EPS) | Accounting earnings | None (distorted by depreciation) | P/E (not typically used for REITs) |
| FFO | Recurring real estate earnings | Adds back depreciation, removes property gains | P/FFO (primary REIT multiple) |
| AFFO | Sustainable distributable cash flow | FFO minus maintenance capex | P/AFFO (closer to "true" cash flow) |
| NAV | Fair value of net assets | Bottom-up property valuation | Premium/discount to NAV |
REIT Valuation in M&A
REIT acquisitions are typically valued on a price per square foot, cap rate, or premium/discount to NAV basis rather than the EV/EBITDA framework used for operating companies. In a REIT merger, the contribution analysis (relative value assessment) evaluates each REIT's contribution based on NAV, FFO, and portfolio quality rather than standard financial metrics.
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