How to Analyze REIT Stocks: FFO, AFFO, NAV, and Cap Rates Explained

Why P/E Is Useless for REITs (And What to Use Instead)

Here's a number that should bother you: Realty Income, one of the most widely held REITs on the planet, trades at roughly 50x trailing GAAP earnings. By any normal equity valuation standard, that looks absurd. But it trades at about 15x AFFO, which is actually reasonable for a triple-net lease REIT growing same-store NOI at 2–3% annually. The disconnect isn't a market inefficiency — it's an accounting one.

REITs own buildings. Buildings get depreciated under GAAP, typically over 27.5 years for residential or 39 years for commercial. But unlike, say, a semiconductor fabrication plant that genuinely becomes obsolete, a well-maintained warehouse or apartment complex often appreciates over time. GAAP forces the REIT to record $2.5 million in annual depreciation on a $100 million building that might be worth $120 million today. That depreciation crushes reported net income while having zero impact on actual cash generation.

This is why the National Association of Real Estate Investment Trusts (NAREIT) created FFO back in 1991. FFO adds back depreciation and amortization of real estate assets, removes gains (or losses) on property sales, and gives you a standardized cash-flow proxy. It's not perfect — we'll get to its flaws in a moment — but it's the starting point. If you're running a systematic stock screen and throwing REITs in with normal equities on P/E, you're comparing apples to transmission fluid.

FFO vs. AFFO: The Metric That Actually Tells You What You Own

FFO: The Starting Point

The FFO calculation is straightforward. Take GAAP net income. Add back depreciation and amortization related to real estate. Subtract gains on property dispositions (or add back losses). That's it. Most REITs report FFO prominently in their earnings releases because NAREIT standardized the definition, making it roughly comparable across companies.

The problem with FFO is that it ignores maintenance capital expenditures. A 1990s-era office building needs new elevators, HVAC systems, lobby renovations, and tenant improvement allowances to remain competitive. A mall needs escalator refurbishment and parking lot resurfacing. These are real, recurring cash costs that FFO pretends don't exist. For a net lease REIT where tenants cover all maintenance, the gap between FFO and AFFO is small (maybe 3–5%). For an office or mall REIT, it can be 15–25%. That difference is enormous when you're calculating payout sustainability.

AFFO: The Real Cash Flow

AFFO takes FFO and subtracts recurring capital expenditures (also called maintenance capex or non-revenue-enhancing capex), straight-line rent adjustments, and sometimes amortization of leasing costs. There's no single NAREIT-sanctioned AFFO definition, which is both a strength (analysts can tailor it) and a weakness (companies can game it). We recommend calculating it yourself rather than relying on management's reported number.

Our AFFO formula: FFO minus recurring capex minus leasing commissions minus tenant improvement allowances, plus/minus straight-line rent adjustments, plus/minus above/below-market lease amortization. Some analysts also subtract stock-based compensation, which we think is correct for REITs with meaningful SBC programs (typically the larger, internally-managed REITs). For a deeper look at free cash flow yield analysis, which uses similar logic for non-REIT equities, see our dedicated guide.

NAV Calculation: What Is the Real Estate Actually Worth?

Net Asset Value is the private-market value of a REIT's real estate portfolio minus liabilities, divided by shares outstanding. It's the liquidation value — what the REIT would be worth if it sold every building at market prices and paid off all its debt. NAV gives you a completely different lens than AFFO multiples because it focuses on the balance sheet rather than the income statement.

Step-by-Step NAV Calculation

Step 1: Get the REIT's annual Net Operating Income (NOI). This is rental revenue minus property-level operating expenses (property taxes, insurance, maintenance, property management). Most REITs disclose NOI in their supplemental data package. Let's use a hypothetical REIT with $600 million in annualized NOI.

Step 2: Select an appropriate cap rate. This is the tricky part. You need a cap rate that reflects what buyers are actually paying for similar properties in the current market. Sources include CBRE, JLL, and Green Street's CPPI index. For our example, assume industrial properties in tier-1 markets at a 5.0% cap rate.

Step 3: Divide NOI by the cap rate. $600 million / 0.050 = $12.0 billion. That's the implied gross asset value of the property portfolio.

Step 4: Add other assets. Cash on balance sheet ($150 million), development pipeline at cost ($400 million), and any non-real-estate assets. Total additions: $550 million. Gross asset value: $12.55 billion.

Step 5: Subtract all liabilities. Total debt ($4.2 billion), preferred equity ($200 million), other liabilities ($300 million). Total subtractions: $4.7 billion. Net Asset Value: $7.85 billion.

Step 6: Divide by diluted shares. If there are 300 million diluted shares, NAV per share is $26.17. If the stock trades at $23.50, it's at a 10.2% discount to NAV. If it trades at $29, it's at an 10.8% premium.

Cap Rates Explained: The Metric That Links Real Estate to Interest Rates

A capitalization rate is simply the yield on a property at its purchase price: NOI divided by purchase price (or current market value). A building generating $5 million in NOI that sells for $100 million transacts at a 5.0% cap rate. Cap rates are the real estate equivalent of earnings yields — they tell you what return the property generates before financing.

Cap rates and property values move inversely. When cap rates compress (go lower), property values increase. When cap rates expand (go higher), values decline. And cap rates are heavily influenced by interest rates, though the relationship is not one-to-one. The spread between cap rates and the 10-year Treasury has historically averaged 150–250 basis points, depending on property type. When that spread compresses below 100 bps (as it did in late 2021 with industrial cap rates near 3.5% and the 10-year at 1.5%), real estate is priced aggressively. When it widens above 300 bps, there's usually a buying opportunity.

Right now (early 2026), we're seeing cap rates in most sectors stabilize after the 2022–2024 expansion cycle. Industrial cap rates sit around 4.8–5.5%, up from the 3.5–4.0% lows. Office cap rates have blown out to 7.0–9.0%+ in many markets, reflecting both higher rates and structural demand destruction from remote work. Data center cap rates remain compressed at 4.5–5.5% because AI-driven demand has outstripped supply. The cap rate tells you the market's required yield for holding that property type — higher cap rates mean higher perceived risk or lower expected growth.

AFFO Payout Ratios: The Dividend Safety Metric Most Investors Ignore

REITs must distribute at least 90% of taxable income to shareholders to maintain their special tax status. But taxable income is not the same as AFFO (or even FFO). Many investors confuse these, which leads to sloppy payout analysis. We've seen retail investors panic because a REIT's “payout ratio” is 120% on GAAP earnings, not realizing that's perfectly normal because GAAP earnings are depressed by non-cash depreciation.

The ratio that matters: dividends per share divided by AFFO per share. Realty Income pays roughly $3.16 per share in annual dividends and generates approximately $4.25 in AFFO per share, giving an AFFO payout ratio of about 74%. That's healthy — a 26% cushion to absorb a bad quarter, fund small acquisitions, or reduce debt. Contrast that with a struggling office REIT paying $2.00 in dividends on $2.10 in AFFO — a 95% payout ratio. One unexpected tenant departure and that dividend is in jeopardy.

Our rules of thumb: below 70% is conservative (the REIT is retaining significant cash for growth), 70–85% is the sweet spot, 85–90% is tight but manageable for predictable sectors like net lease, and above 90% signals elevated cut risk unless the REIT has contractual rent escalators and near-100% occupancy providing exceptional visibility.

REIT Debt Metrics: What Will Kill You Before Earnings Do

REITs are inherently leveraged businesses. They borrow to acquire properties, which means the balance sheet demands as much scrutiny as the income statement. We've watched multiple REITs blow up not because their properties were bad, but because their debt matured at the worst possible time. Here are the three debt metrics we track religiously.

Net Debt to EBITDA

This is the leverage ratio. Take total debt minus cash, divide by trailing-twelve-month EBITDA (or annualized quarterly EBITDA). For REITs, the healthy range is 4.0–6.0x. Below 4.0x is conservatively financed (think Prologis at ~4.5x or Public Storage at ~3.5x). Above 7.0x is a red flag, and above 8.0x means the REIT is one bad refinancing cycle away from a forced equity raise or dividend cut. During the 2022–2023 rate shock, every REIT above 7.0x net debt/EBITDA underperformed, and several (Briarwood, Ashford Hospitality) cut their dividends entirely.

Weighted Average Debt Maturity

How long before the REIT must refinance its debt? This number is published in every REIT's supplemental data package. We want to see at least 5–6 years of weighted average maturity, with no more than 15–20% of total debt maturing in any single year. A REIT with 3.5 years of average maturity and 30% of its debt coming due in 2027 is exposed to refinancing risk if rates stay elevated. Prologis carries roughly 7.2 years of weighted average maturity — that's fortress-level protection. Compare that to some smaller REITs with 3–4 years of average maturity and heavy near-term walls.

Variable Rate Debt Exposure

What percentage of the REIT's debt is floating rate? Fixed-rate debt locks in interest costs regardless of where the Fed goes. Variable-rate debt reprices continuously. The best-managed REITs keep variable rate exposure below 10–15% of total debt. When we see 30%+ floating rate exposure, we apply a sensitivity test: what happens to AFFO per share if short-term rates increase by 100 bps? If the answer is a 10%+ AFFO hit, the REIT is carrying too much rate risk for an income vehicle.

Same-Store NOI Growth: The Organic Pulse of the Business

Same-store NOI growth (sometimes called comparable or “comp” NOI growth) measures the organic revenue growth of properties owned for at least 12 months, excluding acquisitions, dispositions, and developments. It's the REIT equivalent of same-store sales for a retailer. This metric strips out the effects of empire-building through acquisitions and tells you whether the existing portfolio is getting more valuable or less.

Healthy same-store NOI growth is 2–4% for most REIT sectors. Below 1% suggests the REIT has limited pricing power or is experiencing occupancy pressure. Above 5% signals either a supply-constrained market (industrial in 2021–2023) or temporary catch-up from below-market lease rollovers. The components matter: same-store NOI growth driven by rent increases on renewals is higher quality than growth driven by recovering occupancy, because occupancy has a ceiling (you cannot exceed 100%) while rents theoretically do not.

One thing most investors miss: the mark-to-market opportunity embedded in below-market leases. If a REIT's in-place rents average $15 per square foot but new leases are signing at $22 per square foot, every lease expiration represents a 47% rent bump. Industrial REITs like Prologis have carried mark-to-market spreads of 50–70% in recent years, meaning their same-store NOI growth is likely to remain above-trend for several more years as legacy leases roll to market. That embedded growth rarely shows up in headline AFFO multiples.

REIT Sectors Compared: Not All Real Estate Is Created Equal

The single biggest decision in REIT investing is sector selection. An average stock in a strong REIT sector will outperform the best stock in a weak sector most of the time. Here's how the major sectors stack up as of early 2026.

The gulf between data centers and office is striking. Data center REITs like Equinix and Digital Realty command premium multiples because AI infrastructure spending is creating a demand wave that the industry cannot build fast enough to satisfy. Meanwhile, office REITs are dealing with a permanent structural shift — U.S. office utilization is still roughly 50–55% of pre-COVID levels in most major metros. That's not a cyclical downturn; it's a secular change in how people work.

Practical Walkthrough: Analyzing Prologis (PLD) and Realty Income (O)

Prologis: The Industrial REIT Bellwether

Prologis is the world's largest industrial REIT, with roughly 1.2 billion square feet of logistics real estate across 19 countries. We use it as our primary case study because it hits every analytical dimension.

AFFO analysis: Prologis reported approximately $5.8 billion in Core FFO for 2025, or about $6.25 per share. After subtracting ~$0.45 in recurring capex per share, AFFO is roughly $5.80 per share. At a share price around $115, that's approximately 19.8x AFFO. The dividend of $3.92 per share produces an AFFO payout ratio of ~68% — conservatively low, giving management room for accretive development and opportunistic acquisitions.

NAV analysis: With ~$7.5 billion in estimated NOI and applying a 5.0% cap rate (conservative for class-A industrial), the implied portfolio value is ~$150 billion. Add $2 billion in development pipeline and cash, subtract $28 billion in debt and other liabilities, and you get a NAV of ~$124 billion, or about $134 per diluted share. At $115, PLD trades at a roughly 14% discount to our NAV estimate. That discount has widened from the premium the stock carried in 2021–2022 (when it traded at 20–30% premiums to NAV).

Debt metrics: Net debt/EBITDA of ~4.5x. Weighted average maturity of ~7.2 years. Variable rate exposure under 10%. Interest coverage ratio above 8x. This is an investment-grade balance sheet (A3/A from Moody's/S&P). Prologis can access the bond market at attractive rates even in stress scenarios.

Same-store NOI: Cash same-store NOI growth of 5.5–6.5% in recent quarters, driven by 60–70% mark-to-market rent spreads on lease rollovers. In-place rents average roughly $6.50 per square foot; new leases are signing at $10–11. That embedded rent growth provides multi-year visibility even if industrial demand moderates.

Realty Income: The Net Lease Dividend Machine

Realty Income calls itself “The Monthly Dividend Company” — it's paid 654 consecutive monthly dividends and increased its dividend 127 times since its 1994 IPO. It's the quintessential income REIT, owning 15,400+ single-tenant commercial properties leased to tenants like Dollar General, Walgreens, and FedEx on long-term triple-net leases.

AFFO analysis: AFFO per share of approximately $4.25 in 2025. At a share price around $57, that's 13.4x AFFO — cheap relative to Realty Income's 5-year average of ~17x. The annual dividend of $3.16 gives an AFFO payout ratio of ~74%, which is comfortable for a net lease REIT with highly predictable cash flows. The current dividend yield of about 5.5% is historically attractive; Realty Income's yield rarely exceeds 5.5% outside of recessions or rate shock environments.

The key risk: Realty Income's cost of equity has risen with interest rates. In 2021, when the stock traded at $75+ and yielded 3.5%, it could issue equity cheaply and acquire properties at 6% cap rates for a massive 250 bps spread. Today, at a 5.5% dividend yield (implying ~7% equity cost), acquiring at 6.5% cap rates only works with significant financial leverage. Realty Income's acquisition-driven growth model gets harder when its own stock is cheap. This is the paradox of external-growth REITs in a higher-rate environment.

Dividend Tax Treatment: The Unpleasant Surprise

Most REIT dividends are taxed as ordinary income, not at the preferential qualified dividend rate (0/15/20%). This catches many first-time REIT investors off guard. Because REITs pass through rental income to shareholders (and deduct the distributions against corporate income), the IRS treats most of that distribution as ordinary income to the shareholder, currently taxed at rates up to 37%.

There are nuances. A portion of REIT dividends may qualify as return of capital (not immediately taxable — it reduces your cost basis instead), qualified dividends (from the REIT's own qualified dividend income, like dividends from taxable REIT subsidiaries), or capital gains distributions (taxed at long-term capital gains rates). Realty Income's recent distribution breakdown was roughly 75% ordinary income, 15% return of capital, and 10% qualified. The 199A deduction (Section 199A of the Tax Cuts and Jobs Act) also allows a 20% deduction on ordinary REIT dividends for eligible taxpayers, effectively reducing the maximum tax rate from 37% to about 29.6%.

The practical implication: REITs are most tax-efficient in tax-advantaged accounts (IRA, 401(k), Roth IRA). Holding REITs in taxable accounts and paying 30%+ in taxes on distributions erodes the yield advantage considerably. A 5.5% REIT yield taxed at 30% nets you 3.85% after-tax. A 2.0% qualified dividend taxed at 15% nets you 1.70%. The REIT still wins on a pre-tax basis, but the gap narrows substantially after tax.

The Bear Case: Rising Rates and Cap Rate Compression in Reverse

We'd be doing you a disservice if we painted REIT investing as purely rosy. The dominant risk factor for the sector is the interest rate environment, and we think too many REIT bulls are anchoring to the era of free money (2010–2021) as the baseline for “normal.”

Here's the bear math. If the 10-year Treasury settles at 4.5–5.0% as a long-term equilibrium (rather than reverting to the 2–3% range), cap rates across most REIT sectors will likely stabilize at higher levels than the pre-2022 norms. A 5.5% industrial cap rate instead of 4.0% means property values are ~27% lower. That directly compresses NAVs and limits the accretive acquisition math that drives external REIT growth.

Simultaneously, higher rates increase the cost of debt. A REIT refinancing $1 billion in bonds that matured at 3.5% into new 5.5% paper takes a $20 million annual AFFO hit. Multiply that across $5–10 billion in debt maturities over the next 3–4 years, and you can model meaningful AFFO per share headwinds even with stable NOI growth. For a broader perspective on how rates flow through different equity sectors, see our analysis of interest rate impacts on stock sectors.

The sectors most exposed to this bear case are those with the thinnest cap rate spreads over Treasuries (data centers, industrial), the most variable-rate debt (smaller and mid-cap REITs), and the weakest pricing power (commodity office space). The sectors most insulated are those with the widest cap rate spreads (healthcare, net lease), the longest duration fixed-rate debt (large-cap diversified REITs), and strong embedded rent growth (industrial with large mark-to-market spreads).

Our contrarian take: the bear case is already priced into most REIT sectors. The FTSE NAREIT All Equity Index trades at a roughly 5–8% discount to consensus NAV, and several high-quality names trade at 10–15% discounts. The market has done the rate-adjustment math. What is not priced in is the scenario where rates actually decline — which would create a powerful double tailwind of cap rate compression and lower debt costs. We're not predicting rate cuts, but we are noting that REIT pricing already embeds a “rates stay high forever” assumption that may prove too pessimistic.

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