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101 Concepts for the Level I Exam

Essential Concept 85: Relative Value Approach – REITs

Funds from operation (FFO) is accounting net earnings excluding:

  1. Depreciation charges on real estate
  2. Deferred tax charges (deferred portion of tax expenses)
  3. Gains/losses from sale of property and debt restructuring

Adjusted funds from operation (AFFO) is a refinement to FFO and is designed to be a more accurate measure of current economic income.

AFFO = FFO -straight line adjustment – recurring maintenance type capital expenditures and leasing commissions


In relative value approach, we use the P/FFO, P/AFFO, EV/EBITDA multiples to value REITs. The main drivers behind these multiples are:

  1. Expectations for growth in FFO
  2. Risk associated with underlying real estate
  3. Risk associated  with capital structure and access to capital

P/FFO and P/AFFO Multiples: advantages and drawbacks


  1. These multiples are widely accepted.
  2. Portfolio managers can put REIT valuations into context with other investment alternatives. This makes it easier to compare REITs with other investments.
  3. FFO estimates are readily available.
  4. Multiples can be used in conjunction with growth rates and leverage levels for relative value analysis.


  1. Does not capture the intrinsic value of all real estate assets. For example empty buildings do not contribute to FFO but have value.
  2. P/FFO does not adjust for recurring capital expenditures. Although P/AFFO considers this, there are wide variations in estimates and assumptions.
  3. One-time gains/losses create issues with this model.

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