How to Analyse REITs

To analyse a REIT, ignore reported earnings and use funds from operations (FFO) and adjusted FFO (AFFO), which add back property depreciation. Then judge net asset value, occupancy and rent growth, debt and interest cover, and whether the dividend is safely covered by cash flow.

Where this fits: a REIT is a cash-flow business dressed as a property company, so this guide adapts the Five Criteria framework to real estate. Read it alongside why free cash flow matters more than profit, because the whole REIT puzzle is a cash-versus-accounting story.

A real estate investment trust (REIT) owns income-producing property — offices, warehouses, shopping centres, flats, data centres, hospitals — and passes the rent through to shareholders. It sounds simple, and in one sense it is. But REITs come with an accounting quirk so large that investors who miss it get the analysis completely wrong.

That quirk is depreciation. Under standard accounting, a REIT must depreciate its buildings every year, which drags reported profit down sharply. Yet a well-located building often holds or grows its value over time. So the depreciation charge is, for a REIT, a largely fictional cost. If you judge a REIT on its earnings per share, you are judging it on a number that has been artificially depressed by non-cash accounting.

Start with FFO, not EPS

The property industry solved this with a tailored metric: funds from operations (FFO). It starts from net income, adds back property depreciation and amortisation, and removes one-off gains from selling buildings. What is left is a far truer picture of the recurring cash the portfolio generates.

But FFO is not the finish line. It still ignores the fact that buildings need ongoing spending — new roofs, lift refurbishments, tenant fit-outs — just to keep earning the same rent. That is why the sharper measure is adjusted funds from operations (AFFO), which takes FFO and subtracts this recurring maintenance capital expenditure (and usually smooths lumpy rent).

• FFO = net income + property depreciation and amortisation − gains on property sales
• AFFO = FFO − recurring maintenance capex − straight-lined rent adjustments

AFFO is as close as a REIT gets to free cash flow. It is the single best gauge of how much the trust can actually afford to distribute. Everything else in REIT analysis orbits around it.

Measure	What it captures	Use it to
EPS	Accounting profit after depreciation	Almost nothing — depreciation distorts it
FFO	Recurring operating cash before maintenance	Judge operating performance
AFFO	Cash after maintenance capex	Judge dividend safety and value
NAV	Market value of property minus debt	Judge the share price versus asset value

Judge the quality of the portfolio

A REIT is only as good as the buildings it owns and the tenants inside them. Four questions get you most of the way.

• Occupancy. What percentage of space is let? High and stable occupancy signals demand; a falling rate is an early warning.
• Rent growth and releasing spreads. When leases expire, is the REIT re-letting at higher or lower rents? Positive releasing spreads show genuine pricing power.
• Lease length (WALT). The weighted average lease term tells you how long the income is locked in. Long leases with creditworthy tenants are a defensive feature.
• Tenant quality and concentration. A REIT reliant on one struggling tenant is far riskier than one with hundreds of strong ones.

The property sector is not uniform. Industrial warehouses, data centres and flats have behaved very differently from older retail and some office assets. Always ask what structural demand looks like for this type of space, in the spirit of our guide to why a thorough industry analysis is non-negotiable.

The balance sheet is the main risk

Property is bought with debt, so a REIT’s balance sheet is not a side issue — it is the central risk. Our fourth criterion, a sound balance sheet, is where many REITs fail quietly in good times and loudly in bad ones. Focus on:

• Loan-to-value (LTV): total debt against the value of the property. Lower is safer. A conservatively run REIT keeps LTV modest so a dip in property values does not wipe out equity.
• Net debt to EBITDA: the leverage multiple familiar from other sectors.
• Interest coverage: how comfortably rental income covers interest payments. Read our standalone guide to the interest coverage ratio and apply it strictly here.
• Debt maturity profile and fixed-rate share: when does the debt fall due, and how much is exposed to rising rates? A wall of debt maturing in a single year, or mostly floating-rate borrowing, turns a rate rise into a crisis.

The lesson from every property downturn is the same: highly leveraged REITs are forced to sell assets or cut dividends at the worst possible moment, while conservatively financed ones keep paying and go shopping for bargains. Treat leverage with the caution our guide to long-term debt recommends.

Is the dividend safe?

For most REIT investors the dividend is the point, so dividend safety deserves its own check. The clean test is the AFFO payout ratio — the dividend divided by AFFO per share. A payout meaningfully below 100% of AFFO leaves a cushion; a payout at or above AFFO means every setback threatens the distribution.

Be wary of a headline yield that looks too generous. An unusually high yield often means the market expects a cut, not that you have found free money. Cross-check the payout against the balance sheet: a stretched dividend sitting on top of heavy, near-term debt is a classic trap.

Does a REIT have a moat?

Buildings are not, in themselves, a moat — anyone with capital can build one. The durability comes from things that are hard to replicate:

• Irreplaceable location. Prime sites in supply-constrained markets cannot be copied; new rivals simply cannot build next door.
• Scale and network. A logistics REIT with warehouses near every major city offers tenants something a single-site owner cannot.
• Switching costs. Specialised space — data centres, lab buildings, cold storage — ties tenants in, because moving is disruptive and expensive.

Apply the same discipline as how to spot a competitive advantage: the question is whether the REIT can keep raising rents faster than its costs over a full cycle, not just whether it owns nice buildings today.

Management and capital allocation

A REIT’s management team is really a team of capital allocators: they decide what to buy, what to sell, when to issue shares and how much to borrow. Watch whether they issue new shares below net asset value (which dilutes you) or buy back shares when the stock trades at a discount to NAV. The best teams are disciplined counter-cyclical investors; the worst chase growth by overpaying at the top of the market and issuing stock to fund it. This is the capital-allocation hierarchy applied to property.

Valuing a REIT

Two anchors replace the usual earnings multiple.

• Net asset value (NAV). Estimate the market value of all the properties, subtract the debt, and divide by the share count. Comparing the share price to NAV tells you whether you are buying property at a premium or a discount.
• Price to FFO / AFFO. Just as you would use a price-to-earnings multiple elsewhere, use a price-to-FFO or price-to-AFFO multiple for a REIT, and compare it across similar REITs and against the REIT’s own history.

A hypothetical sense-check

Imagine a REIT, REIT A, that owns modern warehouses in supply-constrained logistics hubs. Occupancy sits at 98%, leases are long, releasing spreads are positive, LTV is conservative, and the dividend is covered comfortably by AFFO. It trades at a small premium to NAV. That combination — strong assets, safe balance sheet, covered dividend, sensible price — is the profile worth holding through a cycle.

Now imagine REIT B, with older assets, slipping occupancy, high LTV, a chunk of floating-rate debt maturing soon, and a dividend paying out more than AFFO — yet a headline yield twice REIT A’s. REIT B looks cheaper and is far riskier. (Both are illustrations, not real companies.) The margin of safety you demand should rise with leverage, not fall because the yield is tempting.

Frequently Asked Questions

What is the difference between FFO and AFFO? FFO takes net income and adds back property depreciation and amortisation while removing gains on property sales. AFFO goes further, subtracting the recurring maintenance capital spending needed to keep the properties earning and smoothing out rent. AFFO is the better measure of the cash truly available to pay dividends.

Why do REITs pay such high dividends? In most jurisdictions a REIT must distribute the large majority of its taxable income to shareholders to keep its tax-advantaged status. A high payout is therefore a structural feature of the model, not in itself a sign of generosity or of danger — you still need to check it against AFFO.

How much debt is too much for a REIT? There is no universal line, but watch loan-to-value, net debt to EBITDA and interest coverage together. A conservatively run REIT keeps LTV modest and interest cover comfortably above a few times, so a rise in rates or a dip in occupancy does not put the dividend at risk.

Should I value a REIT on its price-to-earnings ratio? No. Because property depreciation distorts REIT earnings, the P/E ratio is close to meaningless. Use price-to-FFO or price-to-AFFO multiples and compare the share price to net asset value instead.

Are all REITs the same? Far from it. Industrial, residential, data-centre, healthcare and retail REITs face very different demand, lease structures and risks. Analyse the specific property type and its structural outlook before comparing one REIT to another.

Your Next Step

REITs are a superb teacher of the difference between accounting profit and real cash. To go deeper:

• Why free cash flow matters more than profit — the idea at the heart of FFO and AFFO.
• How to read a cash flow statement — to trace where a REIT’s cash really goes.
• The DCF intrinsic value calculator — to value a REIT’s cash flows on your own terms.

For sector-specific templates and worked REIT analysis, see our premium resources.

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About the author: Cameron Hayes is a senior investor relations and finance professional who has worked in IR at Nasdaq Copenhagen-listed companies including Nilfisk and Maersk Drilling. He holds an MSc from Copenhagen Business School and a BCom from the University of Ottawa, and founded Gingernomics to teach individual investors the Five Criteria framework. More about Gingernomics.

The content on Gingernomics is for educational and informational purposes only and does not constitute financial advice. Always do your own research and consult a licensed financial advisor before making any investment decisions. Past performance is not indicative of future results.