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CFA Level I Exam · Real Estate and Infrastructure

Real Estate Risks, Returns and REIT Valuation (NAV, FFO, AFFO)

Updated 7 October 2026 · Fact-checked

Real estate returns come from income and value change, and leverage magnifies both gains and losses. REITs are valued with NAV (market value of assets minus liabilities, per share) or with P/FFO and P/AFFO multiples. FFO = net income + depreciation + amortization + losses on property sales − gains on property sales. AFFO = FFO − recurring capex and straight-line rent adjustments.

Understand Real Estate Risks, Returns and REITs

Real estate returns have two parts: income return (net rent after operating costs) and capital appreciation (change in property value). Income is fairly stable. Value changes depend on interest rates, local supply and demand, and the economy. Real estate is also illiquid, each property is unique, and appraisal-based data smooths reported returns.

Main risks include: property-specific risk (vacancy, tenant default, location, obsolescence), lease and rent risk, interest rate and refinancing risk, liquidity risk, valuation risk (appraisals are subjective), and development or construction risk. Property type matters too: office, retail, residential and industrial react differently to the cycle.

Leverage works both ways. If the property's return is higher than the cost of debt, leverage raises the return on equity. If it is lower, leverage lowers it and can wipe out equity. Leverage also raises the volatility of equity returns.

A REIT is a company or trust that owns (equity REIT) or finances (mortgage REIT) income-producing property. REITs usually pay out most of their taxable income and get favourable tax treatment at the entity level. They trade on exchanges, so they are liquid, but their prices move with the stock market in the short run, more than appraisal-based direct property values do. Direct ownership gives control and diversification of its own kind, but needs large capital, has high transaction costs and is illiquid.

REIT valuation uses two approaches. NAV per share takes the estimated market value of the assets (often net operating income ÷ cap rate) minus liabilities, divided by shares outstanding. The REIT trades at a premium or discount to NAV. Price multiples use FFO and AFFO, because net income understates cash earning power: accounting depreciation on property is large, yet well-kept buildings often hold or gain value.

Key formulas to remember

FFO
FFO = Net income + Depreciation + Amortization + Losses on property sales − Gains on property sales (and other non-cash or non-recurring items)
Adds back real estate depreciation and removes one-off sale gains and losses.
AFFO
AFFO = FFO − Straight-line rent adjustments − Recurring maintenance capex (and tenant improvements, leasing commissions)
Closer to recurring cash earnings. Other adjustments (e.g., non-cash interest) may appear; follow the question.
P/FFO and P/AFFO
P/FFO = Share price ÷ FFO per share; P/AFFO = Share price ÷ AFFO per share
Lower multiples can signal cheaper value, but compare with similar REITs.
NAV per share
NAV per share = (Estimated market value of assets − Liabilities) ÷ Shares outstanding
Use market values, not book values.
Property value via cap rate
Value = Forward NOI ÷ Cap rate
Use the NOI the question specifies (forward or trailing) and no depreciation or interest in NOI.
Levered return
Return on equity ≈ [Property return × Assets − Interest rate × Debt] ÷ Equity
Equity = Assets − Debt. Shows how leverage magnifies gains and losses.
Implied value from multiple
Target price = Target P/FFO × FFO per share
Often used with a peer-average multiple.

How to solve Real Estate Risks, Returns and REITs questions

Use this sequence for most questions on real estate risks, returns and REITs.

  1. 1Identify what is asked: a risk or return driver, a leverage effect, a REIT feature, or a number such as FFO, AFFO, NAV or a multiple.
  2. 2For concept questions, match the clue to a risk (liquidity, valuation, leverage, tenant, development) or to direct versus REIT features.
  3. 3For FFO: start with net income, add depreciation and amortization, then add losses and subtract gains on property sales.
  4. 4For AFFO: start from FFO, subtract straight-line rent gains (add if negative) and recurring capex. Ignore growth capex unless told otherwise.
  5. 5For NAV: value each asset at market (NOI ÷ cap rate), add other assets, subtract all liabilities, then divide by shares.
  6. 6For multiples: divide price by the per-share measure, or multiply the multiple by per-share FFO or AFFO to get a value.
  7. 7Check units (total versus per share) and that exactly one of the three options fits. Numerical options run smallest to largest, so use that to sanity-check.

Quickest way: Fast FFO, AFFO and NAV check

When to use it: Use for numerical REIT questions when you have about 90 seconds.

  1. Write the formula line first, then plug in only the numbers it needs.
  2. For FFO, sign-check: gains are subtracted, losses are added.
  3. For AFFO, only recurring capex and straight-line rent adjustments are deducted from FFO.
  4. For NAV, do cap-rate value first, then subtract debt, then divide by shares.
  5. Eliminate options that use book value, forget the per-share step or have the wrong sign on gains.

Common mistakes in Real Estate Risks, Returns and REITs

  • Adding gains on property sales to FFO instead of subtracting them.

    Students treat gains as income, and net income already includes them.

    Fix: FFO removes non-recurring items: subtract gains, add back losses.

  • Deducting growth or acquisition capex when computing AFFO.

    All capex looks like a cash outflow.

    Fix: Deduct only recurring maintenance capex, tenant improvements and similar items needed to sustain income.

  • Using book value of property for NAV.

    Balance sheets show book values readily.

    Fix: NAV uses estimated market values, usually NOI ÷ cap rate.

  • Saying leverage always raises equity return.

    Students remember the gain case only.

    Fix: Leverage raises return only when property return exceeds the cost of debt; it always raises risk.

  • Treating appraisal-based returns as true volatility.

    Direct real estate indexes look smooth.

    Fix: Appraisal smoothing understates volatility and correlation with other assets; listed REITs show more volatility.

  • Mixing total FFO and per-share FFO in a multiple.

    Questions give both totals and share counts.

    Fix: Divide FFO by shares first, then apply the multiple to price, or use total values on both sides.

Worked examples

Example 1

A REIT reports net income of $40 million, depreciation of $25 million, amortization of $3 million, a gain on property sale of $6 million, recurring maintenance capex of $8 million and straight-line rent revenue of $2 million (a non-cash gain). It has 20 million shares and trades at $30. What are FFO, AFFO and P/AFFO?

Show the solution
  1. FFO = 40 + 25 + 3 − 6 = $62 million.
  2. AFFO = 62 − 2 (straight-line rent) − 8 (recurring capex) = $52 million.
  3. AFFO per share = 52 ÷ 20 = $2.60.
  4. P/AFFO = 30 ÷ 2.60 = 11.54.

Answer: FFO = $62 million, AFFO = $52 million, P/AFFO ≈ 11.5x.

Example 2

A REIT expects next-year NOI of $90 million on its properties. The appropriate cap rate is 6%. It has other assets of $30 million and liabilities of $400 million. There are 25 million shares. What is NAV per share?

Show the solution
  1. Property value = 90 ÷ 0.06 = $1,500 million.
  2. Add other assets: 1,500 + 30 = $1,530 million.
  3. Subtract liabilities: 1,530 − 400 = $1,130 million.
  4. NAV per share = 1,130 ÷ 25 = $45.20.

Answer: NAV per share = $45.20.

Exam tips

  • Expect a numerical FFO or AFFO item where gains versus losses and the capex type are the trap.
  • Know direct versus REIT contrasts: liquidity, transaction costs, control, appraisal smoothing and tax treatment.
  • For leverage questions, compare property return with the borrowing cost before choosing.
  • With three options, remove ones that use book values or skip the per-share step first.

Practice questions from Real Estate and Infrastructure

Real Estate Risks, Returns and REITs in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Real Estate Risks, Returns and REITs: frequently asked questions

Why do analysts use FFO instead of net income for REITs?

Net income includes large depreciation charges on buildings that often do not lose value, and gains or losses on property sales that do not recur. FFO adjusts for both. It gives a better view of recurring operating cash earnings.

What is the difference between FFO and AFFO?

AFFO starts from FFO and deducts recurring capital spending and non-cash straight-line rent. It aims to show the cash flow available to shareholders. It is therefore usually the better base for dividend capacity.

How is REIT NAV different from book value?

NAV uses estimated market values of properties, typically NOI divided by a cap rate. Book value uses historical cost less depreciation. A REIT's price can trade at a premium or discount to NAV.

How do REITs differ from direct real estate investment?

REITs are listed, liquid, low in minimum investment and professionally managed, but their prices move with equity markets. Direct ownership is illiquid, needs large capital and has high costs, but gives control and appraisal-smoothed reported returns.