CFA Level II Exam · Investments in Real Estate through Publicly Traded Securities

Discounted Cash Flow Valuation of REITs

Updated 7 October 2026 · Fact-checked

DCF valuation of a REIT discounts its expected future cash flows to the investor at the required return. Because REITs pay out most of their income, the dividend discount model is common. For multistage cases, discount each explicit dividend, then add the present value of a terminal value from a Gordon growth formula.

Understand Discounted Cash Flow Valuation of REITs

A REIT is a company that owns income-producing real estate and must distribute most of its taxable income. Because of this high payout, dividends are a good proxy for the cash an investor receives. That is why the dividend discount model (DDM) fits REITs well.

The core idea is simple. A share is worth the present value of everything you expect to receive from it. For a REIT that means future dividends plus a final sale price. If you hold forever, the value is the present value of all dividends. In practice you forecast a few years of dividends, then estimate a terminal value that captures all later dividends.

Growth is the hard part. REITs pay out a lot, so they retain little cash. Growth must come from new equity, new debt, rent increases, or recycling assets. High payout means internally funded growth is low. So long-run growth assumptions must be modest and consistent with the property market, inflation and the REIT's ability to raise capital. A terminal growth rate above the long-run growth of the economy is a red flag.

A multistage DDM handles a REIT whose growth changes over time. For example, a REIT may grow dividends fast for a few years as it completes developments or lease-up, then settle to a stable rate. You value the high-growth years one by one, then use the Gordon growth model at the start of the stable stage. Discount everything back to today at the required return.

In the exam, the vignette gives dividends, growth rates and a required return, sometimes through a CAPM calculation. Your task is to place each cash flow on the right date and not mix up the terminal value date.

Key formulas to remember

Dividend discount model (general): V₀ = Σ [Dₜ ÷ (1 + r)ᵗ] for t = 1 to ∞; r is the required return on equity. Dₜ is the dividend per share expected at time t.
Gordon growth model: V₀ = D₁ ÷ (r − g); Requires r > g and constant growth g forever. D₁ = D₀ × (1 + g).
Terminal value at end of year n: Vₙ = Dₙ₊₁ ÷ (r − g_L); g_L is the stable long-run growth rate. Vₙ sits at time n, so discount it by (1 + r)ⁿ.
Multistage DDM with n explicit years: V₀ = Σ [Dₜ ÷ (1 + r)ᵗ] for t = 1 to n + Vₙ ÷ (1 + r)ⁿ; Add the PV of explicit dividends and the PV of the terminal value.
CAPM required return: r = Rf + β × (equity risk premium); Use when the vignette gives beta and a market premium instead of r.
Implied terminal multiple check: Vₙ ÷ Dₙ₊₁ = 1 ÷ (r − g_L); Use as a sense check on the terminal value.

How to solve Discounted Cash Flow Valuation of REITs questions

Use this order for any REIT DCF question in an item set.

1Read the vignette and list the inputs: latest dividend D₀, growth rates by stage, stage lengths, required return or CAPM inputs, and the date of valuation.
2Find r. If the vignette gives Rf, beta and the market premium, compute r = Rf + β × premium first.
3Forecast the dividend for each year of the explicit stage by growing the prior dividend at that stage's rate.
4Find the first dividend of the stable stage, Dₙ₊₁ = Dₙ × (1 + g_L), then compute the terminal value Vₙ = Dₙ₊₁ ÷ (r − g_L).
5Discount each explicit dividend and the terminal value to today, using (1 + r)ᵗ with the correct t. The terminal value uses t = n.
6Add the present values to get the intrinsic value per share.
7Compare with the market price and state the conclusion: undervalued if value is above price, overvalued if below.
8Sanity check: confirm r > g_L and that the terminal growth rate is realistic for the property market.

Quickest way: Terminal value first, then stack the cash flows

When to use it: When the vignette gives a short explicit stage of two or three years and you must pick among three numeric options.

Write the timeline: 0, 1, 2, ..., n. Mark the dividends under each year.
Compute Dₙ₊₁ and Vₙ immediately, then add Vₙ to Dₙ on the year n line so you discount only one number for that year.
Discount each line using a calculator's power key or repeated division by (1 + r).
Sum the results and compare with the three options. Eliminate any option that is clearly far off, for example one that discounts the terminal value by n + 1 years.
If time is short, estimate: PV of terminal value is usually the largest part of the total.

Common mistakes in Discounted Cash Flow Valuation of REITs

Using D₀ instead of D₁ in the Gordon growth formula.
The vignette gives the latest dividend, and students plug it in directly.
Fix: Always grow it once first. The numerator is the next dividend: Dₙ₊₁ = Dₙ × (1 + g).
Discounting the terminal value by n + 1 years.
The terminal formula uses Dₙ₊₁, so students think the value sits at time n + 1.
Fix: The Gordon formula gives a value one period before the first dividend in the formula. So Vₙ sits at time n. Discount it by (1 + r)ⁿ.
Choosing a terminal growth rate higher than the required return, or well above long-run economic growth.
Students carry over the high growth rate from the first stage.
Fix: Use the stable-stage rate stated in the vignette. Check r > g_L. Treat a very high stable growth rate as unrealistic.
Ignoring the payout constraint when judging growth.
Students treat REIT growth like that of a normal company that retains earnings.
Fix: Remember REITs pay out most income. Fast growth needs external capital, so ask where the funding comes from.
Using the cost of debt or a WACC as the discount rate for a dividend model.
Students confuse equity cash flows with firm cash flows.
Fix: Dividends go to equity holders, so discount at the required return on equity.
Forgetting to compound growth across the explicit years.
Students apply the growth rate to D₀ every year instead of to the prior year's dividend.
Fix: Build each dividend from the previous one, and switch rates at the stage boundary.

Worked examples

Example 1

A REIT paid a dividend of $2.00 per share this year. An analyst expects dividends to grow 10% in year 1 and 8% in year 2, then 3% forever. The required return is 9%. Questions: (1) What is the dividend in year 2? (2) What is the terminal value at the end of year 2? (3) What is the intrinsic value per share today?

Show the solution

Dividend year 1: D₁ = 2.00 × 1.10 = 2.20.
Dividend year 2: D₂ = 2.20 × 1.08 = 2.376.
First stable dividend: D₃ = 2.376 × 1.03 = 2.44728.
Terminal value at end of year 2: V₂ = 2.44728 ÷ (0.09 − 0.03) = 2.44728 ÷ 0.06 = 40.788.
PV of D₁ = 2.20 ÷ 1.09 = 2.0183.
PV of D₂ = 2.376 ÷ 1.1881 = 1.9998.
PV of V₂ = 40.788 ÷ 1.1881 = 34.3304.
Total value = 2.0183 + 1.9998 + 34.3304 = 38.3485, which rounds to 38.35.

Answer: (1) $2.376. (2) $40.79. (3) About $38.35 per share.

Example 2

A REIT trades at $30.00. Its latest dividend is $1.50. Dividends are expected to grow 6% a year for 3 years, then 2.5% forever. The risk-free rate is 3%, beta is 0.8 and the equity risk premium is 5%. (1) What is the required return? (2) What is the intrinsic value per share? (3) Is the REIT under- or overvalued?

Show the solution

Required return: r = 3% + 0.8 × 5% = 7%.
D₁ = 1.50 × 1.06 = 1.59. D₂ = 1.59 × 1.06 = 1.6854. D₃ = 1.6854 × 1.06 = 1.786524.
D₄ = 1.786524 × 1.025 = 1.831187.
V₃ = 1.831187 ÷ (0.07 − 0.025) = 1.831187 ÷ 0.045 = 40.6930.
PV of D₁ = 1.59 ÷ 1.07 = 1.4860.
PV of D₂ = 1.6854 ÷ 1.1449 = 1.4721.
PV of D₃ = 1.786524 ÷ 1.225043 = 1.4583.
PV of V₃ = 40.6930 ÷ 1.225043 = 33.2176.
Value = 1.4860 + 1.4721 + 1.4583 + 33.2176 = 37.6340, which rounds to 37.63.
Value $37.63 is above price $30.00, so the stock looks undervalued.

Answer: (1) 7%. (2) About $37.63 per share. (3) Undervalued, since intrinsic value exceeds the $30.00 price.

Exam tips

Draw a timeline before calculating. Most lost marks come from placing the terminal value at the wrong date.
Check that the vignette asks for dividends. Some REIT questions use FFO or AFFO multiples or NAV, so choose the method the question names.
Look for a CAPM step hidden in the vignette. The required return may not be given directly.
Use the terminal value share of total value as a sanity check. If it is over most of the value, the answer is sensitive to g and r.
Qualitative questions often ask why growth is limited. Link it to the high payout requirement and reliance on external capital.

Discounted Cash Flow Valuation of REITs in other exams

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

Discounted Cash Flow Valuation of REITs: frequently asked questions

Why is the dividend discount model used for REITs?

REITs distribute most of their taxable income, so dividends are a large and fairly stable share of what investors receive. That makes dividends a reasonable proxy for cash flow to equity. It is also easy to forecast compared with some other cash flow measures.

How do I find the terminal value in a multistage REIT DDM?

Grow the last explicit dividend by the stable growth rate to get the next dividend. Divide it by (r − g). This gives the value at the end of the explicit stage, which you then discount back to today.

What growth rate should I use for the terminal stage?

Use the rate in the vignette. In general it should be modest, below the required return and in line with long-run growth in the property market and economy. A very high terminal rate is a warning sign.

Is DCF the same as NAV valuation for REITs?

No. DCF values the REIT's shares from expected dividends. NAV values the underlying properties and subtracts liabilities, then compares per-share NAV with price. Both appear in the curriculum, so read which one the question asks for.