An investor who wants to calculate the value of a REIT will not use traditional metrics like earnings-per-share and price/earnings (P/E). Are not applicable. An alternative method to estimate the value of a real estate investment trust (REIT) is funded out of operations (FFO).

Most businesses accept depreciation as a non cash charge. It allocates the investment's cost to a previous period. Real estate, however, is not like other fixed-plant and equipment investments. It loses its value less often than most other investments. However, it can be appreciated.

Depreciation reduces net income, which is a lower indicator of performance. Therefore, it makes sense to evaluate REITs using funds from operations (FFO), which excludes the effects of depreciation.

Funds from Operations (FFO).

Companies must reconcile FFO. It is reported in the footnotes along with net income. The basic calculation is adding net income to depreciation and subtracting gains from the sale of depreciable properties.

These gains are subtracted, not recurring and do not contribute to the REIT's sustainable dividend-paying ability.

FFO must be reported. However, it does not include the capital expenses necessary to maintain the portfolio of properties. Shareholders must report FFO. For example, it cannot be deducted for painting apartments.

To estimate the value of a REIT, professional analysts use adjusted funding from operations (AFFO). Professionals tend to use AFFO more often than FFO. This is due to two reasons:

1. It provides a more accurate measure of residual cash flow available for shareholders and is, therefore, a better "base figure" for estimating value.

2. It is true residual cash flow and a better predictor for the REIT's future ability to pay dividends.

This number is usually found on the REIT's cash flow statement. This number is used to estimate the amount of cash needed to maintain existing properties. However, a closer look at particular properties may yield more precise information.

Growth in FFO/AFFO

The FFO and AFFO are key indicators that we can accurately estimate the value of the REIT. However, we also need to look for expected growth in either one or both metrics. This requires that we carefully examine the sector and the REIT's underlying prospects. This article will not cover the details of how to evaluate a REIT's growth prospects. However, here are some sources:

• Rent increases are possible.

• The prospect of improving/maintaining occupancy rates.

• Plan to improve/upscale properties. A popular strategy is to buy low-end properties and then upgrade them to attract better tenants. Better tenants will result in higher occupancy rates, fewer expulsions, and higher rents.

• Potential for external growth. Many REITs encourage FFO growth by acquiring. It's not an easy task, however. A REIT must disperse most of its profits and doesn't usually have a large cash hoard. Many REITs can trim their portfolios and dispose of properties that aren't performing well in order to fund the purchase of properties with undervalued assets.

Multiplier to FFO/AFFO

Two sources make up the REIT's total returns: price appreciation and dividends paid. The expected price appreciation can be divided into FFO/AFFO growth and price-to AFFO multiple expansion.

These multiples can be interpreted in a different way than industry peers. Similar to P/E multiples, interpretation of price-to-FFO and price-to AFFO multiples isn't an exact science. Multiples can vary depending on market conditions and the specific REIT sub-sectors. We also want to avoid investing in multiples that are too high, just like with other equity types.

Apart from the dividends, price appreciation can be broken down into two sources. First, growth in FFO/AFFO and secondly, expansion in the value multiple (price to-FFO or price to AFFO ratio). Therefore, it is important to consider both sources when looking at REITs with positive FFO growth prospects.

If FFO increases at 10%, and the multiple of 10.55x remains constant, then the price will rise 10%. However, the price appreciation will be 15% if the multiple grows by 5% to 11x (10% FFO growth + 5x multiple expansion).

1. The market's going stock capitalization rate or "cap rate."

2. Our estimate of the REIT's growth FFO/AFFO

Cap rate is a number that indicates how much investors are paying for real property. For example, a cap rate of 8% would indicate that investors pay approximately 12.5 times ( 1, 8%) the net operating income (NOI) for each real estate property.

The Summary

It is easier to understand the results when REITs are evaluated using funds from operations (FFO) rather than net income. Prospective investors also need to calculate adjusted funds of operations (AFFO), which subtracts any likely expenditures required to maintain their real estate portfolio. AFFO is a great tool for assessing the REIT's growth potential and dividend-paying ability.