How to Analyze a REIT

What makes a REIT different, and how to analyze a REIT

A real estate investment trust, or REIT, is a company that owns income-producing property and, in exchange for special tax treatment, must pay out most of its taxable income to shareholders as dividends. That structure makes a REIT a hybrid: part operating business, part income stream. It also means the usual earnings-based tools mislead badly, because the accounting for buildings distorts reported profit in a way it does not for most companies. To analyze a REIT well, you have to swap those tools for a set built around cash flow rather than reported earnings.

The distortion comes from depreciation. Standard accounting assumes an asset wears out over time and charges a slice of its cost against profit each year. That makes sense for machinery, but real estate frequently holds its value or appreciates, especially well-located property that is maintained. So a REIT's income statement subtracts a large, non-cash depreciation charge for a loss that is not really happening, dragging reported earnings far below the cash the buildings actually throw off. Analyzing a REIT starts with undoing that distortion.

Realty Income is a useful anchor because the gap is stark. In fiscal 2025 it reported diluted earnings per share of just $1.17, yet its depreciation charge was about $2.47 billion, close to two and a half times its reported net income, according to its 10-K. Judged on earnings per share alone, its dividend would look impossible. Judged on cash flow, it is comfortably covered. The metrics below explain why.

Why FFO and AFFO beat earnings per share

Funds from operations, or FFO, is the metric that fixes the depreciation problem, and it is the right starting point for any REIT. It takes net income, adds back the real estate depreciation that accounting subtracted, and removes one-time gains from selling properties, leaving a figure much closer to the recurring cash the portfolio produces.

Funds from operations = net income + real estate depreciation and amortization - gains on property sales

The effect is dramatic. For Realty Income in fiscal 2025, adding roughly $2.47 billion of depreciation back to about $1.06 billion of net income lifts the picture from barely over a dollar a share to something several times larger, per its 10-K. That is not accounting trickery; it is correcting an accounting charge that misrepresents what is happening, because the buildings are not actually losing value the way the depreciation implies. This is why seasoned investors never value a REIT on its price-to-earnings ratio, a limit noted in the price-to-earnings ratio.

Adjusted funds from operations, or AFFO, refines FFO further by subtracting the recurring capital a REIT must spend to keep its properties competitive, such as maintenance, leasing costs, and tenant improvements. FFO can flatter a REIT that skimps on upkeep; AFFO is the more conservative, more useful figure because it reflects the cash genuinely available to pay dividends after keeping the buildings in shape. When the two differ, trust AFFO.

Reading the payout against AFFO

The single most important sustainability check on a REIT is its dividend measured against AFFO, not against earnings per share. Because a REIT must distribute most of its income, its payout ratio looks alarming on an earnings basis and reasonable on a cash basis, and only the cash basis tells you whether the dividend is safe.

AFFO payout ratio = dividends paid / adjusted funds from operations

A payout in the 70 to 85 percent range is typical and generally sustainable for a REIT, leaving some cushion while still distributing most of the cash as the structure requires. Realty Income's dividend, which ran to roughly $2.9 billion in fiscal 2025 against operating cash flow of about $4.0 billion, per its 10-K, sits comfortably within that range on a cash basis, even though the same dividend would appear to exceed its reported earnings per share several times over. That contrast is the entire lesson of REIT analysis in one company.

A payout near or above 100 percent of AFFO is the warning sign to watch, because it means the dividend is not fully covered by recurring cash flow and depends on asset sales, new borrowing, or issuing shares to sustain it. That can work for a while but is fragile, especially if property income softens. The general logic of judging an income stream is covered in dividend yield, and for a REIT the coverage on AFFO matters far more than the headline yield.

Cap rates in plain words

The capitalization rate, or cap rate, is how real estate investors express the yield on a property, and understanding it tells you how a REIT creates value. It is a property's annual net operating income divided by its value or purchase price.

Cap rate = annual net operating income / property value

A 6 percent cap rate means a building produces 6 cents of net operating income for every dollar of its value each year. It is simply the property world's earnings yield, and it moves inversely to price: a lower cap rate means investors are paying more for each dollar of rental income, so real estate is expensive, while a higher cap rate means property is cheaper. Cap rates move with interest rates, rising when rates rise, which is one reason REIT values fall when borrowing costs climb.

A well-run REIT creates value by buying properties at cap rates above its own cost of capital, then collecting the spread. If it can borrow and raise equity at, say, 5 percent all-in and buy sound buildings at a 7 percent cap rate, the gap accrues to shareholders. When cap rates fall below a REIT's cost of capital, sensible managers stop buying rather than chase deals that do not pay, the same discipline that defines good capital allocation in any business.

Cap rates also frame what happens when a REIT issues new shares to fund purchases. A REIT is one of the few businesses that routinely raises equity to grow, so whether that growth helps existing owners depends on the spread between the cost of the new capital and the cap rate on what it buys. Growth funded by selling cheap shares to buy low-yielding buildings can actually shrink cash flow per share, even as the company gets bigger. The size of a REIT tells you little; the spread it earns on new capital tells you a great deal, which is why growth for its own sake is a warning rather than a virtue here.

Debt maturity ladders and what good looks like

Because REITs use meaningful leverage to buy property, when their debt comes due matters as much as how much they owe. A debt maturity ladder is the schedule of when a REIT's borrowings mature, and it reveals refinancing risk that a single debt figure hides. A REIT with debt spread evenly across many years can refinance gradually; one with a large slug maturing in a single year is exposed if interest rates are high or credit is tight exactly when it must roll that debt over.

The healthiest REITs stagger their maturities, lock in long-term fixed-rate debt, and keep enough liquidity and unencumbered assets to weather a hard refinancing market. The danger is a wall of maturities coinciding with rising rates, which can force a REIT to refinance at punishing costs or sell properties at bad prices. Interest coverage, covered in the interest coverage ratio, shows whether property income comfortably covers the interest bill, and it should be read next to the maturity schedule.

The table below summarizes what to look for, with illustrative benchmark figures rather than any single REIT.

Two further gauges round out the picture: occupancy, the share of space that is leased, and the trend in rents, since a REIT's whole engine is keeping buildings full at rising rates. Persistent declines in either undermine the cash flow that supports the dividend. Judge a REIT on the durability of that rental income across a full cycle of the property market, not on one strong year.

Where to go from here

Analyzing a REIT means throwing out earnings per share and reading funds from operations instead, because depreciation misrepresents buildings that are not truly losing value. Check the dividend against AFFO, understand the cap rate on the properties, and study when the debt matures. Start with dividend yield to weigh the payout, then see the same balance-sheet lens applied to other leverage-driven businesses in how to analyze a bank and how to analyze an insurance company. To study a real REIT, open the Realty Income financials on Tenet.