For decades, the capitalization rate—a property's net operating income divided by its purchase price—has been the go-to metric for commercial real estate investors. But in Southeast Michigan's value-add market, this single number is systematically misleading buyers, according to Larry Gotcher, a real estate professional at Resource Realty Group with nearly 40 years and roughly 7,500 transactions closed. Gotcher has removed cap rates from his marketing materials entirely, arguing that they obscure the true potential of many properties.
Cap rates are inherently backward-looking, reflecting what a property is doing today, not what it could achieve under different ownership. For value-add properties—where the investment thesis relies on improving occupancy, raising rents, or completing capital improvements—current net operating income bears little relationship to the actual return an investor will earn over time. Gotcher points to a manufactured housing community he is considering selling: currently 10 of 50 spaces are occupied, and the property loses money monthly. A cap rate on current income would be meaningless, yet his pro forma projects a stabilized net operating income of $500,000 annually once fully occupied. “If I use cap rate, it would be terrible on this place,” he says. “Since I don’t market that, I can explain through the pro forma and the cash flow analysis what the future will look like on a project like this.”
Under-rented properties are a particularly common source of distortion. Many commercial properties carry rents significantly below market rates due to long-term leases, passive management, or neglect. A cap rate based on these below-market rents appears low, signaling to cap-rate-focused buyers that the asset is expensive. In reality, the gap between current and market rents may represent the most valuable component of the deal. “Your cap rate doesn’t show the fact that it’s drastically under rented,” Gotcher says. “It’s more important what you can do with the property than what it’s currently doing with the owner that’s failing.”
This dynamic creates a systematic advantage for investors who model future rent potential. They compete for assets that the cap-rate-screened majority has dismissed, often at prices reflecting current—not potential—income. Gotcher also notes a counterintuitive relationship: value-add properties often have higher cap rates because they are riskier and require more work. A high cap rate does not signal a straightforward bargain; it signals that the market is pricing in execution uncertainty. Investors who read a high cap rate as automatic value without accounting for renovation costs, lease-up timelines, and management complexity are likely to be disappointed.
What replaces the single number? Gotcher advocates pro forma analysis, projecting income and expenses after stabilization and evaluating the purchase price against that future income stream. This requires judgment about rent growth, lease-up timelines, and capital expenditures—variables that demand local market knowledge. That complexity is precisely why cap rates persist: they require no assumptions about future performance. Pro forma analysis rewards investors who know what rents a neighborhood can support and what improvements actually cost. “A lot of investors don’t understand that some of these, especially if they’re looking for a value-add property, that value-add properties you can’t just use cap rate,” Gotcher says.
The market consequence is a bifurcated landscape. A smaller pool of investors who model cash flow projections competes for value-add assets, while the larger cap-rate-focused pool concentrates on stabilized properties, bidding up prices. In Ann Arbor, turnkey properties trade at cap rates as low as 2 to 5 percent, according to Gotcher, so compressed that financed buyers lose money for the first couple of years. Meanwhile, adjacent markets like Ypsilanti offer positive cash flow immediately on financed purchases because properties are less polished and require active management. Investors willing to do that work face less competition and buy at lower prices relative to income potential.
For buyers evaluating commercial real estate in Southeast Michigan, the practical question is whether a property's current income represents its ceiling or its floor. Cap rate answers that question only for properties already operating at full potential. For everything else—the under-rented, the partially occupied, the mismanaged—it obscures the answer rather than revealing it. As Gotcher's nearly four decades in the market show, the most profitable deals may be the ones that cap rates hide.
