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Cap Rates Are Misleading Most Commercial Real Estate Buyers in Southeast Michigan
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Date:
28 Jul 2026
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A single number has dominated commercial real estate analysis for decades: the capitalization rate. Calculated by dividing a property’s net operating income by its purchase price, cap rate promises to make dissimilar assets comparable at a glance. But in southeast Michigan, where value-add apartment complexes and under-rented properties make up a large share of available inventory, that shorthand is steering buyers away from strong deals, according to Larry Gotcher, a real estate professional at Resource Realty Group with nearly 40 years of experience and roughly 7,500 transactions closed.
Gotcher has removed cap rates from his marketing materials entirely. His reasoning: cap rates are calculated on current income, which means they systematically misrepresent the value of any property where current performance diverges from future potential. “95% of the buyers were just looking at the cap rate, and then they don’t look any further,” Gotcher says.
The Backward-Looking Problem
Cap rate reflects what a property is doing today – not what it could do under different ownership. For value-add properties, where the investment thesis depends 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. The property currently has 10 of 50 spaces occupied and loses money every month. A cap rate calculation on current income would produce a meaningless number. But his pro forma projects a stabilized NOI of $500,000 annually once the property is 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.”
For stabilized, fully occupied assets with market-rate leases, cap rates provide a reasonable basis for comparison. The distortion appears when investors apply the same metric across the full spectrum of asset types, treating a value-add opportunity with below-market rents and deferred maintenance as directly comparable to a turnkey property with long-term leases in place.
Under-Rented Properties
Gotcher identifies under-rented properties as a particularly common source of cap rate distortion. Many commercial properties carry rents significantly below current market rates, either because of long-term leases signed years ago, passive management, or owner neglect. A cap rate calculated on those below-market rents will appear low, signaling to a cap-rate-focused buyer 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 already dismissed, often at prices that reflect current – not potential – income.
Gotcher also notes that the relationship between cap rates and asset quality runs in a counterintuitive direction for value-add buyers. “Your cap rate is going to be much higher if you buy a value-add property,” he says. “People are willing to give a further discount for a property that’s in rough shape.” A high cap rate on a distressed asset does not signal a straightforward bargain; it signals that the market is pricing in risk and 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’s alternative is pro forma analysis, projecting what a property’s income and expenses will look like after stabilization, then evaluating the purchase price against that future income stream rather than today’s. This requires judgment calls about rent growth, lease-up timelines, and capital expenditure, variables that introduce uncertainty and demand local market knowledge to assess credibly.
That additional complexity is precisely why cap rates persist as the dominant screening tool: they require no assumptions about future performance and no familiarity with a specific submarket’s rent trajectory. Pro forma analysis, by contrast, rewards investors who know what rents a given neighborhood can support, how long vacancy typically takes to fill, and what capital improvements actually cost in that market.
“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
If Gotcher’s assessment is accurate, that the large majority of buyers filter deals through cap rates without deeper analysis, the result is a bifurcated market. A smaller pool of investors who model cash flow projections competes for value-add assets, while the larger pool of cap-rate-focused buyers concentrates on stabilized, turnkey properties and bids those prices higher. Turnkey properties in Ann Arbor, for example, trade at cap rates as low as two to five percent, according to Gotcher, prices so compressed that any buyer using financing will lose money for the first couple of years.
Meanwhile, adjacent markets like Ypsilanti offer positive cash flow immediately on financed purchases, precisely because the properties there are less polished and require more active management. The 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 given 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.
About the Expert: Larry Gotcher is a real estate professional at Resource Realty Group, operating in southeast Michigan with nearly 40 years of experience.
About Resource Realty Group: Resource Realty Group is a full-service commercial and residential brokerage headquartered in Ann Arbor, Michigan. Led by Owner and Broker Larry Gotcher, the firm works with a ten-person team and operates a real estate investment trust focused on income-producing real estate in Michigan and select markets. Learn more at resourcerealtygroupmi.com.
Disclosure: Individuals or companies mentioned may have a commercial relationship with KeyCrew.
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