Why Cap Rates Mislead Value-Add Investors: A Southeast Michigan Expert's Take

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.