Zoning

Zoning is the set of local rules that controls what can be built on a lot and how it can be used: residential, commercial, industrial or mixed, plus limits on height, density and parking. It sets the legal ceiling on a property's income and so on the NOI behind its cap rate.

A duplex in a single-family zone may be a legal nonconforming use that can continue but, in many places, cannot be rebuilt as a duplex after major damage. An extra unit without permits may produce rent that a lender or appraiser will not count. Both situations make the reported NOI less reliable than the cap rate suggests.

Zoning also creates value. A lot that allows more units than it currently has may be worth more to a developer than its rental income implies. That is the highest and best use question, and it is answered by the zoning code, not the rent roll.