The relationship between interest rates and apartment values has dramatically reshaped the LA multifamily market. Understanding this connection is essential for owners considering a sale or refinance.

Understanding the Shift

If you’ve owned an apartment building in Los Angeles over the past few years, the relationship between interest rates and apartment values has never been clearer. You’ve experienced one of the most significant interest rate environments in decades. After years of historically low rates, the Federal Reserve raised rates aggressively starting in 2022 to combat inflation.

These changes have had real consequences for apartment building owners—affecting values, refinancing options, and investment returns. Let’s break down what happened and what it means for you.

The Connection Between Interest Rates and Cap Rates

Why They Move Together

Cap rates and interest rates are closely linked because real estate competes with other investments for capital:

• When Treasury yields rise, investors demand higher returns from real estate
• Higher required returns mean higher cap rates
• Higher cap rates mean lower property values (for the same NOI)

This relationship isn’t perfect or immediate, but over time, cap rates tend to follow interest rate trends.

The Math in Action

Consider a building with $200,000 NOI:

• At a 4.5% cap rate (2021 environment): Value = $4,444,444
• At a 5.5% cap rate (2024 environment): Value = $3,636,364
• Difference: $808,080 (18% decline)

The building didn’t change. The income didn’t change. But the value shifted significantly based on how buyers price risk and return.

What Happened in the LA Market

The 2020-2021 Environment

During the low-rate era:

• Cap rates compressed to historic lows (4-5% for quality assets)
• Buyers could finance at 3-4% interest rates
• Positive leverage was easy (debt cheaper than cap rate)
• Values reached record highs
• Many owners refinanced and pulled out equity

The 2022-2024 Shift

As rates rose:

• Financing costs jumped to 6-7%+
• Cap rates expanded by 75-150+ basis points
• Transaction volume dropped significantly
• Price discovery became difficult
• Many planned refinances became unworkable

The Refinancing Challenge

Why Some Owners Are Stuck

Owners who purchased or refinanced in 2020-2022 face a difficult situation:

• Lower property values: Appraisals come in below purchase price
• Higher rates: New loans cost significantly more
• LTV constraints: Can’t pull out as much equity (or any)
• Cash flow squeeze: Higher debt service eats into returns

Example Scenario

2021 Purchase:

• Price: $4,000,000
• Loan: $2,800,000 (70% LTV) at 3.5%
• Annual debt service: ~$151,000
• NOI: $180,000
• Cash flow: $29,000

2024 Refinance Attempt:

• Current value: $3,400,000 (cap rate expansion)
• Max loan at 65% LTV: $2,210,000
• Would need to bring $590,000 to refinance
• New rate: 6.5%
• New debt service on $2.2M: ~$167,000
• Cash flow: $13,000

The owner can’t refinance without bringing significant cash, and even then, cash flow is worse.

The COVID Rent Freeze Impact

A Perfect Storm

LA apartment owners faced a double challenge:

• 2020-2021: Rent increases frozen or severely limited during COVID
• 2022-2024: Interest rates rose sharply

This meant:

• Income couldn’t grow to offset rising expenses
• NOI was compressed from both sides
• Owners who counted on rent growth to improve returns were disappointed

Ongoing RSO Limitations

Even after COVID restrictions ended, LA’s rent control limits annual increases. The new 90% of CPI formula (max 4%) means income growth remains constrained while expenses—including insurance and property taxes—continue rising.

Negative Leverage Explained

What It Means

Negative leverage occurs when your cost of debt exceeds your property’s cap rate:

• Example: 5% cap rate property with 7% debt
• Every dollar of debt reduces your return
• More leverage = worse returns (opposite of normal)

Why It Matters

In a negative leverage environment:

• All-cash buyers have an advantage
• Highly leveraged buyers struggle to compete
• Returns are compressed across the board
• Some deals simply don’t work with debt

What This Means for Different Owners

Long-Term Holders with Low Debt

If you bought years ago with a low-rate fixed loan:

• Your cash flow is protected
• Paper value may have declined, but you’re not forced to sell
• Time is on your side

Recent Buyers with Floating Rate Debt

This is the most challenging position:

• Debt service has increased significantly
• Cash flow may be negative
• Refinancing options are limited
• May need to contribute capital or consider selling

Owners Considering Selling

The market has adjusted:

• Buyer expectations have reset to current rates
• Well-priced properties still trade
• 1031 exchange buyers remain active
• Quality assets in good locations hold value better

Looking Forward

Rate Expectations

While no one can predict rates with certainty:

• The Fed has signaled potential rate cuts
• Inflation has moderated from peaks
• Long-term rates may stabilize or decline modestly

Market Adaptation

The market is adjusting:

• Buyers have recalibrated expectations
• Sellers are becoming more realistic on pricing
• Transaction volume is slowly recovering
• New equilibrium is forming

Strategies for Current Owners

1. Focus on What You Control

• Maximize income within RSO limits
• Control operating expenses
• Maintain the property to preserve value
• Keep good tenant relationships to minimize turnover costs

2. Review Your Debt

• Understand your loan terms and maturity
• Plan ahead for refinancing needs
• Consider locking in rates if you have floating debt
• Build reserves for potential capital calls

3. Take a Long View

• Real estate is cyclical
• LA fundamentals remain strong (jobs, population, limited supply)
• Well-located properties will recover value over time
• Don’t make panic decisions based on short-term conditions

Quick FAQs

Q: Should I sell now before values drop more?
A: Values have already adjusted significantly. Whether to sell depends on your specific situation, not market timing. If the property still cash flows and you don’t need to refinance, holding may be the right choice.

Q: When will values recover?
A: No one knows for certain. Recovery depends on interest rates, rent growth, and broader economic conditions. Focus on your property’s fundamentals rather than timing the market.

Q: Is now a good time to buy?
A: For well-capitalized buyers, the current market offers opportunities. Less competition, more realistic seller expectations, and the potential for rate relief make this an interesting entry point for patient investors.

Have questions about how the current environment affects your property? Request a valuation and let’s discuss your situation.

How interest rates affect apartment values will continue to be a key factor in the LA market. Contact me for a current valuation that accounts for today’s interest rate environment.