An analysis of how the Federal Reserve's rate hikes have impacted Los Angeles apartment building valuations and what sellers should expect.
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.
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
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
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
While no one can predict rates with certainty, the Fed has signaled potential rate cuts, inflation has moderated from peaks, and long-term rates may stabilize or decline modestly.
The market is adjusting—buyers have recalibrated expectations, sellers are becoming more realistic on pricing, transaction volume is slowly recovering, and a 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