Overview
San Diego’s real estate market is known for its resilience, and despite high interest rates, the multifamily sector continues to defy national trends with persistently low cap rates. As of February 2025, San Diego Multifamily has a median sold cap rate of just 4.3%, notably lower than the 6.1% Multifamily national average.
However, recent trends suggest a softening in prices within the San Diego multifamily market. In the past six months, most sales comparables indicate the final sold cap rates have generally been higher than the initial asking cap rates (according to Crexi) indicating that sellers are having to adjust their expectations to align with buyer demand, signaling a potential shift in the market.
Why Are Cap Rates So Compressed in San Diego?
Despite the recent softening, San Diego still experiences relatively low cap rates due to several key factors:
1. Strong Economic Status
- Robust Job Market: San Diego’s economy is anchored by high-growth industries such as tech, biotech, and defense. This strong employment base supports a high demand for housing.
- Income Growth: Area median income (AMI) in San Diego reached $119,500 in 2024, reflecting a 38.5% increase since 2019. Higher incomes contribute to rising rents and property values.
- Population Growth: The city has experienced a 10% population increase since 2010, driving demand for both residential and commercial properties.
2. Limited Supply & High Demand
- Geographic Constraints: Limited land availability due to coastal and topographical constraints keeps housing supply tight.
- Housing Shortage: It is estimated that San Diego needs to build 108,036 new homes to meet its Regional Housing Needs Assessment (RHNA) targets for the 2021–2029 period, but development is hindered by zoning restrictions and high construction costs.
- Low Vacancy Rates: While national vacancy rates average 7.7%, San Diego’s vacancy rate is just 4.9%.
3. Institutional Investment
- Institutional Capital: Investors like Blackstone have poured over $1B into San Diego’s multifamily market over the past five years.
- Stability & Long-Term Appreciation: Institutional investors are attracted to San Diego’s stability and long-term capital appreciation potential, which compresses cap rates.
- Impact on Smaller Deals: While institutional capital focuses on 100+ unit properties, smaller 2-50 unit properties experience less competition from these large buyers, creating unique opportunities for private client and sub-institutional investors.
4. Interest Rate Dynamics
- Cap Rate vs. Treasury Spreads: The spread between San Diego’s cap rate and U.S. Treasury yields is narrowing, highlighting investor confidence in the market’s long-term potential.
- Cap Rate Stickiness: Despite national trends of rising cap rates, San Diego's market remains resilient due to investor confidence in long-term appreciation and rent growth.
- Softening Prices: Recent transactions indicate that final sold cap rates are generally higher than initial asking cap rates, especially in the 2-50 unit range. This reflects a softening in pricing and suggests that sellers are becoming more flexible with valuations.
Implications for Investors
Opportunities
- Appreciation Potential: Investors can capitalize on San Diego’s ongoing price appreciation driven by supply constraints and high demand.
- Stable Income Streams: Low vacancy rates and consistent rent growth provide stable income, even amid economic volatility.
- Reduced Volatility: The market’s stability and consistent investor demand help insulate property values from broader economic fluctuations.
Challenges
- High Entry Costs: Investors are having to come in with more upfront capital in order for deals to debt-service. With High Yield Savings Account's averaging a 4% return, a lot of investors have been enjoying the liquidity and stable returns.
- Lower Initial Yields: With compressed cap rates, it's important for investors to focus on long-term appreciation and rent growth to achieve enticing returns.
- Regulatory Risks: Changes in zoning laws, rent control policies, or property tax regulations could affect rental income and property values, potentially offsetting gains from appreciation.
- Softening Prices & Adjusting Expectations: The softening in cap rates means that buyers are gaining leverage, and sellers must adjust expectations accordingly.
What Should Investors Do Now?
- Focus on Value-Creation Opportunities
- Investors should target underutilized or outdated properties where renovations or ADU development can increase rental income and property value. With the recent softening in prices, this approach allows for higher yield potential while benefiting from long-term appreciation.
- Capitalize on Less Competition
- With many investors sitting on the sidelines due to the current environment, savvy buyers have a unique opportunity to acquire properties positioned for long-term growth at more favorable terms. Additionally, the softening in prices provides room for strategic negotiation.
- Look for Emerging Submarkets
- Consider neighborhoods with growth potential where cap rates are slightly higher but appreciation potential remains strong. These areas are also seeing the effects of softening prices, creating more entry points for investors.
- Analyze Your Equity Position
- Now is also a great time for investors to evaluate how their equity is performing in existing properties. Understanding whether your equity is working efficiently or if it could be better utilized in a higher-performing asset is key. With prices softening, investors have more opportunities to reposition their equity for better returns.
Conclusion
San Diego’s persistently low cap rates reflect the market’s unique fundamentals—strong economic growth, high demand, and limited supply. However, the recent softening in prices presents a strategic opportunity for private client and sub-institutional investors. Investors who act strategically can secure high-potential assets at more favorable terms.
While large investors focus on 100+ unit properties, they often overlook smaller multifamily deals. This creates a unique opportunity for sub-institutional investors to acquire 2-50 unit properties with less institutional competition and higher upside. By targeting these smaller assets, investors can capitalize on the same appreciation trends while benefiting from higher yield potential and value-creation opportunities.
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References:
- City of San Diego "City of SD General Plan Housing Element 2021-2029"
- San Diego County "San Diego Income Limits"
- Motley Fool "CRE Capitalization Rates"
- Kidder Matthews "San Diego Multifamily Market Reports"
- Freddie Mac "Multifamily Market Report"
- CapRateIndex, “Cap Rate in San Diego CA”
