The Rent Gap That’s Quietly Affecting San Diego Apartment Values
How rent gaps, tenant protections, and higher interest rates are changing the way buyers underwrite apartment deals.
By Nick Hernandez ·
When I start evaluating an apartment building, the first thing I spend time studying is the rent roll.
Not just the total income, but how each unit compares to the market.
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One pattern that comes up fairly often when reviewing rent rolls in San Diego is this:
A lot of buildings are fully occupied, have long term tenants, and appear to be performing well operationally.
But once the numbers are laid out, it becomes clear that rents have slowly drifted well below market.
Sometimes the gap is modest.
Other times it’s significant.
And it usually didn’t happen overnight.
More often it builds gradually over time. Tenants stay longer than expected. Rent increases remain conservative. Units that do turn are priced to lease quickly rather than pushed aggressively toward the top of the market.
None of that necessarily means the property is being run poorly.
Many of these buildings are stable, well maintained, and have produced reliable income for years.
But the market environment today is making that rent gap more consequential than it used to be.
For a long time, buyers viewed under market rents as one of the most attractive aspects of an apartment deal.
If rents were a few hundred dollars below market, the buyer could gradually bring them up over time. As the building’s income increased, so did the value of the property.
In a lower interest rate environment, lenders were also more comfortable underwriting some of that future growth.
Because of that dynamic, buildings with large rent gaps often attracted strong interest.
The upside was part of the story buyers were paying for.
That equation has shifted over the past few years.
Interest rates are higher than they were for most of the last decade. Debt service coverage requirements have become more important. Lenders are placing much greater emphasis on the income a property produces today.
At the same time, California’s rent regulations and tenant protections have changed the timeline for repositioning some buildings.
If a tenant has been in place for many years and their rent is significantly below market, there may be very little incentive for them to leave.
Annual increases are limited, which means closing a large rent gap while that tenant remains in place can take time.
When buyers evaluate deals today, that uncertainty often shows up in the underwriting.
The future upside may still exist.
But it is often discounted more heavily than it was in the past.
What I have noticed in a number of recent transactions is that buyers are anchoring their analysis much more closely to existing income.
If the rents are already near market, the underwriting tends to be straightforward.
If rents are substantially below market but the path to raising them is uncertain, the buyer often treats that upside cautiously.
In practical terms, that means two buildings that look very similar on the surface can trade at noticeably different valuations depending on how close their rents are to the market.
Stable occupancy is generally a good thing. But when rents fall far below market, that stability can come with a tradeoff. The income gap begins to show up directly in how the property is valued.
Where do your rents actually sit relative to the market?
And if the property were evaluated today, how would a buyer or lender interpret the income it currently produces?
In San Diego’s apartment market, relatively small differences in rent levels can translate into surprisingly large differences in value.
Understanding where your property sits on that spectrum can be useful whether the plan is to hold long term or eventually consider selling.
Because in many cases, the rent roll ends up telling the real story.
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