How Do Interest Rates Change What My Building Is Worth in San Diego?

Interest Rates Move Value Through the Cap Rate, Not the Rent Roll

When interest rates rise, your building's value falls because the cap rate investors require to clear their return hurdle expands. Cap rates and interest rates move together because most buyers use debt, and debt is priced off Treasuries. If the five-year Treasury sits at 4.2% and a buyer pays 225 basis points over that for a loan, all-in debt costs land near 6.45%. The investor needs equity returns in the mid-teens to justify the risk, which means the going-in cap rate for a stabilized office building in a submarket like Carmel Valley (92130) moves from 5.5% in 2021 to 6.75% today. Same net operating income, wider cap rate, lower price.

I cover all of Southern California, but San Diego illustrates the mechanic cleanly because the region's wealth-tier stratification creates distinct cap rate bands. Ultra-high-wealth office markets like Rancho Santa Fe (92067) and La Jolla (92037) compress less than secondary submarkets because institutional capital and family offices still compete for scarce, credit-quality product. A medical office building in Rancho Santa Fe with 6% vacancy and a roster of investment-grade health systems might trade at a 5.8% cap today, 50 basis points wider than 2021 but still tight by market standards. The same building in a spillover submarket with higher vacancy and shorter lease terms might require a 7.5% cap to clear, and that spread is the difference between a $15 million valuation and a $11.5 million valuation on the same $900,000 NOI.

The formula is simple: value equals net operating income divided by cap rate. When rates climb and cap rates follow, the denominator grows and value shrinks. Sellers who anchored to 2021 pricing are discovering that the market moved, and the move was structural, not sentiment.

Debt Costs Directly Reshape the Buyer Universe

Higher interest rates don't just compress values. They narrow the buyer pool because levered returns stop working at a certain debt price. A buyer using 65% leverage at 6.5% all-in debt on a 6.75% cap rate office building in University City (92122) generates minimal positive leverage, meaning equity returns barely exceed what the investor could earn in safer asset classes. If that same building requires $3 million in capital to backfill vacancy or renew leases, the effective cap rate drops and the deal moves underwater on a levered basis.

BridgeInvest's $87.9 million acquisition loan for a 152,000-square-foot R&D property in San Francisco shows that construction and credit quality still command aggressive financing, but the asset is a 2023 build in a core life-science submarket, and that profile is the exception. Most office product in San Diego was built before 2015, carries deferred capital, and doesn't fit the narrow credit box lenders are underwriting today. When debt dries up, all-cash buyers take over, and all-cash buyers demand higher returns, which means wider cap rates and lower prices.

Industrial and flex/R&D assets in submarkets like Carlsbad (92008) and Sorrento Valley (92121) hold value better because vacancy is tighter, tenant demand is structural (life science, advanced manufacturing, last-mile logistics), and lenders still lend aggressively on the product type. Sagard Real Estate's acquisition of a fully leased 133,750-square-foot industrial property near Seattle reflects continued institutional appetite for stabilized industrial assets, and that same dynamic is playing out in San Diego's coastal industrial markets where supply is constrained and tenant demand is diversified.

Our complete investment sales and valuation guide walks through how different property types are underwritten in rising-rate environments, and the divergence between office and industrial cap rates is the widest it has been in a decade.

The Cap Rate Stack Reflects More Than Just Debt Costs

Cap rates are not just debt costs plus a spread. They reflect replacement cost, supply dynamics, tenant credit, lease structure, and capital requirements. In submarkets like La Jolla (92037) with 10% office vacancy and strong life-science and professional-services tenant rosters, replacement cost for new Class A office construction exceeds $600 per square foot, which creates a pricing floor for existing stabilized product. When new construction stops because debt is expensive and replacement cost is prohibitive, existing buildings in low-vacancy submarkets hold value because there is no new supply coming.

Downtown San Diego (92101) operates under different math. Office vacancy sits at 22%, which means tenant demand is weak and landlords are competing on concessions and rate. A buyer underwriting a 100,000-square-foot office building downtown has to model lease-up risk, rollover risk, and capital to retain tenants, which pushes the going-in cap rate north of 8% for anything that is not stabilized with long-term credit leases. The cap rate spread between La Jolla and Downtown San Diego is 200 to 250 basis points on comparable-quality buildings, and interest rates widened that spread by making capital expensive and buyers more risk-averse.

Flex/R&D product in Torrey Pines and University City benefits from life-science tenant demand and below-market rents in buildings that were originally designed for tech or traditional office use. A 50,000-square-foot flex building in University City (92122) with 14% office vacancy but strong R&D conversion potential might trade at a 6.5% cap because the buyer is underwriting future repositioning value, not current in-place cash flow. That kind of value-add play still pencils when the buyer can secure debt in the low-6% range and project stabilized yields in the high-7% range post-repositioning, but the margin for error is thin and the capital requirement is real.

Check out our region-specific wealth hotspot mapping to see where tenant demand and investor appetite are concentrated in San Diego's highest-income submarkets.

How Buyers Are Adjusting Underwriting Models Right Now

Buyers are pricing more conservatively across every assumption. Exit cap rates in underwriting models have moved 75 to 100 basis points wider than going-in caps, reflecting the expectation that rate normalization will be slow and that higher cap rates are durable, not cyclical. A buyer acquiring a Carmel Valley office building at a 6.5% cap today is modeling a 7.25% to 7.5% exit cap in five years, which compresses residual value and forces the deal to pencil on cash flow rather than appreciation.

Rent growth assumptions have flattened. Where buyers once modeled 3% annual rent growth across a hold period, most are now using 1.5% to 2% for office and 2.5% to 3% for industrial and flex/R&D, with the first 18 months flat to account for lease-up and repositioning timelines. Lower rent growth plus wider exit caps means deals need to work on current yield, and current yield is a function of the cap rate you pay going in.

Debt is being underwritten at 60 to 65% loan-to-value for stabilized office, down from 70 to 75% in prior cycles, and lenders are requiring debt service coverage ratios of 1.30x to 1.35x instead of 1.20x to 1.25x. That means buyers need more equity, and more equity means higher required returns, which widens cap rates and compresses what buyers can pay. Industrial and flex/R&D assets are still getting 65 to 70% LTV from life companies and CMBS lenders, but only if the tenant roster is investment-grade or the property is single-tenant to a credit user on a long-term absolute net lease.

Our investment sales process page outlines how we position assets to maximize buyer appetite and debt execution in the current environment, particularly for buildings that require capital or carry lease rollover in the near term.

Office, Industrial, and Flex/R&D Are Pricing on Completely Different Curves

Office buildings in high-vacancy submarkets are pricing at replacement-cost discounts of 40 to 50%, meaning a building that would cost $60 million to rebuild is trading at $32 million because cash flow is weak and the path to stabilization is uncertain. That dynamic is most pronounced in Downtown San Diego, where a 150,000-square-foot office tower with 30% occupancy might trade at $200 per square foot when replacement cost is $550 per square foot. Buyers are paying for the land and the option value of future conversion or repositioning, not the current income stream.

Industrial assets in Carlsbad and Sorrento Valley are trading at or near replacement cost because supply is constrained, vacancy is below 6%, and tenant demand from life science, logistics, and advanced manufacturing is structural. A 100,000-square-foot industrial building in Carlsbad (92008) with 5% vacancy and a tenant mix of biotech and precision manufacturing might trade at a 5.25% cap, which is tight by today's standards but reflects the scarcity of product and the durability of cash flow.

Flex/R&D product in La Jolla and Torrey Pines is pricing between office and industrial, with cap rates in the 6% to 6.75% range depending on tenant quality and capital requirements. A 75,000-square-foot flex building in Torrey Pines with 50% life-science tenancy and 50% traditional office tenancy might trade at a 6.25% cap because the buyer is underwriting tenant rollover risk but benefits from strong submarket fundamentals and limited new supply. The cash flow is more durable than pure office, and the capital requirement is lower than full repositioning, which makes the risk-adjusted return attractive even at higher debt costs.

This analysis connects to broader questions about when to sell commercial property in Southern California markets, and the answer increasingly depends on whether your building fits the profile buyers can finance and underwrite confidently.

What This Means for Sellers in San Diego Right Now

If you own a stabilized office building in Rancho Santa Fe or La Jolla with below-market vacancy and credit tenants on multi-year leases, your valuation has compressed 10 to 15% from peak pricing, but the asset is still financeable and the buyer pool is active. Institutional groups, family offices, and local high-net-worth buyers are still competing for scarcity product in ultra-high-wealth submarkets, and that competition keeps cap rates from blowing out completely.

If you own an office building in Downtown San Diego or a secondary submarket with above-market vacancy or near-term lease rollover, your valuation has compressed 25 to 35% because buyers are modeling repositioning risk and lenders are requiring larger equity checks. The market for those assets is narrower, timelines are longer, and pricing is a function of replacement cost and land value rather than income capitalization.

Industrial and flex/R&D assets are holding value better across all submarkets because fundamentals are strong and debt is still available. If you own a single-tenant industrial building in Carlsbad leased to an investment-grade life-science tenant on a 10-year absolute net lease, your building is worth more today than it was 18 months ago because cap rates have barely moved and rent growth has been positive. That kind of product is scarce, and scarcity drives value even when rates are high.

Our guide to how commercial buildings are valued in underwriting breaks down the mechanics of cap rate selection, rent-growth assumptions, and debt structuring across property types and submarkets.

The Path Forward Depends on Your Product Type and Timeline

Interest rates are not coming back to 2021 levels in the near term, which means cap rates are staying wider and valuations are staying compressed. Sellers who need to transact should price to today's cost of capital, not last cycle's pricing, because buyers are underwriting deals on current debt costs and current return requirements. Waiting for rates to fall might take years, and years of holding costs and deferred capital erode value faster than modest cap rate compression gains it back.

Buyers are active, but they are selective. Office buildings that require capital or carry lease rollover are pricing at deep discounts, while industrial and flex/R&D assets in low-vacancy submarkets are trading close to replacement cost. The spread between best-in-class product and everything else has never been wider, and that spread is the direct result of debt costs, capital availability, and buyer risk appetite.

If you are considering a sale, start with a clear understanding of where your building sits in the cap rate stack, what debt is available, and which buyers can underwrite your asset at current pricing. A broker opinion of value is the fastest way to get that clarity, and the analysis is tailored to your specific submarket and product type.

Reach out through the inquiry form if you want to walk through what your building is worth in today's rate environment and how to position it for the best execution.