Multifamily Interest & Cap Rates

When Interest Rates Exceed Cap Rates: A 2025 Playbook for Multifamily Investors | Multifamily Wealth Nation

Multifamily Wealth Nation

In today’s shifting multifamily real estate market, one of the biggest structural risks and opportunities lies in the relationship between interest rates and cap rates. As rates climb, many investors are asking: What happens if interest rates move above cap rates? And more importantly, can such deals still work?

Below is a fresh, data-driven take (2025) on this dynamic, and a guide for how to think about multifamily investing in such an environment.

Key Concepts: Cap Rate vs. Interest Rate

Cap Rate (Capitalization Rate)
This is the ratio of Net Operating Income (NOI) to the property’s current value. It represents the yield you expect from the property’s income stream:

$$\text{Cap Rate} = \frac{\text{NOI}}{\text{Value}}$$

For example: if a multifamily asset generates $200,000 NOI and is valued at $4,000,000, its cap rate is 5%.

Interest Rate (Cost of Debt)
This is the borrowing cost on financing the acquisition (or refinancing) of the property. In multifamily deals, interest rates can vary depending on the product (Fannie/Freddie, bridge, life company, etc.).
As of 2025, representative multifamily interest rates (for quality deals) generally range from ~5.6% to over 9.2%, depending on property class, LTV, sponsor experience, and market. Commercial Loan Direct

When the interest cost (on your debt) exceeds the cap rate (expected yield on the property), you enter a zone where your income doesn’t cover debt service fully, making the deal “negative leverage” or even requiring subsidy. That’s a risky zone.

Market Context in 2025

It’s important to ground strategy in what’s actually happening now. Here’s a snapshot of current trends:

• According to CBRE’s H1 2025 Cap Rate Survey, cap rates across property types slightly declined by ~9 bps on average, despite volatility in Treasury yields. CBRE+1

• In Q2 2025, metrics suggest core cap rates compressed to ~4.75%, while value-add cap rates dropped to ~5.20% as investor optimism returned for repositioning plays. CRE Daily

• More broadly, multifamily performance in 2025 is resilient: as of 2Q, multifamily continues to outperform many other commercial sectors, and negative leverage deals are starting to fade as underwriting improves. Newmark

• Many market observers believe cap rates may have peaked or stalled and could begin modest compression in late 2025, with some forecasting a fall from ~5.7% toward ~5.2% by year-end. First American Blog+2Yield PRO+2

• Meanwhile, interest rates remain elevated and uncertain, putting pressure on valuations, particularly in markets with abundant new supply and softer rent growth. Freddie Mac Multifamily+1

• The multifamily outlook from Freddie Mac anticipates positive rent growth in 2025 (though below long-term average), with vacancy creeping upward, flat cap rates, and pressures from higher cost of capital. Freddie Mac Multifamily

Bottom line: In many cases, interest rates still exceed going-in cap rates (especially for core, stabilized assets in stronger markets). That raises the question: can deals still work? Short answer: yes—but only with more nuance, better underwriting, and creative execution.

Why a Deal That Doesn’t Cash Flow May Still Be Viable

If your deal is in negative leverage territory, it doesn’t automatically mean it’s a bad deal. Here are the levers and strategies that can make it work (or not):

1. Total Return (Appreciation & Exit Valuation)
   Even if current cash flow is weak or negative, gains may come via property appreciation and multiple expansion (or compression). If the market cap rate compresses by even 0.5% over your hold period, that can generate significant upside.

2. Tax Benefits & Deferrals

   • Depreciation, interest deductions, and expense write-offs can shelter income and offset negative cash flow from a taxable standpoint.

   • Cost segregation, bonus depreciation (where still allowed), and 1031 exchange strategies may further enhance returns.

3. Leverage & Capital Structure Engineering

   • Larger equity contributions reduce debt service burden (i.e. lower leverage means less negative spread).

   • Mezzanine, preferred equity, or layered financing can shift risk and cash flows in creative ways.

   • Refinance and recap strategies: if you can refinance later at better rates or higher values, you might convert negative leverage into positive cash flow.

4. Operational Upside / Value-Add Execution
   A deal with upside via repositioning, rent growth, expense reductions, or repositioning vacant or underutilized space may close the gap between interest cost and income.

5. Underwriting Stress & Exit Sensitivity
   Build conservative stress tests — e.g. interest rates rising further, rent growth stalling, cap rate expansion — and understand your downside scenario.

6. Market & Property Selection

   • In strong, supply-constrained markets, cap rates may hold firm or compress, supporting your exit.

   • Premium or niche assets (luxury, urban infill) may justify lower cap rates due to competitive advantage.

Historical & Long-Term Context (Revisited with 2025 Lens)

While long-term historical cap rate data is noisy and market-specific, your experience + some benchmarks can anchor expectations:

• Over your 20+ years, you’ve observed cap rates for multifamily generally ranging from ~5% to ~8%. That is consistent with modern trends when normalized across cycles.

• In the early 1980s, high interest rates pushed cap rates into the 8–10% zone. In contrast, cap rates compressed below 4% around 2021–2022 in many highly competitive markets.

• From 2022 to mid-2024, multifamily cap rates rose by ~100–125 basis points in many markets (for example, First American notes cap rates rising from ~4.5% to ~5.75%) First American Blog

• That shift resulted in property valuations falling 15–25% (depending on NOI stability) as investors required higher yields.

• Some recent reporting suggests we may now be in a plateau or mild compression phase—i.e., we may have “marked the bottom” of cap rate expansion. First American Blog+2CBRE+2

The takeaway: cycles are real, and while we may be emerging from one phase, risk remains. You must assume interest rate risk, cap rate risk, and execution risk simultaneously.

Strategic Outlook: Two Possible Scenarios

Given the current conditions, I see two plausible outlooks:

1. Paradigm Shift
   Many deals may require negative leverage up front, especially in strong markets with compressed cap rates. Investors might lean more heavily on appreciation, tax strategies, operational execution, and creative financing to generate returns—i.e., cash flow becomes secondary to capital growth.

2. Near-Term Price Correction
   The market may undergo a downward repricing, particularly for over-leveraged or over-priced assets, as investors re-assess risk, insurance and operating cost inflation persist, and interest rates fail to come down soon. In that case, property values may decline, creating buying opportunities for capital-rich investors.

My view: It’s more likely we see price compression downward before we see a meaningful drop in interest rates (given persistent inflation and Fed policy). Even if rates ease later, the path down for pricing may be sharper and faster.

In short: High leverage plus stagnant rents plus rising costs equals risk. If you invest, you’d better bring strong underwriting, operating prowess, and flexibility.

How to Evaluate and Compete in 2025 (Advice for Investors & Sponsors)

Here’s how to think smartly in this environment:

• Focus on robust stress underwriting (NOI sensitivity, vacancy, rent growth, exit cap rate scenarios)

• Prioritize value-add deals with realistic upside rather than betting on pure compression

• Use debt structures wisely (pref equity, mezz, lender options) to avoid drowning on negative leverage deals

• Be selective on markets — look for supply-constrained or growing submarkets (Sun Belt, secondary cities with positive fundamentals)

• Monitor macro trends: inflation, Fed policy, credit availability, construction costs

• Keep contingency capital for surprises (insurance, capital expenditures, tenant turnover)

• Think exit first: if your exit cap rate holds or compresses modestly, that might carry your return even if cash flow is weak early

When interest rates exceed cap rates, the margin for error is thin—but that doesn’t mean opportunities vanish. Successful investors will be those who:

• Underwrite conservatively

• Take operational risk where others won’t

• Choose markets intelligently

• Use tax, financing, and exit strategies creatively

• Have capital reserves and flexibility

At Multifamily Wealth Nation, we combine deep hands-on multifamily experience with data-driven analysis and flexible structuring to help investors thrive even in challenging environments.

If you’d like help stress-testing your next deal, constructing a resilient model, or exploring debt structuring options, reach out. Let’s build multifamily wealth the smart way.