Rent growth is good news for investors and developers, but extreme rent growth causes compressed cap rates and drives up prices—and it limits opportunities for investment. This is a trend that has grown in Los Angeles, where rent growth is expected to be in triple digits through 2019. Investors have been paying all-time low cap rates in Los Angeles that range anywhere from sub 4% to a .7% cap rate for a recent multifamily trade in Venice.

“Rent growth should be driving down cap rates,” Richard Green, USC Lusk Center Director, tells GlobeSt.com. “It creates an opportunity for growth that produces lower cap rates and higher valuations. The fundamentals explain the low cap rate environment, but the scary thing is that cap rates can change. If a cap rate moves from 4% to 5%, that is a 20% difference in value immediately. The thing that is a little nerve racking is that you need a small change in cap rates to get a big change in value.”

Despite the high prices, developers can still make a strong profit in California, mainly because it is a notoriously difficult place to build. “If you ask a developer about California, they'll tell you that it is a real pain to do business here,” explains Green. “The good side of that is that you can make a lot of money here because you don't have a lot of people coming in behind you. You can make a lot more money on real estate in California than you can in a market like Texas, where someone can build right next to you. So, the opportunity for rent growth a property value growth is considerably limited. There are really smart developers that have been able to figure out the system and have been able to make a lot of money here as a result.”