Full disclosure, I have not purchased in San Diego since Dec 2021 (shortly before rates rose).  

Additionally, they have another property which has appreciated in value, carries low interest rates, but has negative cashflow and essentially feels like it just locks money away.

What is your rate, term, LTV, and rent?  

Option 1: The loan that the owner has is an assumable loan at a 3.875% rate and still has about $265K.

If not I’d consider staying with the rental and raising the rent to market rate at lease renewal in May.

With some of the new properties they find they are getting great interest rate buydowns from builders. with equity of 1.2M you have many options on where to move. 

The program stipulates that you MUST stay in the home 5 years or you lose a pro rated portion of that 8k.

I assumed that shopping around for the best interest rate would be good enough.

Any input on whether you know of rates likely to drop?

A lot of people tend to mingle these things when they talk about "break even" or "cap rate", but that leads to a lot of confusion.Let's use some real numbers which may be easier to understand.