Last week, I discussed a local Columbus real estate developer, DRK and Co, that carved out a niche for themselves in the workforce housing space. Now that we have established how DRK found their competitive advantage in the Columbus market, I want to look at how are they are positioned against competitors in a constantly evolving real estate market.
To start off, we must look at the commercial real estate market as a whole. A key metric in valuing CRE is the capitalization rate, or cap rate. A cap rate is a property’s net operating income divided by the purchase price. Essentially, it is the ROI an investor would receive if they were to purchase a property in cash. Over the past 7 years, there has been significant cap rate compression across almost all real estate asset classes. As cap rates have lowered, the price of assets is reaching all-time highs. Of all the macroeconomic factors that could affect DRK and Co, and their stronghold on the workforce housing market, cap rate compression may be the most significant.
Cap rate compression means investors are willing to pay a higher price and accept lower returns on cash flowing properties. In years past, the appeal of buying a mid-1980’s build apartment complex, was the low purchase price compared to the cost of new construction. Currently, with construction costs somewhat stabilized, the spread between buying and existing property and building new is increasingly shrinking. If this trend continues, there is potential to see an influx of developers in the CRE space shifting the market dynamics and increasing competition.
If this were to happen, DRK is still poised to retain its competitive advantage, as they have spent years scaling and integrating the entire real estate life cycle. This still gives them an edge over competitors that are entering the space who will face higher development and management costs. An area of weakness that may threaten DRK, if there were a flood of competitors in the market, would be new innovation in the construction industry. With increased competition, comes increased resolve to differentiate from the way things are “normally” done. Should such innovation come along, it could introduce an unforeseen challenge to retain market share.
Overall, I think their business model will remain resilient to changes in market conditions. With the exception of rapid innovation, their structure and focus will allow them to adapt to changing conditions without overleveraging or speculating.