The Death of Short-Term Rentals
By: Chuck Hattemer
Tags: Coronavirus, Real Estate, Covid 19, Economy, Airbnb

Credit: Avondale

The Death of Short Term Rentals

Parents teach their children to be wary of strangers. It used to be common sense that you don’t let strangers stay in your home. And don’t get into a stranger’s car. That changed with Airbnb, VRBO, Homeaway, Uber, and hundreds more creating the sharing economy. This economy now faces its first major setback due to the coronavirus. Will short-term rentals (STRs) survive the pandemic?

In the travel category, Airbnb redefined couch-surfing strangers as guests and hosts with shared values. The brand’s magic changed consumer behavior and spawned an entire short-term rental market for business travelers, corporate housing, large groups, and more. Many of these STR providers used the master-lease model (like WeWork) to secure properties en masse.

With the coronavirus, the future of consumer behavior and the short-term rental market is not at all clear. Due to health concerns and lower travel volumes, Airbnb bookings have dropped by as much as 96% in certain cities. Many amateur real estate investors signed up with Airbnb to create an alternative and sometimes primary income stream, sometimes built on starter debt. A Wall Street Journal article shared the misfortunes of over-leveraged hosts like Cherly Dopp who face looming mortgage payments, maintenance, insurance, taxes, and restrictions.

Airbnb is actively communicating with hosts and set up a $250 million relief fund. However, that $250 million only covers 25% of the loss experienced by hosts, so many are still scrambling to make up for the loss in income. There’s even a class action lawsuit with over 26,000 participants at the time of writing.

Next in line for impact is the STR companies using the master-lease model. Companies such as Sonder, Lyric, Domio, and Zeus Living are on the hook to pay rent to their landlords that they’ve signed master leases with — even if they have no guests. The fundamental business models behind these companies will be reviewed.

At Onerent, we’ve even seen some of the fallout with a 205% increase in new landlord customers seeking to switch their properties to long-term tenants.

Many Airbnb hosts are converting to long-term tenants because they need to recoup the lost income from their vacant property. They also realize that there is a customer base that they had not been seeking prior that is more valuable: those looking to settle semi-permanently.

The current crisis is a lesson in risk-adjusted return and leverage for many whose real estate portfolio relied too heavily on short-term rental income.

Let’s recap the impact COVID-19 has had on the market and what’s in store for the future of short-term rentals.

Bookings Vanish in Hard Times

For short-term rentals, the immediate impact of the 2020 pandemic was a halt in travel. The average urban hotel saw a 54.8 percent drop in occupancy rates. Bookings on short-term rental platforms such as Airbnb and VRBO dropped by 85 percent, according to AirDNA. Market capitalizations for Expedia, Hilton and Booking.com were down 58, 44 and 37 percent, respectively.

Source: AirDNA

Even projecting forward into the popular spring and summer months, travel is slow. The hottest markets on Airbnb are averaging about half the bookings for May that they were getting in February.

Though companies with large coffers may survive, other short-term rental providers will face high vacancy rates and difficulties making up for the lost income. We already see Airbnb pivoting into mid and long-term stays to diversify its exposure in the market.

Operating Cash Dries Up for Master-Leasers

Master-lease STR models, such as Sonder, rely on bookings to pay their rent. When you book a stay, your upfront payment is a deposit for your future stay. Unlike traditional security deposits, your pre-payments for a short-term stay are largely unprotected by the law. STR companies can and will use your money before you even get to your destination. This upfront cash is like jet-fuel for the company’s growth. They borrow money against their bookings and use that debt to pay more master-leases or to fuel growth.

When bookings come to a grinding halt, capital starts evaporating for short-term rental companies. This is especially the case for businesses using the master-lease model (like a residential WeWork). Vacant rentals put immense pressure on these company’s margins because they’re not recouping their costs. In a master-lease model, a company is still legally obligated to pay rent to the landlord. Add that on top of city registration fees, taxes, and property maintenance.

While Airbnb raised $1 billion to subsidize their loss in bookings, smaller operators are on the hook for far greater losses, especially if they’re using master leases.

Consumer Behavior May Never Be the Same

Consumer behavior is evolving at ludicrous speed with the impact of the coronavirus outbreak. Just as the millennial masses reconsider car ownership and work-from-home, they will also think twice about staying in a stranger’s house; especially with prospects for short-term travel continuing to look grim, and ongoing health concerns.

The reasons why people travel and stay in short-term rentals are also under question. For example, people may be hesitant to attend large-scale events like conferences, concerts, or short business trips for less-critical meetings. There is widespread uncertainty about business travel and employees will require higher standards for stays. People are embracing work from home and that means more time spent in a single geographical location.

Saturday Night Live had their fun with this as well:

Certainly, people will start traveling again, but will they stay in a stranger’s house? Will someone still want to rent out their extra bedroom if they don’t absolutely need to? Will Superhosts diversify more of their portfolio with long-term rentals? Will people still embrace “co-living” in close proximity with others? These are some of the major questions every Airbnb host should consider when it comes to assessing future demand.

Just like commercial real estate faces the work-from-home paradigm shift, Airbnb hosts, guests, and financial markets are all re-evaluating demand and risk for short-term rentals given these potential changes in consumer behavior.

Short-Term Rentals Carry Large Downside Risk

Financial leverage

Changes in consumer behavior and the market will make people re-assess the risk profile of short-term rentals.

When WeWork nearly collapsed in 2019, many people in the technology, finance, and commercial real estate worlds adjusted their risk tolerance for the master-lease, community-adjusted EBITDA business model. Now, Airbnb’s master-lease comrades face similar challenges as WeWork. People remembered that businesses are supposed to be profitable, and you can’t just sacrifice everything for growth.

As we look towards the future of short-term residential rentals and in particular, master-leasing, it’s likely that venture capitalists, landlords, and operators all reconsider their risk tolerance. There’s a reason why short-term rentals generate such high returns. It’s because you’re taking on the risk of reduced occupancy rates. The average Airbnb host has 48% occupancy rates without COVID while long-term rentals have an average 93% occupancy nationally. Unforeseen events — economic downturns, natural disasters, and pandemics — add further risk on top of your potential gains with a short-term rental.

The Future of Short-term Rentals

There is still much uncertainty about the future of short-term rentals but it’s clear that there will be a downstream effect when Airbnb hosts lose their income or convert to long-term rentals. Lenders, property managers, cleaners, and handymen could all be financially impacted. It’s also clear that local governments are using the opportunity to impose more restrictions and taking back some of the supply for more affordable housing.

Some local residents, NIMBYers, and economists are also eagerly awaiting a drop in housing costs when short-term rentals convert to long-term. Others disagree, saying there is not enough inventory on Airbnb to have any substantial impact on overall home prices. It’s true, Airbnb accounts for less than 2% of the rental housing inventory, The two may not be directly related, but it’s all part of a larger recession snowball.

On an online host forum, Airhostsforum.com, users are clamoring for answers about short-term guests turned roommates, unclear regulatory changes, and cancellation fees.

The user, Lynick442, expressed their concern:

“I’m personally afraid of this. I have a strict 28 days stay so that they don’t get classified as tenants but they just added a new rule [in] my state about no evictions and I can’t get a straight answer if this applies to Airbnb…I might shut down completely.”

Whatever the future holds, a few things are certain:

Short-term rental owners and operators will switch to long-term tenants for financial security. Bookings will be slow, putting major pressure on short-term rental margins and the master-lease business model. Consumer behavior is likely to change post-COVID, and those changes could impact demand. Everyone involved in short-term rentals will be reassessing the risk involved in the business. In certain geographic areas with high concentrations of STRs, home values could be negatively impacted.

Even after vaccination is found, the short-term rental market will still be battling the after-effects of COVID19. Today — in lockdown — it’s hard to see a future where STRs will ever be the same. Will “shelter in place” beget “no more shelter at my place”?