By Liz Marie, Chief Product Officer - Capital Markets, Revedy.
Introduction
Unless you’ve been hiding out in a remote Airbnb bungalow, you’ve likely seen headlines heralding the end of an era for short-term rentals (STRs). Bookings and occupancy rates in select areas have fluctuated, and virtually all markets have faced headwinds.
The list of macro challenges may seem daunting, yes, and includes the looming possibility of recession, regulation uprisings, and housing supply challenges. Taken at surface value, this leaves many folks wondering if the STR space is still a lucrative asset class. Yet, savvy investors are still able to find opportunities in these challenging times. Why? Because they have the right tools and insights to help them make the right decisions, taking full advantage of the market changes.
Let’s start with the right insights.
Data from multiple sources are predicting many reasons for optimism. Demand and interest in travel hold the power to overcome economic uncertainty for the hospitality industry. If employment and consumer interest in diverse and often more affordable short-term rental experiences remains strong we expect health on both the supply and demand sides of the investment equation.
AirDNA is considered one of the most accurate sources for market predictions and reports. They recently released a 2023 Outlook Report to help investors and operators understand the climate in the year to come. Spoiler alert, performance will not keep pace with the dramatic results the industry saw in 2021 and 2022. But it’s clear 2023 will be a year of mature performance from a battle-tested industry. In the last 36 months alone, STRs rebounded from the COVID-19 pandemic more nimbly than conventional lodging and reached all-time highs in supply, demand, and total revenue.
Key Takeaways for 2023:
Demand: Interest in vacation rental stays has exceeded even high expectations, and our current 2022 demand forecast of 21.1% exceeds our summer forecast by about 50 basis points (bps). 2023 will continue along a more mature path, further growing demand by 5.5% year over year.
Supply: Supply growth has since calmed in the face of falling revenue premiums (and after expanding in the first half of the year). We expect the number of active listings to increase by 21% in 2022, in line with our previous forecast.
Additionally, the number of nights supplied will increase even more, to 25.3%, as existing and new listings broaden their availability. In 2023, growth for nights listed will be 9%, less than in 2022, as the pinch from lower profit potential is felt.
Occupancy: Strong supply growth will create a second year of declining occupancy—although the 2023 forecast of 56.4% is still significantly higher than pre-pandemic levels.
Average Daily Rates (ADRs): Economic pressures and inflation-weary consumers will lead to small ADR gains of 1.7% in 2023.
RevPAR: Small ADR gains won’t be enough to offset occupancy losses, and RevPAR will experience a small decrease in 2023 of -1.6%.
So, what does this mean for aspiring and seasoned investors alike?
The STR market is now poised to be among the industries least affected by an upcoming recession, with positive growth throughout 2023—even in the downside scenario. Continued recovery in urban areas, as well as changing preferences that prioritize travel, create a strong position for STR in 2023 despite economic headwinds.
The market, as a whole, attained pre-pandemic levels by Q3 2021, and, by the end of 2022, returned to trend growth. It is now set to grow along a more mature path than in its earlier, pre-pandemic phase of growth. Although we expect to see slower growth rates in demand, even the downside scenario forecasts demand well above pre-pandemic levels.
Read on to understand how you can optimize the four primary drivers of return on investment. You don’t have to do this alone; with the right data points and tools, you will be poised for success.
What is the Investment Grade framework, and why does it matter?
Revedy, the market leader in evaluating STRs as investments, estimates that there are only 3-5% of STRs that are operating at their peak financial performance. We call these properties Investment Grade. These properties compete at the top end of their local markets and maximize cash flows while minimizing risks.
It takes a tremendous amount of investment, knowledge, and effort to operate STR assets at this level. Many mom-and-pop operators don’t aspire to reach this level and prefer to run their STRs for some balance of investment return, personal use, investment capital, and effort.
However, as larger investors enter the space, they will demand that returns on capital be maximized and new standards set. Over time, we believe this will push the STR renting experience much closer to hotels, while also validating the true potential of STRs as an investment class.
Rather than reinventing the wheel when it comes to scoring an investment as “good,” you can leverage an existing framework built by the market leader in underwriting STRs as an investment asset. Revedy’s framework is not rigid, and factors vary greatly by region. As such, each STR asset should be analyzed using a comprehensive first principles approach.
PRICING IS STILL THE LOW-HANGING FRUIT
A very significant portion of STR assets in the United States are self-managed. In fact, hosts managing only one unit account for 39% of all listings, and hosts with five or fewer account for 63%.
What does this mean for investors? It means they’re not optimizing for full channel distribution, revenue management, and other seasonal or secular travel demand drivers.
At this stage of the STR industry’s development, simply optimizing pricing and listing distribution is the most impactful cash flow driver that a new owner can execute.
For example, a mom-and-pop owner may list their property on one or two channels and update pricing monthly. In contrast, a professional manager will optimize listings across 50+ distribution channels, using dynamic pricing technology that adjusts several times a day to increase revenue and occupancy.
Revedy data shows that listing on multiple platforms and moving to a professional revenue manager typically uplifts revenue by 30%+ compared to a self-managed property. Additionally, AirDNA has found that operators who leverage their Smart Rates™ pricing tool see an average 24% increase in profits.
REVIEWS MATTER
While achieving the coveted Superhost ranking on Airbnb can often literally filter out your competitors, it’s equally important to manage negative reviews—especially while a property is ramping up. While bad experiences happen, prompt and courteous communication can mitigate the effects.
We’ve seen an early one-star review drag revenue down by over 30% relative to projections and comparable properties. The chart below shows a clear correlation between listings’ rating and key metrics of ADR, occupancy, and RevPAR.
DESIGN & AMENITIES BOOST PERFORMANCE
One of the bigger functions that fall on STR investors, and not the VRM to manage, is deciding and executing the level of physical asset optimization, which we define as strategically designing the look and experience of your property to maximize returns.
This optimization can be a huge driver of returns. While even bare-bones STRs can be successful, the highest returns can come from hot tubs (~40% ROIC), managing sleeps per bedroom (10-35% ROIC), EV chargers (12% ROIC), putting greens (30% ROIC), and other key factors that vary across markets. These can comprise a large part of the overall return in an STR.
Here are a few other amenities that often drive profitability:
- Pools: Listings with pools drive 44.7% more revenue than those without.
- Pet-friendly: Properties that don’t allow pets actually earn 3.2% more revenue than those that do (however, this varies greatly by location).
- Instant Book: Properties with instant book enabled earn 12.5% more revenue than those that don’t.
- Parking: Listings with parking available earn 11.8% more than those without.
- Kitchen: Properties with kitchens in the U.S. earn 63% more revenue than those without.
- Gym: Properties with gyms earn 15.3% more revenue than those without.
Beyond the amenities themselves, there’s also strong data supporting revenue increases from interior design and aesthetics. Hiring a professional STR interior design firm like Showplace to furnish your rental can increase your nightly revenue by 25%.
#2 - Investment Grade STRs: Market and Economic Optimization
Local market opportunity, interest rates, inflation, and supply of new STRs and hotels typically dictate the majority of returns for an STR investment. While most of these are extremely challenging to predict, investors can further mitigate risk with the right strategies.
MANAGE SATURATION
Supply risks can still be mitigated by investing early in lower-saturated markets. However, even within highly saturated markets, STRs that are fully optimized to investment grade may be able to outcompete.
GET TARGETED
Tailoring an STR’s appeal towards a particular demand demographic can result in more stable returns. Examples include STR assets geared towards business travelers near a corporate headquarters, sports-themed STRs near stadiums, bachelor/bachelorette amenities, and themed decorations to match locales such as beach themes or even kid-friendly themes.
DIVERSIFICATION
As with any asset class, investors can mitigate risk by building a diversified portfolio. This includes varying your assets across the following factors:
- Geographic region
- Seasonality
- Market type (destination, urban, etc.)
- Target audience
- Pricing tier (budget - luxury)
- Level of optimization
#3 - Investment Grade STRs: Regulatory and Legal Optimization
STAY COMPLIANT
It doesn’t matter if you have the best STR in the world if it’s illegal. The regulatory landscape for STRs is constantly evolving. Most regulations are set at the city council level. The policies of local politicians tend to be more volatile and unpredictable. Investors would be wise to consider what regulations currently exist, the risk of new regulations, and the penalties for enforcement before purchasing an asset.
Within our national database of STR regulations, Revedy has seen fines as small as $20 on one end of the spectrum up to criminal charges for multiple violations on the other extreme.
AirDNA data shows that many markets which top our arbitrage and Best Places to Invest guides are places where moderate to strict regulations are in place. Not surprisingly, markets where it’s most difficult to arbitrage properties— such as Nashville and Charleston, South Carolina—are where it’s often most lucrative to do so. Remember: regulations sometimes veil opportunities other STR entrepreneurs may overlook.
REGULATORY-INFLUENCED MARKET SELECTION
While some perceive the regulatory landscape as a risk, others see opportunity. Many investors are incorporating regulations into their acquisition strategy, including:
- Buying in low- or no-regulation markets
- Buying in environments where regulations are strict but stable
- Buying “scarce assets” in markets where STR permits are limited or capped
- Buying in unincorporated areas adjacent to highly-regulated cities
- Diversifying a portfolio across regulatory regimes
MONITOR FORWARD-LOOKING RISK
If landmark STR decisions in cities like San Diego or Las Vegas have taught us anything, it’s that regulations can change at any time. Investors should stay abreast of changes in their markets and conduct thorough research before
investing in others. In fact, Revedy actively monitors sentiment and activity in key markets to evaluate the risk of future regulations.
#4 - Investment Grade STRs: Financial Transparency
Lack of institutional capital in the space means that the operating histories and track records for most STRs are poorly recorded. Most reported financials are based on cash accounting, and finding a transaction with clean, quality accounting is rare - Revedy estimates this is available in less than 1% of STR transactions.
We expect the short-term rental industry to follow the playbook of other real estate sectors like multi-family and single- family rentals (SFRs), which experienced major consolidation as institutional investors entered the space. Today’s STR investors and owner-operators can position their assets to sell at a premium in the future by implementing:
- Trust accounting
- Clear divisions between the operating company and property company
- Accurately categorized and documented expenses
About the Company/Author:
Liz Marie is an award-winning strategist specializing in alternative investments. Over the last 16 years, Liz has worked with hundreds of brands across every aspect of investments and real estate, including Charles Schwab, Russell Investments, Principal Funds, Kayne Anderson, Angel Oak Capital, Gurtin Capital ($38B municipal bond manager acquired by PIMCO), AIG and more. She is also an STR investor.
Prior to joining Revedy, Liz operated her own consultancy and served as the Creative Director at Griffin Capital, a $9B real estate fund company acquired by Apollo in 2022. She also spent 10 years as Director of Strategy at an investment marketing firm.
About Revedy
Revedy gives investors an edge by providing tools and insights for better short-term rental investing. Since 2019, we’ve analyzed over $22B in short-term rental assets and serviced thousands of investors, real estate professionals, lenders, and professional managers. We leverage our best-in-class expertise, data-driven insights, and strategic partnerships to help investors identify market opportunities and high-performing short term rentals. Revedy has the industry’s first and most comprehensive database of short-term rental regulations with risk and opportunity scores.
Revedy offers an end-to-end solution for investors: Market identification, property underwriting, acquisition services, regulatory monitoring, management integration, asset optimization, and benchmarking.
About AirDNA
AirDNA helps investors, asset managers, and developers capitalize on the explosive growth of short-term rentals by turning data into actionable analytics. Our proprietary channel-matching and reservation algorithms enable us to deliver accurate property-level valuations for short-term rentals across Airbnb and Vrbo in 120,000 markets worldwide.
REITs, funds, syndicates, and individual investors around the world rely on AirDNA for the data to set them apart and the insights to keep them ahead.