Portfolio Manager/Analyst, Global Listed Infrastructure, AMP Capital
In September of 2016, Airbnb raised US$850 million in new equity, valuing the company at US$30 billion dollars and subsequently crowning it the most valuable lodging provider in the world without owning a single room. It is a particularly 21st century phenomenon that a company that started eight years ago, with no tangible product of its own, can overtake some of the most storied and well-known brands in the lodging industry.
During the last 12 months alone, Airbnb grew its US listings by almost 70 per cent and nights booked increased a staggering 125 per cent to almost 40 million room nights1. On these numbers, Airbnb has captured more than 3 per cent of US lodging demand within the last eight years, and is gaining share rapidly.
With each month that passes, the impact of Airbnb becomes more pervasive, and its effects on lodging occupancy and pricing power will become more visible. In the listed space, this will manifest in slower revenue growth, and weaker profitability. Fortunately, the competition from providers such as Airbnb will not be felt equally across the industry. Investors can benefit by finding the names that are insulated from the sharing economy. This article seeks to highlight the opportunities and challenges posed by the sharing economy for real estate investors.
The accommodation sharing economy refers to the growing number of property owners who are making their dwellings available for short-term rentals. These short-term rentals compete with traditional lodging providers by offering an alternative, often cost-effective, form of accommodation in major markets. The accommodation sharing economy is facilitated via a number of internet platforms, most notably Airbnb, which have greatly boosted the viability of short-term rentals as an alternative to traditional hotels. These new platforms increase the ease of marketing properties, managing bookings and facilitating payment, and have led to an explosion in the use of short term rentals.
Since its inception in 2008, Airbnb has grown to have more than two million listings in more than 191 countries2 on its website. This compares to the 1.1million rooms in more than 100 countries of the world’s largest lodging company, the newly combined Starwood-Marriott entity3.
While it is equally true that services like those provided through Airbnb may have enticed more people to travel, thus adding to incremental demand, it is a stretch to claim that the new supply from the sharing economy is having no impact on occupancy levels and pricing power of the traditional hotel sector.
Recent research by commercial real estate company CBRE shows that Airbnb hosts respond to incentives in a similar way to the traditional lodging market just with greater speed and flexibility. Firstly, when demand is strong and pricing can be set at attractive levels, additional supply is brought online. The higher the rate that a host can achieve, the more pronounced the supply response. This highlights one of the key features of the sharing economy; that of an increased elasticity of supply where accommodation capacity can be added and withdrawn rapidly in response to changes in available pricing.
Quantifying the exact impacts of Airbnb is a difficult task because there are so many moving pieces, and demand in the lodging sector is cyclical and sensitive to changes in the broader economy. However, anecdotal evidence from lodging REIT management teams, such as Mike Barnello, CEO at LaSalle Hotel Properties4, suggests that shadow supply from the sharing economy is reducing pricing power by acting as a release in times of extreme demand. This is confirmed by a recent Morgan Stanley report, which showed that the number of compression nights (nights where occupancy is greater than 95 per cent) has declined in the year to May 2016 versus the same period a year ago. This has occurred at a time when average occupancy is close to all-time highs across the market, and supply and demand growth is in balance. This suggests that there has been an increase in the amount of leakage from the traditional lodging sector at times of extreme demand.
Implications for Real Estate
Companies with concentrated portfolios that are exposed to markets with a high degree of sharing economy penetration should be penalised so as to reflect the potential reduction in pricing power and impacts on occupancy.
Lower Operating Leverage
Given potentially lower pricing power and the downward pressure on revenues resulting from an increasingly cost conscious customer set, companies with lower operating leverage should trade at a premium through cycle to reflect more attractive risk/return characteristics. On this basis, the C-corps are seen as relatively more attractive than the lodging REITs.
Commodity-like lodging offerings with lower levels of amenities and reduced service will face the most intense competition from the sharing economy and are most at risk of price competition, loss of market share and the resultant impacts on profitability. The REITs are well placed to control the physical quality of their properties but this may manifest in a higher capex load going forward.
Ability to Control Their Own Destiny
The ability to react and respond to the threats posed by technology should command a premium. This slightly favours the lodging C-Corps over the REITs as they can adjust many aspects of the lodging experience including booking terms and conditions, branding and marketing, loyalty program benefits, and brand standards/product offering.
Low Financial Leverage
In an environment of variable supply and lower pricing power, it is not unreasonable to expect a higher level of volatility in occupancy and rate growth. Consequently, revenue growth will also be more variable, and companies which maintain a lower level of financial leverage should command a valuation premium.
In an environment where corporate profitability has been under pressure and consumers have become more cost conscious, it is evident that technology will play an increasingly important role in helping customers stretch their travel budgets. On the supply side, technologies like those that facilitate the sharing economy have given rise to cost-effective alternatives to traditional lodging and will put downward pressure on pricing power in the lodging sector.
Going forward, it will be important for hotel owners to be proactive and nimble in order to stay ahead of technological progress. Companies that are slow to react may be shocked at how quickly they can lose market share either to new alternatives or to their competitors.
As a cyclical sector, lodging will always have a role in a global real estate portfolio. The ability to reprice rents daily means that lodging names can take advantage of changing economic conditions immediately. As portfolio managers, the ability to take active positions in names with exposure to specific geographies or market segments can lead to opportunities to generate significant alpha through the cycle. Combining a local presence with a global vantage can help identify the best opportunities as regions are never perfectly in synch from an economic perspective. In times like the present, where growth in the lodging sector is anaemic but still positive, one must be mindful of the multitude of factors that can impact lodging company profitability, whether they be macroeconomic in nature or longer term changes in industry structure, and position accordingly.
For more, read our whitepaper HeartBreak Hotel - Opportunities and challenges posed by the sharing economy which highlights the opportunities and challenges for real estate investors.
1Airbnb update from AirDNA; Growth Ahead of Expectations BofAML Research, September 2016
2www.airbnb.com, May 2016
3Marriott International to Acquire Starwood Hotels & Resorts Worldwide, Creating The World’s Largest Hotel Company, Marriott International merger press release, 16 November 2015 www.marriott.com
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