The Fall Of Short-Term Rentals
It’s a story that’s echoed across social media platforms from rental property owners across the nation: Vacation rentals are no longer generating the steady revenue investors grew to expect during the pandemic. The era of #Airbnbust has taken hold.
Real estate investor Sabrina Must, who once rented her 2-bedroom condo in Encinitas, California, for $1,000 per night on a holiday weekend, has dropped her rates to $275 per night due to waning demand, The Wall Street Journal reports. Another couple who got into real estate investing during the pandemic saw strong bookings in the beginning, followed by low occupancy rates this past summer.
It’s a problem for many everyday people who decided to try a hand at real estate investing during a period of booming demand, sometimes without a backup plan or the skills to remain competitive during a downturn. As the situation evolves, the short-term rental strategy is losing its appeal, especially as an entry point for beginners.
Why the Short-Term Rental Strategy is Losing Steam
Oversupply limits cash flow potential
Airbnb occupancy rates have exhibited year-over-year declines for eight months straight, according to data from vacation rental research company AirDNA. It’s not because inflation has curbed the demand for short-term rentals. In fact, nights stayed are up 21.3% as of October when compared to last year. But the supply of Airbnb listings has surged 23.3% year-over-year. 66,000 new rental properties were listed this October, an increase that overshadowed the growth seen the October prior.
What created the oversupply? During the pandemic, demand for second homes nearly doubled as low interest rates collided with remote work opportunities and the desire for more space. The skyrocketing demand for vacation rentals and record revenue data in 2021 also encouraged a new group of real estate investors to buy homes exclusively as rentals. And now, Zillow predicts the number of first-time landlords will grow significantly as second-home owners attempt to earn money from their properties while inflation persists and stock market expectations are bearish. Furthermore, homeowners who have locked in low interest rates may be tempted to rent their homes rather than sell when it comes time to move.
Notably, occupancy rates are still up 12.8% compared to October 2019. AirDNA forecasts that supply will increase another 9% in 2023, despite high mortgage rates causing affordability pressure for would-be second-home buyers—but expects occupancy rates to stay elevated above pre-pandemic levels. However, if rising unemployment cuts into the demand for short-term rentals or if more homeowners decide to become hosts in an effort to boost their incomes, there’s reason to believe occupancy rates could dip even further.
Growth in average daily rates and bookings slows
When compared to 2019, demand for short-term rentals has remained stable or increased all over the world. But Airbnb’s revenue growth slowed from 58% in the second quarter to 29% in the third quarter, and Airbnb predicts that holiday revenue won’t live up to market expectations.
AirDNA also reports slowing growth in average daily rates. The 5.6% growth in average daily rates (ADRs) expected for 2022 actually represents a real loss due to inflation. And ADR growth is expected to slow to 1.7% in 2023, while inflation is predicted to remain elevated. The revenue per available room is also expected to decline because the slightly higher rates won’t offset the decrease in occupancy rates.
Local governments are cracking down
Short-term rentals were relatively unregulated in the beginning days of Airbnb, and there are still plenty of cities that only require hosts to apply for a short-term rental license. But increasingly, local governments are tightening short-term rental rules due to criticism that an overabundance of vacation rentals limits the availability of affordable rental housing in a community.
In New York City, short-term rentals of less than 30 days are prohibited unless the host is present and the guests are given unobstructed access to the entire unit. In San Francisco, short-term rentals must be primary residences where the owner lives for at least 275 days out of the year. Similarly, Denver only allows homeowners to apply for a short-term rental license for their primary residence. These are examples of a growing number of cities cracking down on short-term rentals. It’s evident that investors entering the short-term rental market now will need a backup plan because if large cities that depend on revenue from tourism are passing strict requirements for rental property owners, it can happen anywhere.
How Investor Struggles Could Impact the Housing Market
New investors who snatched up rental properties during the pandemic based on forecasted ADRs at the time may not be able to cover their mortgage payments. As occupancy rates continue to drop, many may be forced to sell their properties. Widespread selling of properties intended for short-term rentals would increase the supply of homes, contributing to a downturn in home prices. Low supply is one factor currently preventing home prices from dropping too rapidly, even as prospective homebuyers pull back due to high mortgage rates.
A more serious problem may occur if prices fall and new investors are left with underwater mortgages. Over the last year, debt service coverage ratio (DSCR) loans have become increasingly common, Bloomberg reports, allowing investors to qualify for larger amounts based on future income projections rather than a large down payment or personal salary. Some of these loans (it’s unclear how many) were packaged and sold to investors as mortgage-backed securities by Wall Street firms. Several lenders in the space have said they expect to issue hundreds of millions in rental-based loans this year, and a significant portion of borrowers will qualify based on projected Airbnb income.
While most experts contend there won’t be a housing crash because lending standards are stricter now than they were before the 2008 financial crisis, these rental-based loans are another story. Without a full account of how many of these loans are out there, it’s impossible to say whether potential defaults could cause enough foreclosures to impact the economy. But certainly, the Airbnb slowdown could contribute to a larger supply of homes on the market.
How to Stay in the Airbnb Game
The extensive supply of short-term rental properties means that investors in the space need to stand out as stellar hosts if they hope to maintain high revenues. Brian Egan, CEO, and co-founder of vacation rental management company, Evolve, tells The Wall Street Journal that the most successful hosts provide an outstanding experience by raising the bar for hospitality and ensuring the property meets or exceeds guests’ expectations after viewing the listing.
Hosts should also research the algorithms each listing platform uses to try to expand their reach and enhance their listings to improve conversions. Prioritizing professional photos and offering competitive pricing and policies can increase the likelihood that guests will book your rental, and quick response times are also important.
Ultimately, a backup plan is essential. You may not be able to achieve the revenue you’re hoping for if there’s an oversupply of properties in your market. A deep recession could curb demand for vacation rentals in general. Or local regulations could prevent you from listing your property as a short-term rental altogether. You may need to shift to a medium-term or long-term rental strategy, which you should ensure is possible in the area where you buy. You should also have enough cash reserves to cover your mortgage payments and maintenance if fair market rent won’t provide positive cash flow.
The Airbnb boom may be coming to an end, but there’s still an opportunity to earn money from short-term rentals, especially for experienced and strategic investors. Even as occupancy rates have dropped from their peak, hosts are earning more money now than they were before the pandemic. But property prices and mortgage rates have skyrocketed since then, so new investors must proceed cautiously. Don’t expect any property you buy to be an automatic success. Understand the risks, make research-backed purchasing decisions, and be prepared to pivot in the changing economy.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.