In September of 2016, Airbnb raised US$850 million in new equity, valuing the company at US$30 billion 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.
Airbnb is the most recognizable international brand in the emerging “accommodation sharing economy”, which 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.
The US is Airbnb’s biggest market, but the company is looking to replicate its success on the other side of the globe for a much bigger prize. Airbnb is making a big bet on China’s rapidly expanding sharing economy, and is already enjoying some success in that market. Fortune magazine reported in October that Chinese travelers have booked over 3.5 million Airbnb listings globally, and that nearly one million guests have booked Chinese listings. According to The Economist, at present Airbnb has about 70,000 listings in China, while local rival Xiaozhu has over 100,000 listings and market leader Tujia has 440,000.
What does it mean for the lodging and hospitality industries?
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 of lodging and hospitality companies. 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.
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.
Particularly in China and emerging Asia, where the expanding middle class has not until recently had the disposable income to enjoy even domestic travel, Airbnb and its sharing economy competitors may capture a higher wallet share of traveler dollars that would have otherwise gone to traditional hotels. This is a disruptive model that has the potential to fundamentally alter holiday spending behavior for an entire generation of new travelers.
How can investors find winners in a sector under disruption?
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 in the US, such as Mike Barnello, CEO at LaSalle Hotel Properties, 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. It is not unreasonable to extrapolate these trends to China and other Asia markets.
The rise of accommodation sharing reveals how consumers are using technology to maximize utility from their fixed travel budgets. This has increased elasticity of supply and demand. In response, investors should identify desirable characteristics for potential lodging investments and seek to appropriately reflect this in the relative attractiveness of investment options. In this new paradigm, it will be imperative for hotel owners to differentiate their offering and to be able to demonstrate the value in hospitality.
Despite these disruptive dynamics, an opportunity exists to generate meaningful relative performance for investors who can identify companies with the most attractive business characteristics that account for the risks created by new technologies.
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.
Meanwhile, investors should expect a higher level of volatility in occupancy and rate growth, which means revenue growth will also be more variable, and companies which maintain a lower level of financial leverage should command a valuation premium.
As a cyclical sector, lodging will always have a role in a global real estate portfolio. 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 returns through the cycle.
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.
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