Last week, we posted the first part of this series by Richard Vaughton, detailing the challenges and opportunities currently presented by the master lease model for urban vacation rentals. You can read Part 1, ‘Why is the master lease model so interesting right now?’ hereEditor

Whether the master lease is from a developer or an owner/landlord, there is clearly more awareness about the market opportunities for this model of property management in the short-term rental industry which has attracted non-property managers to the game.

The new players in the short-term rental (STR) sector are heavily invested and all are competing for growth. In addition to this, there are now businesses offering the technology and contracted management to allow developers to operate their own businesses and maximise income, such as the recently pivoted Lavanda.

The net effect is that supply has become more competitive and will command more aggressive terms from landlords who frequently can be heard saying: ‘After all how difficult can it be to rent an apartment and clean it?’

A laughable comment for anyone in the business, but on the surface this attitude, combined with a perceived healthy profit margin being made by a third party, may see a leasing squeeze. 

With new tools and metrics also being made available to developers to analyse income potential, negotiations may become more difficult for property managers and the all important gross and operating margins may be narrowed further. DIY may well become more popular.

In order for master lease to really work, the asset owners need to be confident of the operator or lessee. Do they have a good track record? Is the balance sheet strong? Do they have the correct ethics? Will they cause neighbourhood problems? Will they sweeten the deal with renovations?

The very nature of the master lease model means that the numbers are much bigger and the deals carry more risk per unit. In vacation rentals, the number of deals can be a thousand fold with subsequently fewer risks. 

Operational management or ownership?

A guideline on where this aspect of hospitality is going could well be given by Marriott’s business. Just over 1% of all rooms are actually owned by the Marriott and 42% managed with the remaining 57% franchised or licensed. The power of brand comes into play here, as does the entire operational power of such an experienced business. If you would like to know the eye-watering capital needed for a Marriott franchise, check this link (2016).

Operational management covers more than 40% of the Marriott inventory. IHG has a similar approach to its business, developing into an asset light company.

This Opco/Propco business model is common amongst many of the property sectors and will no doubt see a revival in the press as STRs grow, and the volume of inventory is managed on behalf of asset owners. Some would determine the better approach is ownership of both – as the risks can be managed more effectively in a downturn. 

Then there is franchising. According to market research firm FRANdata, as of 2018, there were 32,818 hotels in the United States, 93% of them franchised. That’s a total of 30,650 franchised units.

Wyndham, which calls itself the world’s largest hotel franchising company, said that about 95% of its 9,200 hotels globally are owned by others. The portfolio consists of about 5,900 hotel owners.

The operating company and the one that the guest witnesses as a brand, is the game changer, but the likelihood is that big and/or niche/specialist will win most of the time, in my opinion. The reason is that scaling fast and bridging scales of economy to keep the cash flowing has been a fundamentally important strategy. Using this scale with a strong brand, powerful PR and a core focus does bring loyalty. 

However, outbidding competition with poor analytics, heavy investment in infrastructure and reaching too far too quickly can have consequences unless the business has very deep pockets and hurts its competitors in the race to the top. A fine balance is required.

Revenue models will need to change

Any short-term rental business requires a property. And every property is owned and financed. There are many variations of the individual agreements, but these are the majority of the ones in play in STRs.

Master Lease: An owner or asset controller of a building, receives a guaranteed sum for a fixed term. The agreement may have local economy climate changes included to mitigate these fixed fees. The operational management of the brand takes care of all aspects of the property in terms of bookings, guest management, entry, departure, cleaning, minor repairs and renovations due to guest wear and tear. Typically, multi unit in urban destinations, although the likes of James Villas favoured this model long before the Wyndham acquisition. Stay Alfred, Sonder and Dormio are modeled on this approach.

Pros: Technology provides for and allows retention of high occupancy rates. It also cuts operating expenses and allows for intelligent property pipeline development.

Cons: Maturation means supply will outstrip demand and lease terms may be too expensive. Cutting costs dilutes brand and guest experience.

Commission: An owner or asset controller of a building, contracts to a company for management that takes care of all elements of the business except the property’s structural issues and agrees a commission taken on each booking. The management company may subcontract to a third party cleaning and operational activity or do this in house. Repairs and renovations are typically at the cost of the owner. Sykes Cottages would be a large proponent of this business model.

Pros: Cash flow as there are no fixed rents.

Cons: Difficult to scale due to many moving parts. Acquisition is a favoured growth approach and requires significant investment with high EBITDA multiples for large portfolios.

Mixed: A number of vacation rental businesses are using a mixed model and more are looking at this as data tools become more accurate for forecasting income and margins. 

ALTIDO and Vacasa are two examples where fixed rents and commissions are practised.

Again it is worth noting that many ‘Airbnb management’ companies will adopt one or both models but represent many owners with distributed inventory. 

Although working in the same space and many with serious investments, the urban approach is hard to develop efficiently, with on-site branding and the struggle to onboard legal inventory in major cities, due to significant competition. This has led to the rise of companies solving operational issues, such as keyless entry. 

Let’s not forget the influence of the OTAs

Their influence is powerful in any hospitality business. 

Not so many years ago, a good proportion of the small STR companies’ income statements would reflect ‘online marketing costs’, which some now renamed as ‘OTA Costs’. There has been a sea change in attitude as OTAs are accepted as a necessity and not merely as an extra channel opportunity and something to be challenged.

The two important bookends of the short-term rental industry are inventory and guest bookings. 

The big three channels of Booking, Airbnb and Expedia (incorporating VRBO) dominate and have significant influence on many businesses, but not all. We are witnessing continual pushback from managers. 

A phrase we see in many pitch decks, which can seem like a bit of a stretch, is ‘We’ve made $xM in bookings without spending a penny on marketing’. What they really mean is that all bookings are via OTAs and therefore the marketing costs are allocated to the owner, guest or both. It’s still marketing. There is no such thing as a free lunch and complete OTA dependency can lead to future problems.

OTAs can be a significant cost to an operator and in a world where the choice of accommodation is increasing, they hold great influence over booking opportunities and margins. 15% commission from a 60% gross margin on master lease is very significant indeed. As is 15% from a 25% commission in the traditional vacation rental world. This squeeze is the reason many small companies have sold or are struggling to grow.

Ask yourself this question. Which is more important? The property and contract or the booking channels which feed the short-term rental machine? This is a hotly disputed topic and the answer will depend on who you ask.

Without doubt, a brand, a clear message and focus, combined with smart tech and targeted marketing pays dividends. 

From a hotel perspective, the immense success of the UK’s Premier Inns (Whitbread owned) is a good example of a company which follows this criteria. Two of its main tenets are efficiency and technology. A commitment to offering a quality service for less appears to be at the heart of its success. 

Loyalty programs and direct booking campaigns have paid dividends in the past and the big hotel chains are permeating their operations with brand message benefits.

The pressure cooker of the urban ecosystem

If I was to put all the companies into this article that now operate in the urban space and require new real estate to grow – then it may well extend several more pages. 

Just Airbnb’s investments alone are astonishing: Luxury Retreats, Accomable, Niido, HotelTonight, Lyric, Luckey Homes, Oyo, not to mention their acquisitions of many associated verticals, such as Gaest or Tiquet and hotel/condo brand development such as Natiivo.

Hotel brand names could also be seen as well developed in the short-term rental sector with ApartHotels. The Residence Inn chain for example has been acquired by Marriott Corporation. Staybridge Suites and Candlewood Suites are both owned by InterContinental Hotels Group. These are examples of hotels designed for business and extended stay travelers. Despite the 30 day+ ideals they are frequently fed into the short-term rental marketing channels.

As we can see, it is understandable there has been a wall of money ready to enter the short-term rental space, ($2TRn by some estimates). Well, there certainly was before the WeWork debacle. 

There have been spectacular failures in the past and it may be worth noting such as the acquisition of OneFineStay by Accor and subsequent write down. There have also been strategic changes of direction, such as Hyatt’s disposal of Oasis Collection too. Understanding this market is very important. ‘Look before you Leap’ could be a good proverb to adopt in this market sector. 

With so many companies bidding for real estate for so many reasons, these few lines from a TechCrunch article are pertinent:  ‘Over time, landlords and real estate investment trusts like Blackstone could force Zeus, Sonder and others to compete to pay them the most for leases, eating into all the startups’ margins.’

A PropTech approach is now vital to compete

The phrase ‘Property Technology’ covers a broad spectrum of hardware, software and sub-sectors but in the context of the short-term rental industry, the popular ‘Gartner Hype Cycle’ demonstrates a number of the technologies which these STR businesses will need, in order to address and minimise costs, increase efficiencies and compound brands:

As explained on this link they are:

-Customer analytics and continuous experience
-Employee training, motivation and experience
-Mobile customer service, consumer messaging apps and customer self-service
-AI, IoT, VCAs and chatbots

Some of these will only achieve a plateau and be embedded across the business in 5+ years, but we are seeing progress daily of a raft of tech companies entering this space to support demand.

The new breed of urban short-term rental company may be perceived to be in the real estate sector with technology, especially as these are all predominantly Opco businesses that rent space. However, on closer examination, they really do have little to do with property infrastructure and development and everything to do with operations.

To be continued..

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