Room Rentals vs. Hotels: Buffett’s Revenge

Services like Airbnb are altering the economics of the hotel business.
Economist StaffJanuary 13, 2016
Room Rentals vs. Hotels: Buffett’s Revenge

For those exhausted by the festive season, now is the time to book a holiday. Hotels in New York’s Times Square cost four times more on New Year’s Eve than they do just a week into 2016; a room at the cheapest four-star property in Cancún in Mexico on December 31 was half as dear by January 7.

The economics behind this price crash are simple: hotels are expensive to build and staff, and demand for them is seasonal. Only by ramping up prices at peak times can they be run profitably. But seasonality inflicts wider economic costs than eye-watering bills. Tourists find other destinations because rooms are full on their desired dates and, despite lower prices, inventory goes unused during the off-season. One-off events like sports tournaments, concerts, and conferences can exacerbate the problem of mismatched supply and demand, by flooding cities with visitors for just a few days.

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The advent of the “sharing economy” should offer a solution. Just as Uber’s surge pricing draws part-time taxi drivers onto roads at rush hour, room-rental services like Airbnb, HomeAway, and Onefinestay should allow a city’s supply of temporary accommodation to expand when more people want to stay there. Airbnb recently released data to support this hypothesis, showing that many of the site’s hosts list their homes specifically to cash in on periods of high demand (see chart at bottom of story).

The shareholders’ meetings in Omaha, a Midwestern American city, of Berkshire Hathaway, a financial conglomerate, provide a good illustration. In 1980 12 people showed up to the first one, including the firm’s boss, Warren Buffett. These days, the gathering draws some 40,000, the equivalent of nearly 10% of the city’s population. Omaha’s few hotels have built their business models around this surge, jacking up prices to as much as $400 a night and imposing three-day minimum stays around the one-day event. This has outraged the frugal Buffett, who has threatened to move the conference to Dallas.

Happily, home-sharers have begun to offer some competition. In the three weeks before the 2015 meeting, 1,750 Omaha residents added new properties to Airbnb — the equivalent of three Omaha Hiltons, the city’s biggest hotel. That brought the number of Airbnb listings in the city to 5,000, of which 76% were occupied on May 1 at an average price of $209. Moreover, Airbnb hosts only charged 60% more during the meeting than in days before and after. The surge at hotels was 200% or more.

Omaha may be an exceptional case, but it reflects a trend. Across the 31 specific events for which Airbnb shared data, the number of listings rose by 19% in the three preceding weeks. Three times as many stays occurred during the period of the events as in the weeks before and after. Even cities where supply has expanded slowly are seeing more stays. Airbnb bookings during the Volta art fair in Basel, Switzerland, last year were 268% higher than during the neighboring weeks, even though listings rose by only 6%.

The Airbnb figures do not spell the end of extortionate hotel prices. Spare-room rentals and hotels are not perfect substitutes: many visitors want the service and convenience of a hotel. Room rentals, naturally, have more of an impact in smaller cities than in big ones, which can more easily absorb an influx of visitors. Airbnb’s turnover in Paris during the 2015 French Open tennis tournament rose by a mere 4%.

But by easing temporary supply squeezes, room rentals may change the economics of the hotel business, at least in smaller cities. If hotels can no longer double their prices when demand peaks, that could drive weaker properties out of business. Those that stay afloat may need to increase rates at other times of year, which could further depress off-season travel and hurt complementary businesses such as restaurants and taxis.

Conversely, more room rentals should also mean that more money flows directly to residents every time small cities stage a tourist-magnet event. (Airbnb passes on around 85% of guests’ total payments to hosts, whereas hotels spend just 30-35% on labor.) At the margin, that might increase municipal governments’ appetite to host such events. Omaha 2024, anyone?

spareBEDbug©The Economist Newspaper Limited, London (January 9, 2016)

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