Outside investment has been pouring into the short-term rental industry for the last seven years with increasing intensity, but on the heels of Airbnb’s IPO success story, the funding frenzy is now in full swing.
“This year, the investor funding level for startups is tracking at a pace of about 40 percent above the most recent investing peak in 2018, according to data tracker PitchBook,” Skift reported. “The vacation rental sector has drawn attention in light of the success of Airbnb’s initial public offering.”
According to C2G Advisors CEO Jim Olin, “The Airbnb IPO and the pandemic have made our industry ‘sexy,’ so now the investment community looking at us for the first time wants to brand us something that makes it even sexier.”
The news story du jour is Vacasa’s purchase of TurnKey Vacation Rentals for an undisclosed sum. Since 2013, TurnKey raised $120 million through seven funding rounds. By comparison, Vacasa raised $634 million over the same period.
However, hundreds of millions of dollars of investment into short-term rental (STR) companies were wiped away in 2020 via business closures, including $179 million at Lyric, $62 million at Stay Alfred, and $116 million at Domio. Even before the pandemic, Tripping closed after raising $60 million, and LeisureLink shut its doors after bringing in $42 million.
Yet, the money keeps coming. Cosi announced just last week that it had raised $23.7 million, and a few months ago Casai raised $48 million.
With so many companies folding under the weight of inflated investment and so few funded companies reaching sustainable profitability, we’re left to wonder―what is it that the investment community doesn’t understand about the STR industry?
The “Investment Community”
First, who are these investors?
“The ‘investment community’ is a broad term that encompasses venture capital (VC), private equity (PE), family offices, and other various funds and firms,” explained Jacobie Olin, president at C2G Advisors. “They all have different objectives when focusing on the short-term vacation rental industry. Some want to disrupt the startup ecosystem by attempting to solve pain points through technology. Others are trying to ‘roll up’ different verticals, while others are trying to do a real estate play. Airbnb’s recent IPO brought a new wave of exposure on our industry.”
“From our various conversations [with investors], the high-level points that the investment community does not fully grasp are 1) the niches within the STR industry―urban vs leisure, single-family vs multi-family, various business models, and asset ownership―and 2) complexities within the industry―how localized each market is, customer segments (homeowners and guests) that are at many times diametrically opposed to each other, and how operational intensive the business actually is.”
Rented CEO Andrew McConnell added that it’s not just investors who lack understanding. “There are many things people outside of the day-to-day, and hand-to-hand, of this industry do not understand,” McConnell said.
Fragmented Doesn’t Equal Stupid
The vacation rental industry is often described as fragmented and mom-and-pop. These descriptors seem to lead investors to believe that the sector is unsophisticated and antiquated.
“Many investors that I have spoken with in the last year still view the short-term rental industry as a fragmented cottage industry of mainly individual homeowners with rogue businesses and Airbnb listings,” said Amber Carpenter, CMO at Acme House and founder at DemandIQ.
“One of the big things people miss is that the reason there is not ‘yet’ the same kind of consolidation in this industry as we see in hotels is not simply because ‘smart’ people haven’t tried it yet,” Andrew McConnell said. “Many times, over many decades, smart people have come in thinking everyone in the industry had it wrong, and they will fix it (with technology, etc.). Then they face the harsh realities of the incredibly manual, and fickle ground game that this industry requires. Code integrates well and efficiently; super manual on-the-ground operations, less so.”
McConnell continued, “Investors see the large top-line revenue and the quick bursts of growth you can get from M&A and think the margins will come later with scale. The reality ends up often being that scale decreases those margins as the increased complexity grows geometrically, not linearly, as you add nodes (markets, owners, etc.). More money will be spent―and lost―chasing this mirage, that’s for sure.”
Jeff Paglialonga, founder and CEO at Teeming Vacation Rentals agreed, “Wall Street and big money look at this sector as ‘beneath their so-called smartness.’ Little does big money know we (independent operators) are killing it.”
Metrics, Management, and Money
According to Simon Lehmann, founder and CEO, AJL Atelier, “[Investors] don’t understand the fact that we deal with privately owned assets, the challenges that this brings to our industry, and the impact it has on the unit economics.”
Unit Count Doesn’t Correlate with Success
“First of all, when it comes to inventory you are not signing a ten- to twenty-year lease on a building with 200 rooms as with a hotel. You are talking to each individual homeowner every single year, and they change,” said McConnell.
“Unit count alone is not a measure of success,” said Robin Craigen, cofounder and CEO at Colorado-based Moving Mountains. “Guest review scores, owner satisfaction and retention, a stable, experienced and passionate employee pool backed by a strong company culture for delivering exceptional hospitality, and―wait for it―profitability, are the metrics that investors should be considering.”
“It’s not easy to scale and achieve all of these, and without all of them, the business is not sustainable,” Craigen added. “All that glitters is not gold.”
Experienced Management is Critical
“The VR industry is extremely complex, and an industry-experienced leadership team, especially a competent CEO or Managing Member, is essential to financial success,” said Steve Milo, founder and CEO at VTrips. “Conversely, incompetent leadership in this sector, especially at the CEO level, can drive a good company into the ground. Pretty pitch decks and cute cookie cutter business models may raise money from VCs, but they have never proven to work in the property management sector. If that was the case Domio, Lyric, Stay Alfred and other urban players would still be around instead of going out of business the first time they faced adversity.”
“There are no shortcuts to building a profitable business.” Milo said. “Profitability is a mindset and a culture that starts at the top of the business with leadership. It is very difficult to make a business that had a culture of zero financial discipline profitable. It is not about who raises the most money. At the end of day, it is about increasing shareholder value not PE-preferred shareholder value that is the #1 score board.”
“Investors and analysts should consider how a company fared during adversity like a natural disaster or COVID-19. If a company had to lay off 90 percent of their staff and get emergency funding of $100 million at a massive down round to allow them not to go out of business, that company is not a market leader unless it is opposite day,” Milo added.
The Language of Profitability
“The best perspective on the vacation rental community right now as an asset class is to think about a vacation home not as a commodity but as an operating company doing what all operating companies do―seeking to maximize revenue and minimize costs,” said Clark Twiddy of North Carolina’s Twiddy & Co. “As the investment community assesses vacation rentals, I think the primary barrier―if any―is one only of language. For example, if we reframe annual booking revenue into something more akin to a more conventional equity measure―earnings-per-share, for example, I think we’re bridging language. As an additional example, if we describe a sales price to a vacation home as in many ways a reflection of a price-to-earnings ratio, we’re bridging language.”
“The more we’re able as a vacation rental community to bridge those language barriers, the more genuine interest I believe we will find from the investment community,” Twiddy added.
Localized Operations Hinder Scalability
“Vacation rentals are deeply connected to the specific place they are located,” said Margot Schmorak, cofounder and CEO at Hostfully. “Management of each requires a local-centric approach. This goes for revenue optimization, handling policies and regulations, and maximizing auxiliary revenue from in-destination tourism spend. The one-size-fits-all ‘let’s standardize and save money’ approach will not work at scale like it can for hotels. It requires a more flexible approach so unique local factors of a rental can be part of the value proposition. Otherwise, lost revenue will continue to be left on the table.”
In Texas, Sand ‘N Sea owner and manager, Claire Reiswerg, pointed out that funded multinational VR companies can actually cause harm to destinations. “Vacation rentals located in traditional destinations are local businesses,” said Reiswerg. “We live and work here. We support local causes and are connected to the community. We are also well-versed in local ordinances and neighborhood rules, and we respect them all. National companies and investor-modeled VR companies come in to our markets and ignore―or don’t bother to learn―the specifics about a community. It wreaks havoc and creates tension with our community. The result? Complaints abound as do threats of rental bans.”
“In January, we were banned from a longtime bayside neighborhood thanks to the less-than-desirable operations of an investor-model company, and now the neighbors and HOA are mired in lawsuits,” Reiswerg added. “We are also now battling two other proposed bans on the island.”
Christina Thoreson, cofounder and CFO at Chattanooga Vacation Rentals has also experienced the impact of funded companies lacking local knowledge, “Like real estate brokerage, vacation rental management is hyperlocal. You have to know laws and regulations, who to go to for plumbing and electrical, and what events and circumstances might disrupt a guest’s experience, to name a few. For example, we had a direct experience with Mint House ($33 million in funding) wanting us to manage one of their properties in Chattanooga. They said they had master leased several apartments in a newly renovated downtown building. We asked about their permit, They said it’s all fine, and real estate handles that. Six months later, they had two furnished units that were still not approved, and lots of supplies in our office, which they loaded up and moved back out. It seemed to me that investors put in a lot of money, and there was limited concern about how it was spent.”
Paglialonga provided another example of how a lack of market understanding severely limits scalability. “Vacasa has done a decent job of becoming local but are still way behind in local pricing and market knowledge,” said Paglialonga. “For example, Florida is mainly a condo market, and probably the largest rental market in the world. Once you get into having to do applications for guests and deal with all the condo restrictions, scalability goes away quickly. That is why the Vacasa’s and the TurnKey’s have not succeeded in the ‘restricted’ Florida condo market. Panama City Beach is the primary ‘nonrestricted’ condo market in Florida, and about everyone is there which has led to a race to the bottom for commission structure. Hence, it is not a place venture capitalists would find success. Nothing is proprietary there.”
Alex Nigg, founder and CEO at Properly, added, “I seriously wonder whether anybody has shown national or international economies of scale beyond the unbundled managers the listing platforms. What we’ve been seeing so far has basically been stringing a series of local markets together, and then pretending that this amounts to economies of scale beyond the local market.”
Vacation Rental Management isn’t a Tech Play
Nigg added, “If the business had national or international scale you’d expect it to spend more on the scalable bits (technology, brand) over time, and less on the non-scalable ones (operations, sales, asset acquisition, etc.).”
Yet, investors are applying technology multiples to a non-tech sector.
For example Milo says he’s learned that hosted systems provide tremendous opportunities and economies and can be “far more efficient to building a profitable and scalable business than trying to manage internal software IP.”
“They think we are a ‘tech play,’ which we are not, and that we should be valued off revenues and not worry about profit, which is so wrong. Wall Street vs real businesses sometimes are complete opposites,” said Jim Olin. “We are managers, plain and simple, and the best of us throw off large amounts of cash when run correctly.”
According to Audrey Leeds Miller, cofounder and managing director at Cottage Connection of Maine, “It is the wild-wild-west in the VR industry right now. Ethical, eco-centric, consumer safety policies, and sensible regulation are going to become more prevalent. Demand is currently high because of COVID. This will slow down when travel restrictions are lifted and Americans can go to other parts of the world.”
“The feeling on the street is that these national companies are building up their inventories so that they can sell their ‘book’ to a bigger conglomerate,” Miller said. “Just as in the .com era the .com companies didn’t have to prove to investors they were profitable. There will be winners and losers this time too. To build up their ‘book’ they are challenging the small local businesses that have to show a profit to stay in business.”
Miller advised, “Investors should review what happened during the .com bubble, remember that the vacation rental industry is based on relationships, and plan accordingly,”