The Economics of Short-Term Rentals vs. Hotels

When you go on vacation, where do you like to stay?  Thanks to the rise of short-term rental apps like Vrbo and Airbnb, it is a quick and simple process for vacationers or business-trippers to rent vacant houses or apartments for short-term stays.  This has eliminated the monopoly of hotels on short-term vacation stays and given owners of multiple residential properties the ability to earn extra income.  However, the short-term house rental market is not without controversy, and recent trends have seen hotels regain some popularity among vacationers.

History of Short-Term Rental Websites

Although most consumers are familiar with the apps, websites for short-term property bookings came about during the mid-1990s.  These websites were administered by the property owners themselves and were thus more of curiosity than a market.  In 2003, Couchsurfing.org became a sensation as people could list their couches as a place for travelers to “crash” overnight.  The movement was nonprofit and focused on sharing culture, achieving over 3 million members by the end of 2011.  

In 2007, the idea behind Airbnb was born when two men figured they could rent out mattresses in their San Francisco apartment during a popular conference.  The idea took off, with many people around the country seizing the opportunity to make extra income off unused property in desirable areas.  “Air Bed and Breakfast” quickly became a major player in the short-term vacation rental market, and a decade after its inception had three million rentable locations posted in almost two hundred countries (meaning, essentially, worldwide).  A strong rival, Vrbo, rebranded in 2019 and listed about two million rentable locations.

Economics Behind the Rise of Short-Term Rentals

Low Marginal Costs

Building a hotel is an expensive and time-consuming process, complete with lots of bureaucratic restrictions like zoning laws.  Therefore, the marginal cost of building a new hotel is very high.  Short-term rentals in existing residential properties have very low marginal costs because they already exist.  Typically, little work needs to be done to turn a summer home, vacation home, mother-in-law suite, separate apartment, or converted shed into a short-term rental.  These units were already built to shelter people, so marginal costs may be limited to simple cleaning.

Elasticity of Supply

Demand and price for lodging have to rise considerably to make it a worthwhile investment to build a hotel, which is likely designed for a multi-decade life span.  This makes the elasticity of supply for hotels relatively inelastic, with a significant increase in price allowing only a small increase in quantity supplied.  Investors must be confident that demand will remain high over the next few decades to justify enough return on investment (ROI).  This means that short-term increases in popularity of a city, such as a concert or sporting event, will not be met by new hotels.  Rather, short-term rentals can meet that increase in demand quickly, as the structures already exist. 

Economic Challenges of the Short-Term Rental Market

Rapid Fluctuations in Supply and Demand

Due to low marginal cost and highly elastic supply, short-term rentals can quickly flood the market when demand rises.  This can be advantageous to some, but harmful to others.  The hotel market, by contrast, is much more stable due to the longer market period during which supply is completely inelastic (fixed).

Surplus Causes Price Crashes in Rental Market

In large cities, thousands of people can set up short-term rentals on apps virtually overnight.  This can cause a surplus of available rentals, driving down the price.  Critics have called this the “Airbnb apocalypse”, which allegedly hurt the hotel and long-term rental industries by undercutting them on price.  A $150 hotel room can scarcely compete when individuals are renting out their backyard mother-in-law suite for a third of that price.  Of course, falling short-term rental prices also hurt the owners themselves, who quickly discovered that they could not cover their costs.  

Shortages in the Housing Market Drive Up Prices

During the rise of short-term rentals in the late 2010s, many single-family houses were purchased by entrepreneurs and companies to become short-term rentals.  As a result, there were fewer houses on the market for families to purchase, driving up those prices.  In many cities, young families complained that they were being priced out of the housing market due to companies out-bidding them for houses that could be turned into revenue-generating Airbnbs or Vrbos.  

Neighborhood Resistance and Hotel Industry Lobbying

Angry residents in some towns and cities lobbied to place restrictions on short-term rentals, which they blamed for harming neighborhoods through trash, noise, and congestion.  There were also concerns about increased crime and negligent oversight or care of the rental properties, with rental owners concerned only about maximizing short-term profit and not about long-term neighborhood charm or stability.  If a short-term rental did go out of business, the property could be left unattended and become an eyesore, dragging down property values nearby.

Hotel industries in many large cities joined the lobbying effort, arguing that unregulated short-term rentals were unfairly undercutting them on price.  While hotels had to go through inspections and meet regulatory standards, short-term rentals rarely did, leaving vacationers in potentially risky situations due to unsafe equipment.  

Limits on Short-Term Rental Markets: Zoning Laws and Rising Fees

Some cities responded by changing zoning laws to outlaw short-term rentals, especially in single-family neighborhoods.  If you were going to purchase a single-family dwelling, it had to be a primary residence.  Other cities did not ban short-term rentals in specific neighborhoods, but did advance regulations on how many days a property could be rented out per year.  Others required expensive permits and introduced oversight to limit the number of haphazard rentals.

Overall demand for short-term rentals also cooled after 2020, with vacationers blaming excessive fees with pushing them back to hotels.  By the early 2020s, the novelty of booking an Airbnb or Vrbo had worn off, cooling demand based on consumer tastes and preferences, and rising prices through allegedly hidden or misleading fees were outraging customers.  These fees were often related to cleaning, with guests feeling they were unfairly charged fees retroactively for leaving their rentals messy.  Other guests felt the quality of short-term rental stays had declined in recent years due to decreasing amenities - perhaps due to owners overextending themselves by owning too many rental properties.  Hotels, by contrast, became seen as more stable and inclusive in terms of providing services advertised.