Short-term rentals are a ticking time bomb for residential property

Tougher regulation of short-term renting may be inevitable, which could have significant implications for property related investments.
Brad Matthews

Brad Matthews Investment Strategies

Travelling on a bus down the main street of Newcastle (NSW) a few years back, I sat behind a couple of locals who were doing it tough and looked like they had done some rough sleeping. They were discussing accommodation options as we passed various establishments. One pub was $100 a night, another was $110. 

At that time, I was lucky enough to be renting a small studio apartment in Circular Quay with harbour views for $460 per week

The comparison was salient in that a property with one of the world’s most iconic outlooks was effectively 35% cheaper than what was being charged nightly for the most basic of accommodation in a regional city. This anomaly highlighted the difference in the economics between the short-term and long-term rental market.

However, technology is rapidly removing the barriers between the markets for short-term and long-term residential accommodation. 

Platforms such as Airbnb have made it possible for landlords, who would otherwise have only considered the option of long-term rentals, to offer their properties to the more lucrative short-term market. Estimates suggest there are more than 200,000 properties available via short-term rental platforms in Australia.

Undoubtedly short-term rental technology platforms offer convenience and efficiency to both the landlord and tenant and may contribute to the economy’s aggregate income by boosting our capacity to service foreign tourists. However, these platforms have some downsides as well. Most notably, rental affordability is likely to be negatively impacted by a shift in properties away from long-term rental markets. 

The current rental crisis, which has long-term rental vacancy rates of just 1.0% nationally, is likely to be attributed at least in part to the growth in the popularity of short-term rentals.

This historically low vacancy rate belies the fact that Australia has come through a period of unusually low population growth at a time when residential construction has been high. In fact, the 1 million new dwellings completed in the 5-years to December 2019 (just prior to the COVID crisis) was some 41% above the longer-term average level of dwelling completions.

The downside of the growth in short-term rentals

Higher long-term rents, due to properties increasingly being diverted to the short-term market, is not only a social problem but is also contributing to inflation. Rents have a 6% weight in the Consumer Price Index. Rental increases of the magnitude currently being experienced can have a material impact on inflation and therefore indirectly lead to higher interest rates and lower house purchase affordability.

From an overall economic efficiency perspective, it could also be argued that the accommodation needs of those seeking short-term rental accommodation are better served by custom-built and managed hotel and tourist facilities, rather than standard residential housing stock. 

Hotels are generally run with higher occupancy rates and lower floor space and land footprints per occupant than the “cottage industry” approach of the short-term rental platforms. As such, the call on the economy’s scarce resources and infrastructure is lowered via tourists using fit-for-purpose tourist accommodations. 

Many who have experienced the encroachment of short-term rentals in their own neighbourhoods would also argue there is a loss of “community” and local area custodianship when long-term residents are replaced by short-term renters.

In 2019, the Mayor of Paris, Anne Hidalgo, suggested short-term rentals threatened to turn the city into an “open-air museum”.

Concerns over the negative effects of short-term rentals are magnified by the fact that there is no mechanism to cap the growth in its popularity. As many European cities have experienced, tourist numbers can overwhelm available infrastructure. With populations in excess of 1 billion each, tourist numbers from India and China will potentially grow exponentially as the middle class and wealth of these economies expands. 

This demand for tourist accommodation could see a much more substantial shift in supply away from Australian long-term renters, leading to further deterioration in rental affordability.

More regulation may be inevitable…with significant implications

Aiding the rapid expansion of short-term rental platforms has been somewhat opaque regulation addressing the practice. Traditionally, laws haven’t differentiated between short-term and long-term renting. Jurisdiction over the introduction of controls has been blurred between State and local governments and strata bodies. 

Complicating any consideration of increased regulation is the differing of needs of individual cities and regions. Many country holiday locations have relied on short-term rentals long before the likes of Airbnb came along and may prosper from the additional capacity provided by these platforms in punctuated seasonal peaks. However, left unchallenged, short-term rentals could completely change the character of other locations such as Bondi Beach.

Many overseas cities have more stringent controls than those generally existing in Australia. New York only allows rentals of less than 30 days if the property owner is present. San Francisco has similar arrangements. Other cities, such as Amsterdam, charge landlords a “tourist” tax on rentals.

Although not sitting neatly within its regulatory bailiwick, the prospect of curbing short-term rental activity may become increasingly compelling for the Commonwealth Government. 

There is unlikely to be any other supply-side reform that could so quickly address the dual policy objectives of lowering inflation and addressing rental affordability. With National Cabinet possibly having all mainland State Labor Governments from March 25th, the potential for centralised coordinated housing policy has never been greater.

The Reserve Bank’s reference to rental costs in their Statement following the March Board meeting was notable as it highlighted an area of inflation that is outside of its control – and therefore implies other policy levers need to be engaged. In fact, higher interest rates are likely to add to rental inflation as landlords pass on the cost of higher interest rates. Increasingly, it would seem, there will be pressure on the Commonwealth Government to act to address inflation.

Opponents of increased regulation may argue that the efficiency of the free market is being compromised by an attempt to restrict the use of short-term rentals. However, the need for zoning of land for specific purposes is well accepted. 

It could be argued that short-term rentals are more akin to a commercial activity, which is incompatible with land zoned “residential” where there is an implicit expectation that this is land set aside for the population to “reside”.

At a time when residential property prices are already under stress, regulatory risks associated with short-term rentals should be a consideration for residential property investors. Any new restrictions could trigger the need for some landlords to sell their properties. Risks extend to other investment categories as well. 

A question that should be asked of any manager of a mortgage fund or private credit fund holding residential loan assets is “what percentage of their fund is backed by short-term rental income streams?”. 

There could be a fundamental difference in the credit quality of an owner-occupied residential loan vis-à-visa a loan backed by a short-term rental property. This difference in credit quality is unlikely to be currently reflected in the return offered to investors.

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This document has been prepared by Plain English Economics Pty Ltd, trading as “Brad Matthews Investment Strategies” (BMIS). Plain English Economics Pty Ltd is a Corporate Authorised Representative of First Point Wealth Management P/L AFSL 483004. Any advice provided is of a general nature and does not take into account personal circumstances. Any decision to invest in products mentioned in this document should only be made after reviewing the relevant Product Disclosure Statements. Past performance is not a reliable indicator of future performance.

Brad Matthews
Brad Matthews Investment Strategies

I founded the investment consulting business, Brad Matthews Investment Strategies. BMIS provides assistance to financial planning practices in developing their investment philosophy and creating portfolio solutions consistent with this philosophy.

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