What do the theory and the results of studies from different cities show so far?
How has the global emergence of ridesharing changed the dynamics of housing markets? Dozens of studies from different cities confirm that the development of short-term rentals is associated with an increase in housing prices. The phenomenon has become known as the "Airbnb effect" because Airbnb was the innovative company that first enabled mass short-term rental housing. Nowadays, there are other alternatives to Airbnb, but the business brand remains synonymous with short-term rentals. This article aims to explain why short-term rentals lead to an increase in house prices. To this end, it examines how the Airbnb effect affects the demand and supply of residential properties.
Supply Mechanism: Transition to Short Term Rentals
The outflow of housing from the long-term rental market to the short-term rental market is fundamentally changing the supply of residential properties. Of course, the main driver for this is the opportunity to make more profit from short-term rentals. But also in certain situations, property owners can benefit from the flexibility of short-term letting. For example, when they decide that they will use their apartment, but not permanently. Or when they use Airbnb as an alternative without committing to long-term tenants, while planning to sell their home in the near future. With a sufficient critical mass of such homeowners, the supply of long-term rental apartments decreases at the expense of the growing number of Airbnb apartments. The smaller number of available long-term rental housing leads to higher competition between tenants, and therefore an increase in traditional rental prices. The increase affects house prices, as the price of a property can be seen as the value of the sum of all future cash flows that the house can generate. Investigating this market mechanism in different cities, the empirical studies done so far establish:
- 1% increase in active US Airbnb properties from 2012-2016 leads to 0.018% increase in rents and 0.026% increase in home prices nationally
- Airbnb activity for the period 2009-2017 in Barcelona leads to a 1.9% increase in rents and a 3.7% increase in housing prices; in the hot tourist districts, rents increased by 7% and prices by 17%
- For the 2014-2018 period, the effect of short-term rentals across Los Angeles was a 3.6% increase in home prices; for the attractive parts, however, the increase is several times greater - in a range of 2.5 kilometers from Hollywood, the growth in property prices is 15%
There are similar established results for a number of other cities such as Amsterdam, Paris, Beijing and others. From the results so far, what stands out is that short-term letting is a phenomenon that has the greatest impact mainly in the central and tourist areas of large megacities. The reason is that the main driver of demand for short-term rentals is tourists, and the central city areas are where the entertainment, historical sites and commercial attractions to visit are located. But more on the search later. What is of further importance in relation to the supply of properties in the center are the constraints that cause inelasticity to characterize the market in these parts of the city.
The inelasticity of the supply of properties in the center.
Why are city centers attractive to investors?
The center finds itself with limitations for both geographic and market and regulatory reasons. Since ancient times, central urban areas have played a significant role and have been the heart of the city, where the markets between buyers and sellers are concentrated and created. To this day, the downtown area is one of the most competitive and attractive for all kinds of private and public activities, making the area densely built up. Thus, the central areas are not only geographically limited, but it is also more difficult to find new terrain on which new housing can be built. What's more, downtown building regulations tend to be stricter. Firstly, because of the scarcity of empty spaces, and secondly, because a large part of the architectural-historical heritage is located and preserved there. The combination of all these constraints causes property markets in central parts of cities to be more inelastic in terms of supply than in other residential areas, making prices in the center more volatile than normal. The more inelastic the supply, the more difficult it is to create new housing in central locations. Then, in the absence of the ability to build enough housing, with increasing demand for property purchases, the market achieves equilibrium by more sensitive price increases, rather than by creating new supply.
Notes: The initial position of the graph is at the housing market equilibrium value P0. The price is formed at the intersection of demand ("Demand 0") and supply in the market where there is Q0 per number of properties for sale. As demand increases, the demand function shifts up and to the right (from "Search 0" to "Search 1"). Two parallel cases follow. Under Elastic Supply, Q2 number of homes for sale appear on the market, and the price increases from P0 to P1. In Inelastic Supply, the inability to build more homes for sale is reflected in Q1 being less than Q2. The equilibrium market value under inelastic supply rises from P0 to P2, which is a higher price when supply is elastic (P1).
How does the dynamics of home purchase demand change in the presence of a short-term rental market?
Given the inelastic supply in the inner city, what exactly would be the mechanism by which Airbnb should influence the increase in house prices in the area from the purchase side? As already mentioned, central apartments are becoming an alternative that attracts a significant part of the influx of tourists and business travelers to the cities. In such a case, property owners in these parts are targeting the short-term market. When the alternative becomes a more profitable venture than long-term letting, this process generates new demand for buying homes in the area among investors motivated by higher yields and returns on residential property investments. Due to the inelastic supply resulting from the increased demand to purchase property in the city centre, this new demand will be more tangibly capitalized into existing house prices in the area than the same demand in other areas of the city with more elastic supply.
Conclusion
The article presents an analysis of how short-term rentals affect housing prices in different cities around the world. It becomes clear why some cities are experiencing such an aggressive "Airbnb effect" - this phenomenon can simultaneously put upward pressure on housing prices on both the supply and demand sides. The question remains - is it possible that the theory suggests how the Airbnb effect would also manifest itself in Sofia? In fact, a similar study is currently being conducted for our capital as well. When the results are available, we would be happy to share the observations and how well they fit the theory of the Airbnb effect.
Author: Iliya Sarandaliev
