By Hans Detlefsen
As Airbnb and other short-term-rental platforms have grown during the past decade, regulators and hotel industry associations have fought to limit their impacts. The hotel industry has generally viewed these new platforms as competitive threats. As such, the hotel industry sought to level the playing field by asking municipalities to impose taxes and regulations on short-term rentals that would be comparable to what hotels experience.
Overview of Short-Term Rental Policies in Chicago
In Chicago, the effort to constrain the short-term rental industry went farther than just leveling the playing field. Airbnb bookings are now taxed at a higher rate than hotels. Aldermanic privileges have created sizeable barriers to entry for would-be hosts. The City of Chicago implemented a new registration fee that short-term rental hosts must pay every year.
Combined with the pandemic, these policies were temporarily successful in reducing Chicago’s inventory of short-term rental units. The supply of active short-term rental units in Chicago has declined from approximately 10,600 at the end of 2019 to about 5,500 in the first quarter of 2022. HA&A has identified four main factors that we believe have contributed to this trend.
1. Pandemic – Many hosts removed their listings from Airbnb and similar platforms during the Covid-19 pandemic. Some hosts were concerned about safety and uneasy about letting strangers into their homes during a pandemic. Other hosts were concerned about liabilities. Many hosts were not traveling during 2020, so they did not have any dates available to rent out their primary residences anyway. And some hosts simply determined that the sharp decline in travel demand during the pandemic meant it was no longer worth the headache and cost of trying to rent out their units.
2. Airbnb Cleaning Protocol – During the pandemic, as Airbnb was attempting to prepare for their IPO, the company published a strict new cleaning protocol. All hosts were required to sign off on the new protocol to remain actively listed on the Airbnb platform. Despite good intentions, this protocol was deemed overly aggressive by some hosts. When interpreted literally, it made hosting cost prohibitive for many listings that were furnished or equipped like a primary residence. This new cleaning protocol led to a further reduction in active listings, especially among hosts renting their primary residences who opted out.
3. Aldermanic Privilege – Chicago city council members (aldermen) enjoy an unwritten veto power in council votes affecting their own wards, especially in cases of zoning, variances, and related regulation. Some council members, such as Alderman Marty Quinn (13th Ward), have used this power to veto applications from homeowners in their wards that seek to register homes on short-term rental platforms. The effect of these campaigns to fight short-term rentals has further reduced participation, by curtailing the property rights of homeowners in certain wards.
4. City Registration Fee – In 2021, the City of Chicago implemented a new, annual registration fee for all short-term rental units. Hosts are now required to pay an annual registration fee of $125 to the City, to maintain an active listing, regardless of whether they end up renting out their unit. This has especially affected hosts who occasionally listed their primary residences on short-term rental platforms. If you only rent out your home a few days per year, this new administrative burden and fee, make the business case for participating much less attractive. However, if you are a professional management company renting out multiple units every day of the year, then this new registration fee is less burdensome, when measured as a cost per occupied room night.
The first factor has been largely reversed since lodging demand began rebounding in 2021. According to our interviews, many Airbnb hosts have experienced 2021 occupancies and ADRs that exceed their prior peak levels of performance. This is partly due to the mismatch in supply and demand; as demand rebounded, supply continued to decline in Chicago.
The second factor was also reversed, as Airbnb revised their cleaning protocols. The company individually contacted former hosts to explain the policy reversal. Airbnb’s current cleaning protocol has removed much of the overly strict language that had scared off former hosts.
But the other two factors remain in place, continuing to limit and reshape the short-term rental industry in Chicago. Aldermanic Privilege has not been challenged or successfully countered; instead, this anti-Airbnb policy stance has spread to multiple wards, especially in wards with Aldermen seeking to score political points by turning short-term rentals into a political wedge issue. The City’s registration fee also continues to limit participation by hosts renting their primary residences and other small operators.
Filling the Void
The rapid rebound in demand, combined with the rapid reduction in supply, has led to a high-performance period for those left standing on Chicago’s short-term-rental playing field. Many operators report 2021 as their peak occupancy year, even with several months negatively affected by the pandemic and restrictive travel protocols. The winners have generally been multi-unit owners with professional management. The losers have generally been single unit owners, owner-operators, and hosts who occasionally rented out their own primary residences while out of town. In short, professionals are winning while the amateur hosts are losing. As a result, we are witnessing a rapid professionalization of the short-term rental industry in Chicago.
Professional investors and operators are filling the void that was created by Chicago’s recent reduction in supply. According to some confidential interviews with developers, we estimate more than a dozen short-term rental development projects are planned in Chicago for 2022. All of these projects involve large, multi-unit buildings. All seek to retain professional operators. Moreover, each project aims to market all of their units year-round as full-time lodging operations. So, the new supply filling the void will be much more like traditional hotel rooms – with standardized guestroom designs, year-round operating strategies, and professional management.
One goal of Chicago’s policies was to limit the competitive impact of short-term rentals on the hotel industry. However, these policies are beginning to backfire. A series of unintended consequences are leading short-term rentals to have a more direct, competitive impact on the hotel industry. What is happening and how is it worse for Chicago hotels?
There are three important unintended consequences that current and prospective hotel investors in Chicago should consider. Firstly, the total competitive supply from short-term rentals may increase even though the number of active rentals has been decreasing, if permanent supply replaces elastic supply. Secondly, there will be less geographic and product differentiation as single-family homes from diverse neighborhoods become increasingly displaced by centrally located, multi-unit properties. Thirdly, as the short-term rental industry shifts more towards professionally managed properties, these properties will increasingly be marketed more directly to traditional hotel guests as professional operators increasingly implement more sophisticated revenue management and channel management strategies to maximize revenues. Let’s summarize each of these effects in turn.
How can supply increase when the number of active short-term rental units is decreasing? The number of nights each unit is available is the key. Supply in the lodging industry can best be measured by the number of available room nights. This supply metric is the product of (i) the number of units built multiplied by (ii) the average number of nights each unit is available in a year. [Units x Nights Available = Annual Supply]
Suppose Market X has 10,000 active short-term rental units that are rented out an average of 14 nights per year. In this example, Market X has 140,000 room nights of added supply from these short-term rental units each year. Furthermore, if these units are primarily rented out during peak demand periods, when many hotels are sold-out anyway, then the supply impact on traditional hotels may be negligible. One silver lining of the Airbnb platform was that many hosts were induced to rent out units when demand spikes outstripped supply. As a result, these short-term rental units made lodging supply more elastic, expanding during demand peaks and constricting during demand troughs. They primarily accommodate pent-up demand that otherwise could not be accommodated in the market. Supply elasticity is a good thing for the hotel industry.
Contrast this with Market Y, which has 5,000 active short-term rental units that are available 365 nights per year. Market Y has 1,825,000 room nights of added supply. Moreover, Market Y gets none of the benefits of elastic supply. These 5,000 units are operated year-round and can have a severely negative impact on traditional hotels during the slowest periods of demand.
So, Market Y has 50 percent fewer units than Market X. But Market Y has 13 times more competitive supply, measured in room nights available, than Market X. Moreover, the average impact of the new supply in Market Y is more negative on the hotel industry than the relatively elastic supply in Market X.
Investors in Chicago’s hotel market should consider that current policies incentivize a less elastic lodging supply than what existed a few years ago, and Chicago’s lodging inventory will likely be less elastic than other markets that have not imposed similar policies that deter amateur homeowners from participating in platforms like Airbnb. Policymakers in other parts of the country may wish to learn from the experience of Chicago and craft more nuanced policies and regulations to keep short-term rentals safe without the unintended consequences. In general, we recommend considering policies that maximize supply elasticity; encourage diversity of product and location; and allow amateur homeowners to compete on a level playing field with professional short-term rental management companies.
 Detlefsen discussed the positive aspects of elastic supply (or seasonal supply) when interviewed by Long Live Lodging for a podcast titled Disruptive Innovators. It was broadcast on July 10, 2019. His comments are shared at approximately 18:05 through 23:30 on this podcast: https://longlivelodging.com/disruptive-innovator-measuring-airbnbs-impact-part-1/#.YgaZLt_MIps