Realty turns pure financial arbitrage

Via FtAlphaville:

There’s a popular joke in finance that venture capital is just one giant ploy to subsidise millennial lifestyles.

While there’s an element of truth to this with ride-sharing, food delivery or ready-made meal kits, the service provided has always been in-kind — an underpriced meal, or a cheaper-than-cost taxi ride.

That is, until we came across an article in Sifted — a sister company of the FT — on Wednesday. From the piece [with our emphasis]:

It was two years ago when Chaouachi started Leavy, which announced a $14m funding round led by Prime Ventures on Tuesday, as a way to broaden the reach of the short-term online apartment rentals popularised by Airbnb.

The model is slightly different from its larger US rival. With Leavy, hosts receive a predefined amount of money when they hand in their keys, regardless of whether anyone stays or not. This is typically slightly less than Airbnb, but with less admin and it’s guaranteed.

Yes, you read that correctly, Leavy will guarantee a cash payment for your apartment when you’re away, regardless of whether the company manages to rent it out. Critically, it will also front you this money before the trip, according to TechCrunch.

As Benchmark’s Bill Gurley sniped on Twitter, “perhaps this is the natural result of near-zero rates”. Although he did also invest in Uber, so there you go.

Regardless, Leavy’s model of leveraging its own balance sheet to act as a principal, rather than an agent like Air BnB, does remind us of on-going debate in banking over which model is more effective, and therefore can extract the most rents.

It is fundamentally a question of risk. A principal gets a few big advantages over an agent. Its able to sit in-between both sides of a trade, and therefore extract easy rents when temporary mismatches in demand and supply emerge. It can also benefit from privileged information flows. Lend overnight at 0.75 per cent, and borrow overnight at 0.5 per cent, and Bob is perhaps your uncle. ‘Perhaps’ because if there’s no one to fund your lending, then there will be liquidity repercussions, as Leavy may find out. And equally because you may have priced the market all wrong, and can’t shift the inventory in time. A similar dynamic has played out in the sharing economy businesses — if both legs of a trip to the suburbs can’t be funded, the unit costs will quickly turn negative. There’s also the obvious balance-sheet exposure if something unexpected — like the gilets jaune start to riot on your street– happens and the real-estate becomes un-rentable.

On the flipside, Air BnB’s broker-like stance assumes less risk and therefore in good years will have lower margins due to an inability to take advantage of potential arbitrage opportunities.

For Leavy to succeed then, it will likely have to employ some core trading strategy to arbitrage the cash offers to home owners looking to fund a holiday, and the reality of the demand for the property in that week. The issue here is that, unlike in energy or rates trading, the product offered is highly heterogeneous. A barrel of brent crude in Nigeria is relatively fungible with one from Norway, an apartment in the 6th arrondissement less so with one in the Mission District. That denies Leavy the economies of scale that can be achieved in other commodity-based market-making models.

Extremely detailed specialist knowledge of real estate markets will instead be needed as well as a topnotch trading team incentivised by performance-related bonuses. That’s both expensive and time consuming to procure.

On another note, if Leavy does end up assuming the role of market-maker, those who think real estate is too heavily financialised already might be in for a rude awakening.

Still, those looking for an extra few euros to fund the winter break won’t be complaining. Where do we sign up?

Ah yes, the family home. Not. Doubtless coming to an Australia near you.

David Llewellyn-Smith
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