The Victorian short term 7.5% accommodation tax is being imposed at a time when increased interest rates have stifled demand and fixed overhead costs have escalated. Is the new tax the straw that broke the camel’s back for budget short term accommodation? Is it time to re-evaluate your business model particularly if you are operating a value or budget one? I think so. My analysis has driven me to a new approach where I have lifted tariffs across the board of 30%. Read my reasoning below and comment on whether you see this as a business as usual scenario or you see this as a point to re-access strategy? If you are changing your business model, then in what way?
The reasoning is somewhat complex and detailed. If you are not operating in Victoria, or in some other area with or expected to have a very high short term accommodation tax, then you may not wish to read past the summary above. However if you are operating in another jurisdiction which has also introduced a very high short term accommodation tax (I think Victoria’s is the world’s highest) then comments on your experience as to how it has affected occupancy and ability to cover fixed overheads would be appreciated by hosts in Victoria.
We have been in short term accommodation business for 50 years. We started with a slightly neglected three bedroom pre-war workman’s house in the Victorian High Country near Falls Creek alpine resort. From the beginning our plan was to let out short term when our family did not need the house. After an initial spend to bring the house up to a very comfortable level above average for the area at the time, we have gradually and continually improved the house in comfort and convenience for guests.
Our business strategy for 50 years has been to operate in the value segment. Better than average facilities but lower than average prices. This has given us high occupancy and good revenue to re-invest in progressive comfort improvements and reduction in operating cost. To be successful this business model requires a low cost operation. We have kept costs very low by astute purchasing, doing as much of the maintenance and upgrades ourselves. Checkout cleaning and lawn mowing we outsource, but the deep cleans and other gardening we do ourselves. We do not provide linen as commercial laundry is very expensive in our area. There is a big demand from guests who wish to save by bringing their own linen. You cannot run a low cost holiday house model using a commercial laundry service, in my opinion. Now that we have invested in PV, battery and heat pump our variable cost per booking is significantly lower.
My observations indicate that our bookings are divided onto two basic segments. The savvy and repeat guests in one segment. Savvy guests who research their accommodation well and recognize the extra value we provide. Repeat guests who originally attracted on price and return for the value. The other category is the budget guests who only look at the pictures and book the cheapest or near cheapest price for attractive pictures.
Despite our low variable cost, our business model has been under pressure from escalating fixed annual costs that need to be covered by the variable margin on every booking. Government imposts are a key factor in this escalation. Our local rates now have a 43% surcharge for short term accommodation, we have been hit with land tax, and water rates have skyrocketed, and on top of this insurance cost has doubled. Airbnb takes 18.8% of the guest payment. The last straw is the 7.5% Victorian short term accommodation tax. A low cost, low price, high volume business model requires both low variable cost and low fixed cost. We have kept our costs low but high government charges have destroyed the value model for short term accommodation. On top of this high interest rates have savaged the budget segment of the holiday market. It feels like every arm of government is deliberately sabotaging anyone trying to offer budget holiday accommodation.
I have reassessed our business strategy. In my opinion the value segment we have so successfully operated in for 50 years is dying. We have decided our only option is to move to a high price, high margin business model as a way to cover the escalating fixed costs. When the post covid revenge travel boom hit, some of our competitors hiked their prices and left us behind in the pricing ladder. We increased tariffs only moderately and got a big boost in revenue and profitability. We reinvested funds in improving guest comfort and convenience, but most of the investment went into energy saving equipment to the extent that our net annual energy cost was reduced to almost zero. However the downside of very high occupancy is escalating wear on furniture, furnishings, bedding, appliances and increased internal maintenance and repair. Of course this is part of the variable cost for each booking and is included in the pricing calculation. But when these assets wear out it is a big capital commitment.
We modeled various alternatives. Reducing tariffs by say ten percent to offset the 7.5% tax and boost occupancy is unlikely to work in the current economic where demand is already down. A moderate increase in tariff of say ten percent, with lower demand due to high interest rates will not be sufficient to cover the increased insurance and government taxes and rates.
My modeling suggests the best strategy is to increase tariffs substantially by thirty percent. This will move our pricing from being in the bottom twenty percentile to moderately above average, but not massively out of line with other houses in our area offering similar facilities. Based on previous comparative pricing in the area. This will increase our marginal profit per booking by 35%. It is moving us from a Value business pricing strategy to an on market pricing plus strategy. It seems that high interest rates have already reduced the budget segment by about 20%. I expect that the 7.5% tax price increase will reduce bookings by a further 5%. Increasing our prices by 30% I assume will reduce bookings a further 20%. So a total reduction in budget bookings of 45%. With the savvy and repeat segment we expect the reduction will be 10% after increasing tariff by 30%. The overall net reduction we expect will be an average of 30% with a product mix of two thirds in the lower prices off-season and one third in the high season.
I have taken into account that in areas where there is significant individual short term accommodation it creates competition and it depresses how much the commercial providers such as motels and holiday flat complexes can increases prices and therefore restricts their profitability. The short term tax will reduce the competitive pressure, as commercial operators are not subject to the tax. In other jurisdictions controls and taxes on short stay accommodation has resulted in hotels and motels increasing prices and I expect that Victoria will be no different. The commercial operators can increase prices by 7.5% without affecting their relative competitive position, and it is reasonable to assume that they will do so.
As I see it there are two ways to attack this situation. One approach is to just increase prices as usual to cover the higher costs, such as land tax, rates and insurance etc. and wait and see what impact the 7.5% tax has on occupancy rates. Then when occupancy rates fall as I am sure they will, increase prices the next year to make up for the lost variable margin. When occupancy falls further due to the higher prices increase prices again for the following year to make up the reduced margin. After three or four years you will achieve equilibrium but you will have four years when you have not adequately coved your fixed overheads.
The alternative approach that I think will work better is to go hard with a new strategy and increase prices substantially from the get go to offset the expected reduction in occupancy. The advantage of being a small operator is that you can be flexible and agile. If occupancy drops much more than expected after a price increase you can quickly reduce prices to see it if it stimulates enough extra demand. But once you have accepted bookings at too low a price there is nothing you can do about it.
Overall despite a 30% reduction in bookings we expect the 30% higher tariff will generate sufficient marginal profit to cover the increased overheads of insurance and government rates taxes etc. The 7.5% tax on top of our 30% tariff increase will raise our prices to be payable by guests for 2025 to be 40% above 2024. This is sad situation where we are forced into a major reversal of business strategy. We do not aim to make significant profits from our holiday house. However after so many years of investment in time and money on our holiday house focused on guest needs we believe that now it is reasonable that short term letting for the vast majority of the year that we do not use it ourselves should generate sufficient revenue to cover all costs plus some free cash flow for modest continual improvements.
It is hard not come to the conclusion that the government wants to punish budget holiday makers. The 7.5% short term tax gets added on top of the tariff increasing the cost to cash strapped families. All levels of government also seem to have an ideological attack on people renting out their holiday homes when not using them. Local government with special levies on short term rental holiday houses, and the Victorian government with land tax and the new 7.5% levy. Annual fixed costs are being escalated at the same time that the number of days booked per year to cover the cost are reduced due to high interest rates impacting guest’s budgets to go on holiday.
Big companies and government authorities are having no reluctance to pass on their cost increases so while we would like to continue operating a value business model, a 30% Tariff uplift to a high margin, low volume model appears the only practical choice.
How are other Victorian hosts approaching the new situation? If you are from an area which also imposed a very high short term accommodation tax what was your experience?