A Closer Look at Sonder’s Tech-Focused Bet on Next-Gen Rentals

Step into Sonder’s latest outpost in Philadelphia’s museum district and you could be forgiven for believing you were in a hip, almost boutique, hotel. One of the units, a studio apartment, has a four-poster bed and a kitchen stocked with cooking equipment and stainless-steel appliances.

But Sonder isn’t a hotel; it’s a serviced apartment licensed to run as a hotel. Serviced apartments aren’t new, of course. But Sonder is using technology to give the concept a fresh spin. Investors have invested $135 million in the San Francisco-based company since its founding in 2012. The startup runs currently bookable units in 13 U.S. cities plus London, Montréal, and Rome.

In the next year, Sonder expects to book about $250 million in revenue, said an investor pitch deck obtained by Skift. In 2018, Sonder’s daily rate averaged $201, across cities. The average daily rate ranged from $100 a night in Montreal to $300 a night in London and worked out to $129 per bedroom.

Last year, Sonder kept its units occupied about 77 percent of the time, on average. That meant that its revenue per available unit averaged $155, the deck said.

The company has served 260,000 guests. Last year, the average length of stay was four days. A third of guests stayed for business, while a fourth traveled as families, the deck said.

A Tech Company

Francis Davidson-Tanguay, Sonder’s 26-year-old founder and CEO, talked in an interview about his company as if it were a tech firm rather than a hospitality brand.

“A huge part of us having a competitive edge over a typical hotel is that we rethink and automate many processes,” said Davidson.

“The fact that hotels still have a person typing in who knows what when you’re checking in at a hotel is a complete joke,” Davidson said. “On everything from mobile keys to smart locks and housekeeping management, it’s really laughable how far behind the hotel industry is from a tech perspective.”

Davidson employs 50 engineers — and plans to double that headcount this year — out of about 300 full-time employees and another 300 contractors. The engineers streamline several processes from property selection to guest interaction.

“We view technology as the key input for each one of the functions of our business,” Davidson said. “It underpins how we acquire real estate, design and furnish our units, and handle day-to-day operations, and distribute our rates and inventory.”

Last year, Sonder built a machine-like process to design and open rentals. That machine is gaining speed. In the first three months of this year alone, it expects to add 1,900 units, raising the company’s total above 4,000, its pitch deck said.

Sonder uses technology to source properties and to avoid signing duds. It narrows down which ones meet local regulatory requirements for short-term rentals, for example. It then furnishes the units with items it sources and distributes via its own warehouses.

An image of a studio apartment for rent with a king-size bed, tall ceilings, and a fully-equipped kitchen with stainless steel appliances that is located in Philadelphia’s Museum District. Source: Sonder.

Skeptics Raise Questions

One critique of Sonder is that it is principally engaged in two types of real estate moves. The startup typically signs master lease deals where it pays a landlord or a real estate investment trust (REIT) a fixed amount each month on typically five-year initial leases, and it tries to earn more than that monthly rent by selling the rooms nightly. It generates free cash flow thanks to how quickly it can collect cash from travelers and how long it can wait to pay rent to property owners.

“What Sonder is practicing is arbitrage, and arbitrage only goes in one direction as a market matures and it’s down,” said Steve Milo, founder and CEO of VTrips, a professional vacation rental property management company based in Ponte Vedra, Florida, that exclusively manages 1,800 units.

“The problem is that the owners of these REITs — the Blackstones and Greystones of the world — are sharks who are loyal only to what maxes out their revenue,” Milo said. “So they’ll play Sonder and its competitor brands off each other to get the best master lease arrangement on their terms,”

“Lease squeezing hasn’t happened yet because supply still needs to catch up to match a recent surge in category awareness about urban rentals,” Milo said. “But saturation in some urban markets will happen, and that will trip up some of these startups — especially in a recession.”

In other words, Sonder might find its gross margins may not expand rapidly enough if rivals, including startups and legacy brands, flood the category.

To somewhat reduce the risk on its shoulders, it has put a small rent abatement in the event of a recession in a majority of its leases.

For now, Sonder often has the upper hand. For example, it sometimes targets developers of buildings still under construction, who are facing the burden of vacancies for many months until they can fill their units with multi-family apartment owners.

Sonder makes revenue guarantees for those early months that exceed what developers could otherwise often get, and developers can often pay lower interest on loans when banks can rely on the planned income. In turn, Sonder gets freshly built properties for its guests.

WeWork does a similar real estate arbitrage to Sonder, only for co-working. It’s a notable analogy because it has grown to the point it may now be “too big to fail.” WeWork makes square footage more productive by persuading its subtenants to use less space than they previously did. Sonder can’t subdivide its space and has to work harder than WeWork to bring in guests because of the more transient nature of travelers versus office outsourcing.

A Tech Company at Heart

“Technology underpins our capacity to scale in all the other business parts that matter, such as supply growth, revenue generation, operation, and guest retention,” said Davidson.

For property selection, Sonder uses machine learning to analyze data on revenue generated by nearby hotels and Airbnb units to forecast what price guests will pay and what occupancy it can expect. Over time, it gets better at pinpointing which variables are the best predictor of its potential revenue gains.

Tech also helps its supply chain team make sure it’s buying the right amounts of furniture, mattresses, and linens. An overseas team buys containers worth of items that they ship to distribution centers. Sonder built its own software for warehouse management.

Designers at headquarters use software to choose pieces of artwork and other furnishings available at its distribution centers and decide how they should be placed in any given unit. Details include how to paint the walls and the heights for hanging artwork. A designer typically creates a plan for one unit a day.

Another person then packages the items necessary, using a spec list on a mobile app for reference. They send the items to the property, where they’re installed according to plan — with software tracking those steps, too.

Some question if this tech-powered effort is worth it. The more Sonder looks like a serviced apartment, the less appealing it may be for some consumers, these critics said. To put that another way: Do guests care if the couch is of consistent quality, or are they more interested in getting a reliable stay in a district of town with low-rise buildings where large hotels can’t easily compete?

Some argue that the lesson from how Airbnb disrupted hotels isn’t to apply hotel-like consistency to rentals but instead to focus on how a slice of customers prefers the non-commoditized aspect of homes.

Sonder may be misguided in its drift from offering certainty to offering consistency. In other words, it may be shifting its mission from providing certainties like reliable Wi-Fi and responsiveness when something breaks to offering a standardized experience, such as by designing decor in a centralized way. The market may not be interested in rewarding the latter to the extent that justifies the required industrialization.

But Sonder argued that it’s simply applying tech to make a service more productive.

Sonder taps tech to make its housekeepers and maintenance workers more productive. For example, the first app the company built helped streamline housekeeper scheduling. Engineers also built a system that can grant access to housekeepers to enter a unit only when they know the guests aren’t inside.

Many Competitors

Other companies also strive to appeal to consumers seeking a blend of a rental’s quirky decor and vibe with a hotel chain’s consistent services.

Stay Alfred, which raised $47 million in funding last autumn, is the next largest venture-backed company, by inventory — though its model differs somewhat.

Sonder’s other rivals include, in rough order of size, The Guild (which raised $9 million in funding last autumn), Domio (said to be about to raise another round), WhyHotel, Zeus, Lokal, 2nd Address, MagicStay, AtHomeHotel, and Homelike.

“The arrival of VC backing as a permanent fixture in the alternative accommodation capital stack speaks volumes as to the future of the space,” said Sean Worker, CEO of BridgeStreet, a Reston, Va.-based booker and housing program manager for company employees that serves 22,000 cities.

Perhaps as significantly, Airbnb offers more than 2,000 homes under its Airbnb Plus program. More worrisomely for Sonder, Airbnb may soon invest in rival rental brand Lyric, The Information has reported.

Many traditional serviced apartment and extended stay brands compete, too, including Frasers, Travelers Haven, and Vision. Some lodging executives question whether Sonder and other serviced apartment startups are significantly different in their main business models and in their access to technology than traditional players.

Hotel chains are experimenting with rental soft brands, such as Hyatt’s The Unbound Collection, Marriott’s Tribute Portfolio Homes, and AccorHotels’s Onefinestay.

Davidson hinted that some hotel companies had approached Sonder to see if they could outsource rental management to his firm.

Sonder’s valuation is unknown, but given the investment it has received, it seems likely that investors value it differently than a typical hotel or serviced apartment company. However, investors likely expect higher multiples in return for their investment in Sonder and its peers.

On the other hand, last October, when Hyatt bought Two Roads Hospitality, a traditional hotel company, it paid $600 million, reflecting a multiple of about 12 to 13 times stabilized 2021 earnings, which may be in line with expectations for the multiples for Sonder & Company.

Davidson said his company has “a two or three years” head start in its tech sophistication and if it can keep accelerating its pace, it will sustain the lead.

Rivals might easily mimic Sonder’s tech-based efficiencies. When asked about whether his segment has low barriers to entry, Davidson disagrees.

“Yes there are low barriers to entry to start something small,” Davidson said. “But once you start dealing with 100-unit properties like we have begun to, the complexities multiply, and advantages accrue to early movers like us.”

“For example, in buildings where we have, say, at least 100 units, there’s an opportunity to provide more rigor when it comes to yield management,” Davidson said. “Instead of providing travelers 100 rooms to choose from, we limit it at any given moment to, say seven, and slot their booking in the room where the calendar most optimally fits that bookings and optimizes overall occupancy.”

Marketing Challenge

In 2018, the company will focus on the first phase of a multi-year marketing campaign to make Sonder a recognizable hospitality brand, Davidson said.

That marketing effort could become perilously expensive.

In the meantime, Sonder depends on tech platforms, primarily Airbnb, for attracting customers. As of today, only about 16 percent of its bookings come directly or from repeat customers, its pitch deck said.

Most rental brands are beholden to the tech platforms for guest acquisition and risk getting squeezed on those commissions over time.

However, Sonder might minimize some of that problem.

“Sonder may be able to build a strong direct business by providing a consistent guest experience and by making good analytical use of the data they collect on customers, which would separate it from countless property owners who can’t generate repeat business,” said Graham Donoghue, CEO of Sykes Holiday Cottages, a private-equity backed company based in Cheshire, UK, that exclusively manages nearly 14,000 vacation homes across the UK and Ireland. Like Sonder, Sykes leans on 100 engineers to automate and streamline its operations and guest acquisition and claims a majority of its bookings are either repeat or direct.

Sonder’s rise certainly plays on one of Skift’s Travel Megatrends for 2019 that everything is converging in hospitality.

But Sonder’s story is also about how technology can provide leverage in business models that had otherwise been stagnant.

“This year we’ll keep putting way more money and aggressive hiring behind our engineering than in any other part of our company,” Davidson said. “It is the source of our durable competitive advantage.”