Course Correction

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It’s here. The inevitable slowdown in the housing market that industry analysts have been predicting for years is finally impacting the country. Housing starts were down in 2006 and a further slowdown is predicted for at least the first quarter of 2007.

So how can this possibly be good news for the kitchen and bath industry? There are several reasons – most prominent among them continued favorable demographics, lifestyle factors that still lead consumers to focus on kitchens and baths, and the residual strength of the nation’s remodeling market.

Whatever the reasons, however, most analysts interviewed by Kitchen & Bath Design News remain largely optimistic.

According to most analysts, the housing slowdown couldn’t have happened at a better time, and the downturn, expected to continue into the early part of 2007, is being characterized as a “correction” – an inevitable slowdown from an unsustainable and unrealistic pace.

In addition, most experts expect the nation’s residential remodeling market to remain strong, as those people who purchased homes during the recent boom continue to invest in upgrading. Likewise, an aging Baby Boomer market with collectively the largest disposable income in history is expected to increasingly look toward upgrading the amenities in their homes so that they can continue to live in them comfortably for years to come (see related story, below). Finally, other positive factors such as still-favorable interest rates, job growth, gains in household income, high homeownership rates, an aging housing stock and a growing economy suggest cause for optimism, even amidst talk of a slowdown.

All of which is good news to kitchen and bath dealers and designers, who expect business to stay strong for the coming year (see related story, "New Study Shows Vast Majority of Older Americans Want to Remain in Current Homes".) despite the decline in housing starts. While some dealers and designers are planning to shift their focus toward remodeling to offset a slowdown in new-home jobs, others expect to spend 2007 catching up on spillover jobs from the influx of the past few years.

HOUSING DECLINE

From an economist’s perspective, the biggest change in 2007 relates to the drop-off in housing starts and both new- and existing-home sales (see Graphs 2, 3 and 4).

“From the high of the market, which was the first quarter of 2006, to the bottom of the market, we’re probably going to have a 20-25% decline in housing starts,” predicts Kermit Baker, director of the Remodeling Futures Program for The Joint Center for Housing Studies at Harvard University. “That’s significant and certainly beyond the standard definition of a ‘soft landing.’ But,” he adds, “it isn’t a full-blown recession like we saw in the early ’80s and ’90s.”

“I’d characterize 2007 as a rebuilding year,” comments Ken Fears, manager for regional economics at the National Association of Realtors (NAR). “At roughly another 8.7% decline for 2007, we’ve got a little bit further to go in terms of a correction in new-homes sales, but we’re expecting the markets to hit a strong plateau toward the end of this spring.”

Other economists’ predictions are more optimistic. “We’re calling for only a little bit more of a decline in housing starts in 2007,” says Heather Jones, construction economist for the Raleigh, NC-based housing analyst FMI Corp. “We’re looking at 6% off from 2006.”

“We were producing homes [for the last several years] at levels well in excess of what the long-term demand for these homes was,” explains Baker. He adds that this fairly significant overhang simply “needs to be cleared out before we get back to another expansionary phase.”

That’s the bad news. The good news? Most experts agree that this downturn couldn’t have happened at a better time. “Long-term interest rates are still favorable and the economy is still growing and creating jobs,” comments Baker.

“We saw very sharp price increases across the country over the last five years,” Fears states, adding that, as prices come down, “affordability conditions will finally improve and we’ll begin to see sales pick up.”

In addition to starter homes, some of the indicators factoring into the boom in the last few years were Baby Boomers buying second homes, an influx of minority and immigrant households and Gen-Xers “jumping ahead.” All were eager to take advantage of low interest rates and other unique opportunities during the boom. As Baker explains, “Many of these purchases were pushed backed to 2004, 2005 and early 2006 when normally they wouldn’t have happened until 2007 or 2008.”

“While affordability really took a hit and we saw sales fall off sharply, it was a good landing nonetheless,” says Fears. Looking forward to existing-homes sales for 2007, NAR analysts predict that sales will be down another 0.6% from about a 9% percent decline in 2006.

Fears believes sales will “plateau near the end [of 2006] and carry forward at the same rate for 2007.”

With mortgage rates expected to stay below 7% for 2007 and the economy in an expansionary mode, the consensus is that this leaves the market with a firm foundation under which it is going to be very difficult for it to fall. The demand for new homes – a demand that was still being generated to the tune of about 1.85 million starts in 2006 – is going to help absorb some of the weakness in the housing market.

And the very good news? Historically, 2007 is predicted to be around either the third or fourth strongest year in history for the housing market. Even in what most are assuming will be a “correction year,” experts agree that is still very strong ­– all good news for kitchen and bath dealers.

“In 1995, we were at $150 billion dollars [in new construction],” explains FMI Corp.’s Jones. “In 2005, we were at $415 billion.”

While some housing industry analysts are calling for housing starts to fall as low as 1.3 million for 2007, most are predicting a more likely number of about 1.7 million, down from an estimated 1.9 in 2006, which is still, historically, an extremely high rate. Baker at Harvard projects about 1.65 million, while the National Association of Home Builders (NAHB) is even more optimistic, projecting 1.81 million starts for 2007.

According to the NKBA, its estimates, released last month, reinforce the overriding view of analysts that spending on kitchen and bath remodeling will increase modestly in 2007 compared to last year, while kitchen/bath spending in the new construction sector will decline, as a reflection of dwindling housing starts (see Table 1).

NKBA estimates peg kitchen remodeling spending rising 2.4% this year, to just over $130 billion being spent on some 7.6 million jobs. Estimates are for bath remodeling spending to rise 1.1%, to some $68 billion, on 10.4 million jobs. Total kitchen and bath spending in 2007, however, is projected to decline slightly – the result of continued softness in new construction.

DEMOGRAPHIC DRIVERS

Interest-rate fluctuations aside, the housing and kitchen/bath markets will still be supported in 2007 by a sturdy foundation built largely on demographics, analysts point out.

“If you map housing starts over time, we’re going to be at a whole new plateau,” says Jones, citing immigration as a key factor. “We think we’re going to need two million starts a year just to keep up with [immigration] demand,” she says.

“The influx of immigrants is certainly a factor,” adds Allan Pattison, CMKBD, president of the Hackettstown, NJ-based National Kitchen & Bath Association (NKBA). But it’s not just immigration that is driving consumer demand, Pattison believes; it also has to do with changes in age and household composition. For instance, he notes, “People are also building larger homes because there are multiple generations living in them.”

Indeed, consumer demographics have a powerful impact on the remodeling market. For instance, in addition to the Boomers who, according to Baker at the Joint Institute, were responsible for 50% of the home improvement market last year, many analysts are beginning to look at the up-and-coming Gen-Xers as a key driver for remodeling.

“That’s the so-called ‘infill’,” says Dick Titus, executive v.p. of the Kitchen Cabinet Manufacturers Association (KCMA). “You see it in urban areas, where younger people will buy old property and significantly remodel it or flat-out tear it down and start over.”

“The Gen-Xers have more expendable cash than the Baby Boomers did at the same point in their careers,” says Dan Taddie, director of education for the National Association of the Remodeling Industry (NARI). “You’re going to see that the younger generations will really have more buying power and be able to set the tone in the future” (see Graph 5).

With the oldest Baby Boomers having just turned 60, industry professionals can look to aging-in-place as a future driver, but, “it’s a fairly narrow piece of the whole pie [right now] and it isn’t really kicking in yet,” says Baker.

However, with more accumulated wealth than any generation in history, it’s clear that the Boomers are here today and many are in their homes to stay, as they continue to add improvements and renovations after their children head off to college or even after those same children come back to the nest with their diplomas in hand.

“You have a very large Boomer population and they like their homes,” notes NARI’s executive v.p. Mary Busey Harris, who posits that since Boomers have come to enjoy their independent lifestyles, they’re not going to want to leave their homes for retirement communities or nursing care facilities. So, she says, “these are people that will look at continued potential improvements [as they age].”

“On the other hand,” says Baker, “we’re doing some projections that show that share is going to fall over the next 10 or 15 years. Its got to fall because households in their 60s and 70s just don’t spend as much on home improvements as households in their 30s and 40s.”

Consumer preferences, too, will continue to play a key role in the kitchen and bath market. Among these is the continuing desire on the part of consumers for larger homes with more upscale amenities, which is expected to moderate the downturn in new- and existing-home sales, most experts agree.

Square footage also will continue to edge up, analysts say, which is what leads FMI to predict only a 3% decline in put-in-place dollars, while true housing starts are expected to fall lower than that.

Though many are calling for square footage to be scaled back at some point in the future, even here, there is a positive outlook. As the Baby Boomers retire and want smaller homes, experts predict that they will want more high-end amenities in those homes, “which is going to keep the dollars that are put in place up,” adds Jones.

REMODELING STRENGTH

As kitchen and bath industry experts are well aware, the remodeling market has been mirroring the housing boom of the last few years, and has consequently experienced a record growth. So is the remodeling market safe from the slowdown? Analysts’ predictions range from optimistic to cautiously optimistic.

“Some of the same cracks in the armor that we’re seeing in new construction, we’re also seeing in remodeling,” says Baker. “It’s just that with remodeling, it tends to be a little later [about six months] in the cycle.”

Since new construction peaked in the first quarter of 2006, experts agree that the remodeling industry should be just beginning to see some softening in the market. Yet the word from kitchen and bath dealers and designers is that remodeling still seems to be looking strong.

As NKBA’s Pattison says, “The sense is that designers have been so busy that, in some respects, they’re looking forward to things backing off a little bit [in 2007], but [it’s not going to happen] to the point where they’re going to have to be concerned.”

According to NARI’s Harris, the remodeling market as a whole did not dip in 2006. “What we’re looking at now is a softening in some markets that are trailing a softening real estate market,” she says, noting, however, that NARI’s long-term outlook is positive. “I think nationally and broadly, we can expect remodeling to still do very, very well and to be very vital,” she adds.

With record projections for remodeling in 2006 as high as $281 billion, NARI’s predictions are likely on the right track. The KCMA’s Titus, for example, points to 127 consecutive months of growth for the cabinet industry through October, 2006. It’s not surprising that he agrees the remodeling market has remained solid. Year-to-date through the first 10 months of 2006, the KCMA was reporting 8.6% growth.

Appliance executives seem equally bullish. In fact, domestic shipments of major home appliances are expected to rise modestly – but, once again, to record levels – in 2007, according to the latest forecast issued by the Association of Home Appliance Manufacturers.

“Existing-home sales help remodeling because they say that, within two years of buying an existing home, it gets remodeled,” says NARI’s Taddie.

According to the NAR, existing-home sales, expected to fall 8.6%, to 6.47 million in 2006, are projected to be essentially even in 2007, with a 0.6% decline to 6.43 million.

Pattison believes that kitchen and bath designers are “looking forward to having a good year, but also looking forward to having a bit more time than they’ve had [in the last few years] to do things like upgrade their showrooms and take care of other business.”

While there are unknown factors like rising oil prices, the Iraq war and raw materials being sucked into the Gulf rebuilding efforts, all of which could have a negative impact on the remodeling market, most analysts surveyed by KBDN are optimistic and believe that the overall remodeling market will remain strong through 2007.

“I think there are pockets [of softening] in the country for the remodeling market,” comments Pattison. “But I think we’re already in the correction. We’re all optimistic and positive still.”

“Short term becomes a bit of a question mark,” Harris adds. “But the other thing you have to put into perspective is the vitality of the remodeling industry. It’s so resilient.”

“While growth of remodeling activity slowed as new home construction has declined, we still anticipate a strong year in the remodeling market,” says David Seiders, chief economist for the NAHB.

The remodeling market has nearly doubled in size over the past decade, with upper-end projects exhibiting the fastest growth segment, according to Harvard’s Baker, who points to rising home prices, low financing costs, income growth and post-9/11 “nesting” as the key factors fueling growth.

Baker and other economists do caution, however, that home price appreciation continues to soften and cash-out refinancing has clearly peaked.

 

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