Soft Landing

The kitchen and bath industry – booming, like the nation’s housing market, for the past several years – may be headed for a modest softening in 2006. However, no one could tell it from the comments of dealers and designers, who are generally bullish about their prospects for continued growth in the new year.

But while kitchen and bath professionals remain upbeat about both 2006 market conditions and their business strategies (see related story, Page 58, and Market Pulse, Page 12), housing industry analysts are pointing to an inevitable slowdown from what has been a torrid and unsustainable pace in recent years.

In other words, the housing market should be down this year from its record pace, but still be strong from a historical perspective, analysts say. And, the kitchen and bath market is likely to mirror that scenario.

Rising interest rates and skyrocketing housing prices are the prime culprits behind the expected “soft landing” for housing starts and home sales (see graphs above and on following page). Counterbalancing those downward forces, however, is a series of positive demographic and lifestyle factors, including increased home-buying activity among “echo boomers,” immigrant and minority households, a trend toward larger homes, and a spate of natural disasters expected to drive rebuilding efforts for several years to come. Also lending impetus to continued strength for housing is a relatively strong economy, an increase in jobs, growth in the residential remodeling market and a trend toward larger homes featuring higher-end amenities.

“Housing starts are expected to fall to 1.9 million units this year from an estimated 2.1 million last year,” notes Dick Titus, executive v.p. for the Kitchen Cabinet Manufacturers Association (KCMA). “This would be comparable to starts in 2004, which was a good year for cabinet manufacturers.”

Titus also observes that the remodeling market is expected to remain strong, “with a manageable increase in interest rates in 2006, anticipated investment in hurricane damage restoration and the need to maintain an aged housing stock.”

Of course, forecasters have predicted only moderate growth for several years running, only to find the housing market far outperformed everyone’s expectations. However, unlike previous years, there are now solid indicators to suggest 2006 will witness a slowdown from the previous years’ explosive growth.

According to Kermit Baker, director of the Remodeling Futures Program at the Joint Center for Housing Studies at Harvard University, “The difference between now and the last five years is, a lot of what was guiding the [forecasters’] scenarios was the sentiment, ‘Well, this just can’t sustain this level; it’s stronger than we thought it was and therefore it must be time for a slowdown.’

“That sentiment is still there, but it’s coupled with the fact that there are some real market indicators going on, too,” Baker comments. “The inventory of new homes and existing homes is beginning to run up at levels beyond what they have been in the past. We’re seeing housing affordability concerns begin to kick in as mortgage rates edge up and house prices continue to rocket up. And, the combination of those two things have made homes less affordable than they were in the past.”

Baker sees real evidence of this in that mortgage applications have slowed from their previous pace. “I think we are going to see a bit of softness this year, and lower consumer spending,” he states. “Certainly the consumer confidence numbers are weaker, and if we see a slowdown on the consumer side, I think that’s got to kick into housing eventually.”

Demographic Drivers
Yet several strong factors continue to drive optimism for those in the kitchen and bath industry. In housing sales, starter homes remain a major driver – with immigrant and minority households an increasingly significant part of the market.

“The household formation numbers have been a very key driver for the last decade and will likely continue to be for the next decade,” Baker points out. “Minorities and immigrants are playing a very dominant role in terms of demand in the housing market. The key reason so many people have continued to miss the boat [in terms of forecasting actual growth in the housing market is that] everyone – most conspicuously the U.S. Census Bureau – has underestimated the number of immigrant and minority households that have been formed in recent years.”

“This trend is expected to remain strong until at least 2025,” comments Heather Jones, a consultant for the Raleigh, NC-based housing analyst FMI Corp.

“Immigrants tend to be younger than the median age and buy homes at an older median age,” Jones explains. “They also have a lower percent of homeownership currently. Increasing immigrant ownership rates and immigrant population growth are going to be the next big drivers for residential construction.”

“Barring more restrictive immigration policies from Washington, the trend should continue,” adds the KCMA’s Titus.

Another growing group is “echo” boomers, who seem to be acquiring property at an earlier age than previous generations.

“Low rates have brought in many non-traditional buyers, such as non-married households and under-30 households,” says Lawrence Yun, senior economist with the National Association of Realtors.

Baker points out that lower interest rates have played a part in encouraging many renters to buy. Another increasing segment of the market – “flippers” – buy property, only to improve it and put it back out on the market at a higher price.

“The anecdotal evidence is that, in certain markets, you do have a lot of short-term investors who are driving up demand,” Baker says. “Estimates run as high as 20% [of the total market], probably nationally as high as 10%.”

The Boomer Revolution
While starter homes may be driving the home-buying market, the remodeling explosion is largely due to aging Baby Boomers – the wealthiest, healthiest, hippest and most active generation to ever reach age 60. Baker points out that, more than any other generation, Baby Boomers are using that wealth to age in place, and to retire in the same house in which they raised their family.

“In previous generations, they haven’t had the wealth to do that,” he notes. “As you get a little older, you have to revamp your house somewhat so it meets your needs, and there are accessibility concerns.”

He posits that the Boomers’ wealth may prevent them from retiring to retirement communities or nursing homes. Instead, “you’re going to see more and more attention to the current housing stock, modifying it,” Baker remarks. He adds, however, that “there’s no lack of new, million-dollar homes being built, and there’s strong evidence there’s demand for upscale new construction. But we’re also seeing households that are comfortable where they are. They find out they have a lot of equity in their home, and feel like they may want more space or more amenities.”

He adds that the strongest part of the remodeling market is upscale discretionary remodeling activity such as the kitchen and bath.

And, just because Boomers are busily turning their college-bound children’s rooms into enormous master bathrooms, exercise areas and lavish home theaters, don’t assume they’re staying out of the buying market.

Jones notes, for example, that Boomers are busily buying vacation homes, and some are still trading up in their primary residence. “Those who are trading down are buying less square footage but more luxury,” she notes.

“Boomers continue to heavily influence the remodeling market and, also, new construction,” echoes Titus. “Rather than buying second homes and facing the significant transaction costs involved, many Baby Boomers are using existing home equity to expand, modernize and otherwise improve their ‘empty nest.’”

Another factor fueling remodeling growth is the high rate of homeownership in the U.S.

“A record 69% of Americans owned their homes by the end of 2004,” points out Mary Busey Harris, executive v.p. of the National Association of the Remodeling Industry (NARI). “The universe of this activity, with its interesting ebbs and flows, keeps the country riveted on private property and fuels the already-charged remodeling industry,” Harris says.

Outside Factors
Dramatic events such as Hurricane Katrina have also affected both the direction of the market and the future of the building and remodeling industries.

“Natural disasters make the public more aware of the need for high-quality construction,” believes Harris, of the Des Plaines, IL-based NARI.

Harris notes that groups in disaster-prone areas are currently examining the need for stricter codes to help housing withstand the ravages of natural disasters. Others note that building material prices – particularly for oil-based products – are likely to rise in the aftermath of rebuilding in the Gulf states.

Titus believes that long-term rebuilding efforts in the Gulf states will add to the housing/remodeling market. Others, like Jones, insist it’s really too early to tell what the impact of Katrina and other hurricanes will be on the overall market.

“It took people in Florida at least a year to begin rebuilding, plus the Gulf Coast has political issues that Florida didn’t,” Jones explains. “We don’t know when or how the Gulf will rebuild. Will they be allowed? Where? When? Will new standards be applied?”

The war in Iraq is another external factor that could have an impact on the housing market.

Here again, though, forecasters have different opinions. “Unless it has a drastic effect on consumer confidence and consumer spending, the impact will be minimal,” believes Jones.

“The war in Iraq is adding billions to the national deficit,” counters Titus. “Combine this with additional billions needed to respond to the recent natural disasters and a continued loss of U.S. manufacturing jobs to foreign countries, and the potential for a significant spike in inflation and higher interest rates are real threats to the economy, particularly the housing and remodeling markets.”

Likewise, the high gas prices were an important influencing factor for 2005, which may or may not continue into 2006. “If gas prices had remained low, we could have generated a half-million more new jobs,” believes Yun.

“Rising oil prices have had a major negative impact on the economy,” agrees Titus, “but they now appear to be stabilizing. The increases have caused many leveraged home buyers to cut back on their spending on other items, and even threaten their ability to make mortgage payments in some cases. Increased energy costs have affected the financial performance of many companies negatively, as well.”

However, the job market overall “was surprisingly pretty good,” adds Jones.

Yun adds that the creation of new jobs certainly adds to the housing demand.

The stronger dollar is also expected to be a positive factor for 2006, attracting foreign investors to housing development in the U.S., even though some observers say the nation’s current trade deficit could lead to significant future problems in terms of interest rates, jobs and funding vital government services such as Medicare and Social Security.