Cautious Optimism

Cautious Optimism

A 2002 filled with surprises, unexpected fluctuations and a robust kitchen/bath market leads to a cautiously optimistic forecast for 2003 unless, of course, there's a surprise.

By Daina Darzin Manning

It was a year that brought new meaning to the term, "the best of times, the worst of times."

Uncertainty, and an element of surprise, reigned over an overall strong year for housing and the kitchen/bath market in 2002. And, that prescription is likely to continue in the New Year, according to housing analysts, kitchen/bath professionals and trade association officials surveyed by Kitchen & Bath Design News.

"There were a lot of surprises [in 2002]," says Timothy Aylor, an economist for the Raleigh, NC-based FMI. The first one, he notes, was that "The recovery wasn't quite as big as we first [predicted]; we were in this deeper than we thought."

"We were in recession at the end of 2001, and out of it by the end of 2002, though no one has declared the recession over yet," observes Kermit Baker, of the Joint Center for Housing Studies at Harvard University. "The year started out fairly strong and weakened through mid year."

"We expected a more systematic economic recovery," agrees David Seiders, chief economist for the National Association of Home Builders, who cites "unforeseen shocks to the system" as the reason. "The trust factor in corporate America, the further decimation of the stock market, and all the uncertainties in the Middle Eastthese things have taken the starch out of the economy."

"[The market] has been dragged down by some of these corporate accounting scandals," comments Kevin McNulty, executive v.p. for the National Association of the Remodeling Industry. It's worn down the psychology of the investor."

Ironically, though, all these economic problems created a tremendous housing and remodeling market in 2002, industry analysts agree. Housing, in fact, staged almost a miraculous performance throughout the past year, becoming a virtual pillar of strength for the economy and helping stave off an even-deeper downturn.

"The housing sector has come through this with better numbers than we anticipated," Seiders states. "The key is the interest rates which occurred because of these other problems. In addition, house price behavior has been great."

"The last year was a banner one for the housing and real estate industries," agrees National Kitchen & Bath Association president Les Petrie, CMKBD.
Indeed, housing starts fueled by positive affordability surged to 1.6 million units in 2002, while sales of both new- and existing-homes ascended to all-time records. At the same time, the U.S. residential remodeling market, driven largely by favorable population trends, an aging housing stock, changing lifestyles and other key factors is expected to grow to roughly $170 billion in 2003.

All this has resulted in a surge in shipments and sales of kitchen and bath products. Cabinet/vanity sales have increased over the previous year for some 75 consecutive months, according to the Kitchen Cabinet Manufacturers Association (KCMA). Domestic shipments of major home appliances reached record levels in 2002, with even more growth in sight this year, the Association of Home Appliance Manufactuers (AHAM) reports. Shipments of other key products such as plumbingware and countertops remain robust (see Barometers, Page 8). Most kitchen/bath dealers and suppliers report favorable levels of activity.

Normally, remodeling is something that should decline with a rise in unemployment and weak job growth, notes Baker, adding that homeowners generally avoid big-ticket, discretionary purchases in that type of environment. However, low interest rates continue to have a dramatic effect on home-related purchases, Baker and other economists point out.

"As the stock market continued to perform poorly, investments in real estate are [perceived as] more solid, and are doing much better," notes Dick Titus, executive v.p. for the KCMA.

"People became more family- and home-oriented," Titus agrees. "That helped maintain the strength of the remodeling market."

In addition to low interest rates, "cash out" financing has also helped buoy remodeling.

The current lending environment has not only spawned the lowest mortgage rates in 40 years, it has also unleashed the greatest torrent of home refinancing ever producing an atmosphere in which cheap borrowing and escalating home values have enabled millions of Americans to tap home equity by taking cash out of a refinancing deal or through a second mortgage.

"You refinance your mortgage and take extra cash out to pay off unsecured debt," explains Baker. "About a third of that cash is used for home improvement. That's a huge influx of cash into this market."

When people refinance, "more than half [of them] take a larger loan amount than is necessary to pay off the previous debt," confirms Lawrence Yun, senior economist for the National Association of Realtors. "Refinancing activity in 2002 is anticipated to be a record. Many people are recognizing that home prices are rising very fast, and [that remodeling the home is] an attractive investment."

Looking ahead
The 2003 housing market while strong from a historical perspective is expected to be somewhat off from robust 2002 levels that many housing industry analysts considered virtually unsustainable.

Most housing analysts see housing starts declining in 2003, although still remaining above the historically strong level of 1.6 million units. Existing single-family home sales which hit a record 5.47 million units last year are also expected to decline to about 5.27 million units this year. (That would still rank 2003 as among the housing industry's best years in history.) Similarly, new single-family home sales also coming off their greatest year in history, at 945,000 units are expected to decline to 921,000 units in 2003, still extremely high by historical standards (see accompanying graphs).

The National Association of Realtors sees 30-year fixed mortgage rates pretty much holding at current levels of just under 7% through 2003 more good news for the market. At the same time, home prices are expected to continue to rise although less dramatically than in 2002 while the nation's homeownership rate should resume an upward trend and remain at, or near, record levels of just under 70%.

And NKBA's Les Petrie adds, "The upward trend in the stock market is easing the concerns of many high-end purchasers and it would appear that we can anticipate a positive business climate for the near future and beyond."

With all of 2002's favorable factors still in play, there's a general sense of optimism regarding 2003. There's also, however, a distinct sense of uncertainty particularly in the face of unexpected domestic and global events, such as a war with Iraq.

On one hand, there's the strong feeling that the housing market and related kitchen/bath sector will remain vibrant in 2003, against a backdrop of a steady overall economic recovery, a stabilized stock market, continued low inflation, improved corporate profitability, an easing of unemployment and interest rates that should remain historically low.

On the other hand, analysts are well aware that there's a couple of wild cards present. And those wild cards bear careful watching, they warn.

"Mortgage rates have been unusually low," Baker asserts. "Since no one predicted them going that low, should one be concerned that they'll be spiking higher than anyone is calling for?"

Baker adds that, "We've used up any pent up demand [among consumers]. There is the concern that maybe we've gotten ahead of ourselves."

There are parallel fears that a price bubble, wrought by wildy escalating home values, could damage housing in some local markets although most housing analysts do not foresee this on a national level. And, paradoxically, a greatly improved stock market could actually hurt the housing market by prompting a jump in interest rates.

An even more prominent and unpredictable wild card is the specter of war and the economic impact it could have.

"It's the uncertainty that's the big problem," explains Seiders. "It causes everybody just to hold back. As soon as it's clear what's going to happen, things are gong to improve."

"You get these dire predictions and you just have to wait and see," says Titus. He cites a worst case scenario where, for instance, the rising price of oil prompts a worldwide depression, but he feels this dim view is exaggerated.

"Despite its impressive statistics, 2002 will end with more questions than answers about how the economy and housing will fare in 2003," says David Lereah, chief economist for the National Association of Realtors.

And each of these factors could impact homebuying decisions in 2003, Lereah notes. "The good news for housing is that such a double dip recession means downward pressure on mortgage rates, making homebuying more affordable. The bad news? It also means a fall in consumer confidence, jobs and income gains, which could inhibit the demand for homes," he states.

Yun says his forecasts for 2003 incorporate the possibility of a war by projecting larger spending for defense, but notes that a prolonged conflict could lead to higher oil prices, inflation and higher mortgage rates.

Similarly, Baker notes, "There's nothing worse than uncertainty in the marketplace, so once [the conflict] gets resolved, that will be a plus. Again, you can imagine a scenario where it doesn't get quickly resolved, where it drags on. That could totally disrupt energy markets and oil prices. It could cut into trade, and potentially decimate our economy."

In that case, Baker says, "all bets are off."

Cautious optimism
With all of these factors to build into their 2003 business plans, most kitchen/bath dealers and designers interviewed by K&BDN regional differences aside remain cautiously optimistic over prospects for the next 12 months.

Most agree, however, that 2002 was, in fact, a pleasant surprise.

"I felt that, after the magnitude of [9/11], the work I do became rather frivolous," recalls Rebecca Gullion Lindquist, CKD, CBD, of the Duluth, MN-based Lindquist and Co. "Most of my clients in reality don't need [new] kitchens and bathrooms. They're upscale, they live in nice homes. There were other things that were so much more important. I remember thinking, 'well, that's it for my business'."

Instead, after a brief interlude, Lindquist reports her clients started calling to say they wanted to go ahead with their projects. As a result, she notes, "this last year has been our best ever. Our business has been up 25% over the previous year. It's been mind-boggling."

Lindquist believes that clients wishing to re-invest money, and divert it from the stuggling stock market, is one reason they're pushing ahead with remodeling. She also credits the trend toward cocooning. "I've also had people say to me, 'why are we putting this off?'," she adds. "Maybe life is just a little bit more fragile than people thought. [So they think], 'if we're going to do it, let's do it now.'"

Gail Drury, CKD, CBD, owner of Drury Design, in Glen Ellyn, IL, agrees that "2002 went way beyond our expectations; it was phenomenal."

Drury was greatly relieved with this uptick in business, especially since her company was moving into a larger showroom in the autumn of 2001, and business went into a slump in the aftermath of the 9/11 tragedy. But it rebounded strongly in the first quarter of 2002 and wound up 20-25% over the previous year.

Drury credits low mortgage rates, as well as people's nesting instincts and reluctance to travel. "People are realizing their home is a better investment than the stock market," she comments. "Home values have consistently gone up, year after year."

For many West Coast businesses, 2002 was somewhat of a disappointment. "I knew it was gong to be soft, but I thought we'd recover [more quickly]," says Jeff Burton, owner of The Bath and Beyond, in San Francisco.

Burton blames the Bay Area economy overall. "The banking industry's moved out, the 'dot-commers' are gone, and Silicon Valley is depressed," he reports. "The general economy is cautious. Even though we've got great refinancing rates now, everybody's just holding on."

Burton is highly optimistic about the future, however. "I think the pent up demand is going to be phenomenal," he comments.

Similarly, Jim Wallen, CKD, of the Oakland-based Acorn Design Studio, notes that business was better than expected through mid-2002, but then dropped off. "I think people are concerned about going to war," he observes. "People are uncertain of the impact [war could] have and they're being conservative."

"I think it's going to be another good year," says Lindquist. "Whether it will be like 2002 that would be nice, but I'm not going to count on it. I always approach my business very conservatively. We really watch our overhead costs."

After 25 years in business, she says, "I know we could weather some pretty adverse conditions." She adds, however, that she plans to step up her marketing plans, which are usually minimal for her mostly-referral-based business.

"I'm a little cautious [about 2003] because what goes up has to come down," agrees Drury. "I realize this [the current pace of business] might be a little too good to be true. I think it will be good for six to eight months and then it's going to slow down."

Wallen reports he's proceeding by "not spending any money on stuff I don't need to spend on." He believes economic prospects for 2003 are uncertain, and says he plans to cut back in some areas for example, shelving a program to introduce retirement plans for his employees and canceling plans for new displays.
Burton expects that pent up demand in his market will take hold by the second half of 2003. "I don't think the stock market is going to come back for several years," he notes. "And people have to do something with their money. They don't want to be sitting there making 1-1/2% and getting taxed on half of that. They might as well put the money into their homes." KBDN