Small Dip Helping to Improve Health of Remodeling Market
Looking on the bright side, the current slump in remodeling activity will gradually lead back to a healthier market than existed at the height of the housing boom, when big spenders accounted for a disproportionate share of home owner improvements, Kermit Baker, senior research fellow at the Harvard Joint Center for Housing Studies and project director of its Remodeling Futures Program, said at last week’s Remodeling Show in Las Vegas.
In 2005, Baker said, 5% of the households remodeling their homes accounted for 60% of total market activity, which was “highly concentrated” and “not healthy over the longer term.” A revival of smaller-scale projects and a movement to greater household participation is “healthier for the industry, and more sustainable,” he said.
Following the downward path of the overall housing industry but not nearly as precipitously, remodeling should resume growth in 2009 coinciding with a turnaround in housing sales and starts. With market conditions back to normal, the annual increase in remodeling volume should be in the traditional 6% to 7% range through 2011, he said.
The remodeling industry will also receive a boost from household formations, fueled largely by strong immigration, Baker indicated, with the Joint Center projecting 2 million more formations in the current decade over the previous decade, which was a period of rapid population growth.
Despite easing in owner remodeling spending beginning in mid-2006 and continuing into this year’s first quarter, the latest period for which statistics are available from the U.S. Census Bureau, the industry is profiting from an “economic tailwind,” Baker said, as the expansion of the nation’s economy continues, generating jobs and income.
“Remodeling does better during expansions than recessions,” he said. Since 1990, the home remodeling market, which is now close to $300 billion a year, showed an average annual increase of 6.7% when the economy was growing but only 2.3% when it was in decline.
In additiion, remodelers don’t have to contend with the sizable inventory of unsold homes that has been troubling builders. “Remodeling doesn’t build up excess inventory, so it can’t get so far ahead of itself,” Baker said.
On the negative side, Baker noted that remodeling contractors have been experiencing a significant slowdown in revenue. According to Qualified Remodeler magazine, the top 500 contractors reported a 4.7% median annual rate of revenue growth last year, down from 7.5% in 2006 and 12.5% in 2004. “There will be further erosion this year and next,” he predicted.
Also, in today’s down housing market, home owners are more concerned that they may be “over-improving,” Baker said, and more routine improvements and replacements have become stronger than big kitchen and bath overhauls.
According to the latest annual survey by Remodeling magazine and the National Association of Realtors® on the cost of remodeling projects and the percentage of those expenditures on improvements that are recouped when the home is sold, the trend has been down in the last two years — declining from a national average of 80.7% in 2005 to 75.5% in 2006 and 70.0% in 2007.
This year’s study also found that mid-range improvements and replacements are generally having better payback today than upscale projects. For example, home owners are recovering 68% of the cost of upscale bath remodels, compared to 78% of mid-range bathroom improvement jobs.
Baker noted that there is still “relatively strong demand” for housing, “but there is a huge inventory of unsold homes that needs to be worked off.” Conditions “would be far worse if the economy tipped into recession,” he warmed, but remodeling is “likely to see a fairly shallow downturn and an early recovery.”
Falling Prices the Biggest Negative
Gopal Ahluwalia, NAHB’s vice president of research, identified home price declines as the biggest negative factor for the current remodeling market. When they see prices heading down, “home owners are not likely to spend on remodeling,” he said.
The industry is also taking a hit from the slowdown in home sales, Ahluwalia said, because home owners undertake a large amount of remodeling work soon after they purchase the property.
Remodeling is most threatened in the West, where the housing slowdown has been most pronounced, Ahluwalia said. Per household remodeling expenditures in that region averaged $2,493 per household last year, according to Census Bureau statistics, followed by $2,345 in the Northeast, $1,920 in the Midwest and $1,566 in the South.
Even so, the remodeling slowdown looks relatively mild, with a decline of less than 5% he said, compared to a 45% drop in overall housing activity.
Accounting for the biggest share of owner-occupied housing remodeling expenditures in 2006, Ahluwalia said, citing the Census Bureau:
- Households in the 35 to 54 age group accounted for 48%, followed by those 55 to 64, 23%.
- Work on homes valued at $250,000 or more accounted for a disproportionate 67%; only 32% of all homes were this expensive.
- Homes acquired between 1990 and 1996 accounted for a 66% share of the remodeling volume.
- Owners with household income of $75,000 or more were responsible for 65% of the volume; only 31% of home-owning households had income of $80,000 or more.
Contractors Most Vulnerable
Smaller remodeling contractors are most vulnerable to the fluctuations now being felt in the marketplace, Baker noted, and “we expect a growing list of business failures as we move through this transition.”
The 200,000 remodeling firms with payrolls in 2002 were dominated by smaller businesses, he said, with 48,800 general and special trade remodelers reporting annual receipts of less than $100,000 and 67,700 with receipts of $100,000 to $249,000. There were only 1,700 with receipts of $5 million or more.
According to Case Design/Remodeling, remodeling businesses should be ideally in the $750,000 to $2.5 million range for specialties in kitchens, baths, basements and decks; small and handyman jobs and large and design/build projects; and restorations.
Baker cited Census figures showing that 12.9% of the remodeling contractors who were in business in 2003 went out of business in 2004, and the smaller the payroll, the more likely they were to cease operations. Of those with payrolls under $30,000 in 2003, 22.1% went out of business in 2004. The business failure rate was 7.8% for those with payrolls of $30,000 to $69,000; 5.3% for $70,000 to $129,000; 3.8% for $130,000 to $349,000; 2.4% for $350,000 to $1.49 million; and 2.4% for $1.5 million or more.
Failure rates are also significantly higher for new remodelers and those with declining payrolls, Baker said:
- Twenty percent of the establishments started in 2003 went out of business the following year — including 24% of those with payrolls of less than $30,000 and 7% with payrolls of $1.5 million or more.
- Of firms experiencing a decrease in payroll in 2002-2003, 18% went out of business — including 31% with payrolls of less than $30,000 and 3% with payrolls of $1.5 million or more.
- There was almost no difference in the failure rate of companies with stable (0% to 4.9%) and with increased (5% or more) payrolls for the 2002-2003 period, Baker said, showing that there is no advantage to rapid payroll growth.
Failure rates also depend on how long the firm has been in business and the kind of remodeling it does, he said.