Harvard: Long-term Growth Ahead for Remodeling Market

The latest report on remodeling from the Joint Center for Housing Studies of Harvard University shows that the market continued to grow through 2007, reaching $326 billion. Although 2008 showed declines in remodeling activity, the study concludes that the long-term outlook for remodeling is good. Professional Remodeler talked to Kermit Baker, director of the Remodeling Futures Program at the Joint Center, about the report. Visit www.ProRemodeler.com for more coverage, including a podcast interview with Baker.

The report identified three major opportunities for growth: aging rental stock, growth in immigrant households and increased interest in sustainable remodeling. Let’s take those one at a time. Aging rental stock, why is that important?

With all the focus on homeownership over the last 10 years and households increasingly moving to homeownership to take advantage of this run-up in house prices, there was less demand for these rental units, particularly in the upper-end range of the distribution. I think it took a lot of households out of the market and moved them into homeownership. Rental property owners didn’t have a lot of incentive to reinvest in those properties because there just wasn’t much demand in the upper end of the rental scale. The result is there was just very little money invested in that market.

For many reasons, more households are looking to rent, whether it’s foreclosures or households deciding home ownership is not everything it’s cracked up to be, particularly in a market where house prices are declining. This will put more pressure on the rental stock, particularly on the upper end. Rental property owners, to be competitive, are going to have to reinvest in those units to attract those tenants.

We haven’t seen it yet because of this inventory overhang on the construction side. What a lot of folks are doing is renting those homes out in the short run until the market recovers and they can find buyers. We’ve seen this glut of what I would call temporary rental units. Condos also fit in this category — homes that were designed as for-sale condos, but are being rented out until the condo market recovers.

Once the market begins to correct, I think we’re going to see a new reality in terms of demand for rental units that’s not really in sync with the supply that’s out there. It’s probably not going to happen for another year, year and a half, but when we get there I think that’s a market that offers a lot of potential.

How about immigration?

The majority of the household growth we’re seeing in this country is from immigrant and minority households. We’ve never really looked at it as a specific market for remodeling, and when we were looking through the file this time and we were toting up what share of spending immigrant households were responsible for, we saw that it had broken into double digits, somewhere over 10 percent of total market spending.

We identified two markets [Houston and Miami] where immigrants accounted for more than 30 percent of spending in 2007 and another three [San Diego, San Francisco and Washington, D.C.] where they were responsible for 25 to 30 percent of spending.

It’s a message not only for the industry in these gateway cities but really throughout the country that this is going to be a source of a lot of growth moving forward. To the extent — and we haven’t done a lot of research yet — that immigrant households make different home improvement decisions or need different services, it would behoove the industry to focus on that.

What about sustainable remodeling?

It’s obviously something that’s gotten a lot of attention in the industry lately. When we were looking at this, it was an effort to see to what extent sustainable remodeling was just kind of a buzzword for energy-efficiency projects.

We were quite surprised that remodelers were reporting that these other motivations were as popular as energy conservation. It looks like this is more broadly based than we thought it was. Because of that it is unlikely to fade as quickly as other cycles have. Since the environmental movement has gotten underway, we’ve seen it kind of ebb and flow. Every time there is a spike in energy prices, people get more focused on it. Then when energy prices return to more normal levels, people kind of forget about it.

This seems to be different in our view because, No. 1, how long the spike was, and No. 2, the perception that although energy costs have eased, when the economy recovers we may see those spike up again, and we really do need to treat this as a new reality and adjust our life cycle to energy costs that are going to trend higher than they have over the last two or three decades.

Last year, we saw a pretty steep decline in remodeling. What are some of the reasons for that?

It was really the cycling down of the same forces that caused the growth. The story we tried to tell in the report and prior reports is that we were seeing very strong house price appreciation. This house price appreciation generated strong growth and equity for homeowners.

Federal Reserve Board surveys indicate that a high share of that equity that homeowners pull out of the house — somewhere between 25 and 30 percent — homeowners have traditionally reinvested back in their homes through home improvements. And then those home improvements pushed up house prices even further, leading to more equity, more to extract. You had this circle sort of cycling up, and once it flipped, it had the reverse effect. With house prices declining, households had no equity to pull out of their house. They were losing money; they felt poor. Even if they had cash they might have devoted to home improvements, they decided to hold on to that.

If households had owned their homes for a while and still had equity despite the housing downturn, banks made it more and more difficult to tap into that. It was kind of the mirror image of what caused the upturn in the market causing the downturn.

One of the things you highlight in the report is you expect remodeling to recover more quickly than new construction. Why is that?

Historically, it doesn’t cycle as much on the upturn and doesn’t cycle as much on the downturn. A lot of households were attracted to homeownership because of the price appreciation potential they were seeing. I think most people don’t believe that anymore. They don’t believe they’re going to get a 6 or 8 or 10 percent increase in the value of their home moving forward.

The homeownership rate has declined a full percentage point and a half over the last two or three years after growing very rapidly prior to that. I think there are a lot of households that are going to say renting is just fine for me at this stage in my life. A lot of those owners were single individuals in their 20s or 30s that historically have not been very active in the homeownership market and got lured into it because of some unique characteristics. As we return to life as usual, they won’t be as attracted to it.

When can we expect to see a recovery?

The when is a tricky question, and it depends on a lot of things that haven’t happened yet. Are we going to see a stimulus package? And what impact is that stimulus package going to have on the economy? How long is it going to take to get the credit markets back lending again?

Our leading indicator doesn’t look like it’s going to break back through zero in 2009. We’ve got projections out through the third quarter, and we’re still in double-digit declines. It looks like we may be close to a bottom in terms of the rate of decline, but given the current trend, I wouldn’t see that creeping back up to begin a recovery until well into 2010.

A lot of people have suggested that the last few years were an anomaly and that to expect to quickly get back to that level of remodeling activity would be unrealistic.

I think to get back to that level, we will get back to that level, but we’re going to creep up to it. We’re not going to see the 8, 10, 12 percent growth we saw earlier this decade. A lot of what generated that growth was a very thin slice of the market undertaking very high-end projects, and I think that market has largely evaporated.

We’re going to be rebuilding it through $10,000, $15,000, $20,000 remodeling projects and more of them, and not through the $50,000, $75,000, $100,000 projects that really drove the market over the last few years.

Listen to a podcast with Baker at www.proremodeler.com.

Why Harvard is optimistic about the long-term strength of the remodeling market