Remodeling Forecast: Modest Recovery for 2010

The good news: the recession appears to be over. The bad news: the recovery isn't going to be great.

That seems to be the consensus of most economists as we head into 2010 — the worst is over, and we'll start seeing modest recoveries in the housing and remodeling markets this year.

"It was the worst downturn since the Great Depression, but it does appear to be over," says David Crowe, NAHB's chief economist. "It won't be a strong recovery, but there are some positives for housing."

The fourth-quarter ended up being better than many economists expected, with gross domestic product growing at a 5.7 percent clip in the last three months of 2009. Still, a sluggish job market has many pessimistic about a long-term recovery, especially in housing. (Residential investment did slow from 18.9 percent growth in the third quarter to 5.7 percent in the fourth, probably due to the impact of the new home buyer tax credit.)

"A recovery in the employment market is the key," Crowe says. "We need to see continued employment growth, and it's going to be at least several months before we see that happen."

NAHB is forecasting unemployment to go below 10 percent in the second quarter of this year and below 9 percent in 2011. Those high rates will continue to put pressure on the housing market, says David Berson, chief economist of mortgage insurer The PMI Group.

"The job market is going to look a lot like it did last time — a jobless recovery," Berson says. "That will hold down the strength we see in housing."

Remodeling recovery

The Joint Center for Housing Studies of Harvard University estimates that the overall residential remodeling market was $246 billion in 2009 — down almost 25 percent from the 2007 market peak of $320 billion. That's still better than the new construction downturn and has lead to the long-predicted surpassing of that market sector by remodeling.

"At this point, remodeling is larger than new construction," says Kermit Baker, director of the Remodeling Futures Program at the JCHS.

Both NAHB and Harvard are predicting remodeling will start a nascent recovery in the second quarter. The overall remodeling market can be difficult to measure and forecast now because of the Census Bureau's elimination of the C-50 survey and other indices that tracked remodeling activity. Only improvements to owner-occupied homes can be tracked with any accuracy, but that measure leaves out maintenance and repair, as well as work on rental properties.

That portion of the market fell to an estimated $110 billion for 2009, down from its 2007 peak of nearly $150 billion. Harvard's quarterly Leading Indicator of Remodeling Activity measures remodeling on a rolling four-quarter basis (see graph). The LIRA is predicting a drop to a $103 billion rate this quarter before starting to rise next quarter, although it would still be below the 2009 second quarter rate. If that plays out, it'd be the first quarter-to-quarter improvement since the second quarter of 2007.

"We're seeing more interest in discretionary spending," Baker says. "This quarter will be the cyclical low, and if you project ahead we could be in positive year-over-year territory by the fourth quarter."

NAHB is estimating improvements in owner-occupied homes to reach $115 billion by the end of 2012, says Paul Emrath, NAHB's vice president of survey and housing policy research.

Opportunities and challenges

There are several positive signs that point toward an upswing in remodeling and housing, including tax credits for home buyers and energy-efficient remodels.

"Sales of existing homes are on the rise, and home price declines are moderating in most markets across the country," Baker says.

Analysis of Census Bureau numbers show clear patterns of higher spending on remodeling by recent buyers. The average homeowner spends $2,413 a year on remodeling, compared with $4,275 for buyers of new homes and $4,642 for buyers of existing homes, Emrath says.

"When you have a government policy that stimulates selling homes, you get some extra remodeling activity," he says.

NAHB estimates that the new home buyer tax credit resulted in $123.8 million in remodeling last year.

While mortgage rates will probably rise this year, the historically low levels combined with low home prices and the extension of the home buyer tax credit should continue to drive sales, Crowe says.

Increased demand for energy efficiency retrofits and other green remodeling is also putting positive pressure on the market. The existing tax credits have already helped and proposed increases in those credits or the approval of Home Star or a similar program could have an even larger impact, Emrath says.

According to NAHB research, 30 percent of remodelers have seen increased demand for energy efficiency remodels, and 5 percent of remodeling jobs last year were driven by the tax credits.

There are also some significant challenges to the recovery. Financing still remains difficult for many home buyers and homeowners to obtain. "The lack of financing will be a significant retardant on a housing recovery," Crowe says. (For more on how remodelers are obtaining financing, be sure to read our cover story on p. 26.)

High unemployment combined with lower home prices also mean foreclosures are likely to increase — leading to lower prices and even more foreclosures.

Many bank-owned homes are still being kept off the market by servicers, and what those owners decided to do with them will play a key role in the direction of the market and recovery, Berson says.

"We don't think they'll dump new foreclosures on the market, which means it will be longer before we see a recovery in home prices," he says. "We expect it to be three years before we get back to normal growth, but that's probably better than getting everything dumped on the market right now."

PMI is predicting more declines in home prices in the short term, as the government extracts itself from the mortgage market, Berson says.

Those lower home prices will probably continue to make many homeowners reluctant to remodel, Emrath says.

"Home prices are now back in line with income," he says. "Now we're facing a psychological problem. If you think the prices of homes are going down in general, you're going to be reluctant to remodel."

The new lead paint regulations on pre-1978 homes could also throw a wrench into any remodeling recovery. According to NAHB, 69 percent of remodeling is done on homes built before 1980, and many have questioned whether owners of those homes will be willing to pay the additional costs required to follow the new rules.

"The cost of compliance could discourage homeowners from hiring professional homeowners," Emrath says. "Our surveys show this is a major concern." (For more on the lead paint regulations, read our exclusive research on p. 30.)

Finally, remodelers are facing even more competition for the smaller market that is out there. In a recent Professional Remodeler survey, 40 percent of remodelers reported an increase in competitors, with former home builders being the largest group coming into the market. And late last year, when NAHB surveyed its builder members, 66 percent of them reported they either had added residential remodeling to their business in 2009 or planned to in 2010 and more than 20 percent said the same of commercial remodeling.

Remodeling market should start to come back this year