Stormy Forecast

While 2007 had its rough moments, 2008 seems to be the year that the housing downturn really hit remodeling. Fundamentally, the remodeling industry follows the trends of homebuilding. While the troughs are not as deep and the peaks not as high, new construction is a good predictor of remodeling activity.

July 31, 2008

The Upside of Gas Prices

Thinking Positive

While 2007 had its rough moments, 2008 seems to be the year that the housing downturn really hit remodeling.

Fundamentally, the remodeling industry follows the trends of homebuilding. While the troughs are not as deep and the peaks not as high, new construction is a good predictor of remodeling activity.

Not surprisingly, that means it's been a tough year, and 2009 expects to be even worse, at least in the early going. Even many of those markets — such as Seattle, Portland and Texas — that had been relatively strong as the rest of the country suffered have had struggles this year.


"We're really getting caught in the housing downturn," says Kermit Baker, director of the Remodeling Futures Program at the Joint Center for Housing Studies at Harvard.

Existing home sales and home prices are the two best statistical predictors of remodeling activity, Baker says. With the precipitous decline in both categories, it's no surprise that remodeling activity has fallen.

"It's unlikely we're going to see much of a turnaround until we begin to see a turnaround in the broader housing market, or at least those key features of it begin to turnaround," Baker says.

Growth by 2010?

The National Association of Realtors predicts that existing home sales will increase to 5.7 million next year. That's a 6.6 percent increase from the nearly 5.4 million the group projects for this year and a slight increase over 2007, but still well below the 7 million recorded in 2005. It's also worth noting that a year ago, NAR projected 6.1 million in sales for 2006 and 6.3 million for 2008. As for home prices, NAR forecasts a 3.7 percent increase for existing homes in 2009.

Harvard is predicting a continued decline in the market in 2009. The Leading Indicator for Remodeling Activity released in July projects an 11.1 percent decline for the first quarter of 2009 compared to first quarter 2008. (The LIRA uses a four-quarter moving rate of change, so the 2009-1 number, for example, is based on activity in the second, third and fourth quarters of 2008 and the first quarter of 2009.)

2009 could see a turning point, Baker says. That is the point when the rate of decline slows, but the market still isn't producing positive growth. Sometime in 2010, we could expect to see a return to a positive market, he says. That would be the first growth in the LIRA since the second quarter of 2007.

"We should be back into the growth range in 2010, but it's too early to say when," Baker says.

The LIRA only measures improvement activity in owner-occupied homes, not maintenance and repairs, which typically remain fairly stable.

"If you have a repair project, you're unlikely to defer that even if the economy is bad," Baker says. "In most cases, those projects go ahead as they would independent of the economy."

The LIRA also doesn't track improvements to rental housing, an area that has been underinvested for years. While increased investment isn't showing up yet on a large scale, there is great potential for the next decade, Baker says.


Harvard's LIRA, which uses four-quarter moving totals to track remodeling volume, is predicting a drop to $122 billion for the year ending in the first quarter of 2009 — down 11 percent from a year earlier and a drop of more than 17 percent from the market peak.

Tighter credit standards and increase in foreclosures are putting pressure on the rental stock, as people who were homeowners rent again and people who a couple of years ago would have bought homes stay in the rental market.

"What's muddying that trend now is that just as these households are coming back to the rental market, a lot of these housing units are, too," Baker says. "We've got houses that were built for owners turning into rentals, condos turning into apartments, so we're seeing an increase in both the supply and the demand side."

In the long term, though, the trend still looks positive for remodeling growth in the rental market because of increasing demand and more than a decade of underinvestment in upkeep.

Staying Strong

If companies want to survive the downturn, it's necessary to change things. Owners should look at every aspect of the company, from sales and marketing to production and staffing. Being willing to make changes is the difference between success and failure.

Sun Design Remodeling Specialists in Burke, Va., is one of the few companies that can point to a healthy increase in business this year. The design/build firm expects to hit its goal of a 14 percent increase in revenue over last year, says vice president Bob Gallagher.

Even so, the company has had to adapt its sales and marketing efforts to focus more on building relationships with potential clients.

"The sales process has become a courting process," Gallagher says. "We got very accustomed to signing design agreements at the first meeting. Now, we'll be meeting with people three to four times before they sign."

The reluctance to pull the trigger on a project has been a problem for Normandy Builders of Hinsdale, Ill., as well despite leads approaching record levels, says vice president Andy Wells.

"We're seeing a lot of people still, but closing ratio has gotten worse," Wells said. "Wait and see is kind of the attitude."

Sun Design is seeing a reluctance by many clients to make the decision, taking more time before signing anything.

"I think people generally have a sense that it's a market where they don't have to rush," Gallagher says. "We are seeing some apprehension in people getting off the fence."

The company's sales team has also rededicated itself to a consultative sales approach, focusing on what made the company successful originally. The process has to be more about the "why" (why they want to remodel) than the "what" (what they want done).

"We have rediscovered it more clearly than two years ago," Gallagher says. "We need to hear them on an emotional level and prescribe solutions."

The Sun Design staff is also emphasizing networking and branding in its marketing efforts, to become more personally connected to people. That means attending events the company wouldn't have in the past — such as a local wine festival — to get out in front of potential clients.

"The point is when the market changes and the thing you've done for years doesn't work, you can dig in your heels and be stubborn or you can find some alternatives," Gallagher says.

Job size has also gotten smaller. Normandy Builders is seeing a shift away from large additions toward smaller kitchen projects, which Wells believes has been caused by the drop in home sales. The two types of projects actually represent two different sets of clients, he says.

"Some people would have moved, but now they can't sell their house, so they're remodeling their kitchen instead," Wells says. "The bigger additions came from people who moved into a house and decided they were going to remodel. I think the clients who would have done the addition are now doing nothing instead."

Earlier this year, the company started making cuts to be more efficient and position the company to succeed when the market comes back. That meant watching every dollar, avoiding big purchases, consolidating some jobs and laying people off.

"We had to lay off some people we really liked, but you just have to do it," Wells says. "We had to recognize that right away, because if we waited too long to make those decisions it could hurt the company."

Layoffs have also been a necessary survival tactic for Feinmann Inc., an Arlington, Mass., design/build firm. President Peter Feinmann let 25 percent of his staff go. The company has also been chasing more leads. Typically, Feinmann would visit 40 to 45 percent of the leads that come in. This year, it's closer to 80 percent.

"We want to be in front of as many people as possible these days," he says.

The company also cut prices to get some work this year, something Feinmann says was possible because he had reinvested past profits back into the company over the years.

"We didn't have to make a lot of money this year; we just had to be maintaining what we were doing," he says.

The company closed three or four jobs this past winter by cutting margins, yet still maintaining profitability. Making those tough decisions allowed Feinmann to avoid more layoffs.

"At that point, it was that job or no job, and I was better off getting the work at low margins than not getting them at all," Feinmann says. "So we were very aggressive this winter selling jobs with the specs and prices that we could make a decent amount of money to keep the energy of the company flowing. Some people didn't do that, and they got in trouble."

The other big change has been focusing on smaller projects and being more efficient in those projects, Feinmann says.

"There are less larger projects, so we need the smaller projects to keep us going," he says.

Smaller job sizes have also been the theme for Los Angeles-based Custom Design & Construction this year. A couple of years ago, the company had jobs in the $500,000 to $600,000 range. Those projects are now closer to $400,000. The company is taking on the same number of projects this year, but revenues are down about 25 percent.

"It used to be if someone wanted to spend $500,000 and we designed a project for them that was $600,000, and they fell in love with it; they'd do it," says President Bill Simone. "Today people are holding hard and fast to what their intended budget is. That's it, and they're not going to exceed it."

One significant competitive advantage for the company has been that it can carry the financing for its projects. In today's lending climate, that has helped close many deals, Simone says. (For more on the company's financing program, see the Innovators article in the January issue of Professional Remodeler).

Where Do We Go From Here?

A big part of making it through the downturn will be having realistic expectations for the recovery. It'll likely be quite a while before the industry reaches its 2005–2006 highs because of fundamental changes in the residential construction industry — and that's probably a good thing.

"I'm not sure the peak is something we should really be looking for, because when the market was at it's highest level, it was driven by a fairly thin slice of the population, spending a lot on fairly high-end home improvement projects," Baker says. "That's not something I consider a very healthy market and probably not something we want to replicate."

Much of that growth was driven by unsustainable increases in home sales and prices. Instead, we should look for a return to the healthy market of the 1990s, Baker says, when the industry was growing, but not being driven by a very small upper-end clientele.

"It should be a much healthier industry with more broad-based activity and more and more households undertaking home improvement projects," he says. "We're looking for a good mix of projects to restore a healthier industry."


The Upside of Gas Prices

Rising costs of staples like fuel, food and utilities obviously reduce discretionary income and hurt spending on luxury items, including remodeling. It also drives up material costs.

But there may be a benefit to rising fuel prices, as well, says Kermit Baker, director of the Remodeling Futures Program at Harvard's Joint Center for Housing Studies.

"It's suddenly gotten a lot more expensive to live in a new subdivision 40 or 50 miles from downtown," Baker says. "One thing it's going to do is force prices up closer to downtown and in older suburbs and force prices down in remote locations."

That's a trend already being seen in many markets. For example, in Washington, D.C., property values inside the Beltway are staying strong, while far-flung exurbs are suffering.

"It's simple supply and demand," says Bob Gallagher, vice president of Sun Design Remodeling Specialists in Burke, Va. "People are just not buying out there anymore."

Take a look at the foreclosure map for almost any major metropolitan area, and it gets worse the further you are from the city center. 

The benefit for remodelers is that those homes in the cities and near suburbs are older and in more need of remodeling. As prices there rise, it presents a great opportunity for work.

"These are prime targets for major remodeling activity," Baker says. "It encourages home improvements, often big additions or, at the very least, major structural improvements to the home."

Thinking Positive

Even in a down market, there can be opportunities. Here are some of the key ones:

  • Rental market — The increasing demand for rental units means rising rents are allowing owners to invest after years of not doing so.
  • Handyman work — The maintenance and repairs segment of the industry remains strong even in economic downturns.
  • Urban remodeling — The rising price of gas is making cities and near suburbs more attractive for commuters and those older areas ripe for remodeling.
  • Financing — With tightening credit markets, helping clients land a loan could be the difference between selling or not selling a job.

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