Myths & Realities: Preparing for a downturn
Friday, December 6, 2019 from Floor Covering Weekly
As noted in a recent column, the residential markets are not likely to suffer much of a downturn even if the broader economy were to weaken over the coming quarters. Falling mortgage rates are providing a solid footing for any potential slowdown. For example, after declining through most of 2017 and 2018, sales of existing homes are seeing a slight lift, and 2019 totals may well exceed those of 2018. Ditto for housing starts, which should at least match their 2018 levels of 1.25 million this year after trending down each quarter last year.
Still, some industry myths perpetuate regarding doing business during a downturn. Many remodeling contractors feel that regardless of what happens in the economy, their traditional well-heeled clientele will forge ahead with their project plans. They have adequate resources, so goes the conventional wisdom, to withstand any economic setback. However, if we look back at prior cycles, the evidence is somewhat to the contrary. In 2007, at the peak of the last upturn, the upper 20 percent of homeowners by income accounted for 44 percent of all home improvement spending nationally. By 2011, at the depth of the recession, their share of spending had dropped to 38 percent. The bottom 20 percent of the homeowner income distribution accounted for less than 9 percent of market spending in 2007, but their share actually rose to 10 percent by 2011.
So upper-income households often do respond to economic conditions, and maybe even more so than those with lower incomes when it comes to their home improvement decisions. There already are signs that consumers are a bit more wary about undertaking larger scale home improvement projects. Design-build remodeling contractors reported that their average project size declined 8 percent last year, while full-service contractors reported a 10 percent decline in their typical project. Significantly, however, replacement contractors, who typically deal with much smaller projects, reported an increase in their average project size.
So, moving through a business cycle, projects that homeowners might want but not need tend to get deferred when there is concern over future economic conditions. For example, kitchen and bath remodels and room additions (often considered discretionary projects) accounted for almost 42 percent of all home improvement spending at the peak of the market in 2007, while interior replacements, exterior projects and system upgrades (replacement projects) accounted for under 40 percent. By 2011, when the market was bottoming out, the discretionary share had dropped to 32 percent of market spending, while replacement project spending climbed to over half of total market activity.
Maybe the most dangerous industry illusion is the overreliance on project backlogs and industry back orders as in indicator of business well-being. Given the labor shortage in the remodeling industry over the past several years, many contractors are running unusually large backlogs. As a remodeling contractor, with five or six months of work in hand, it’s easy to think that there is no need to worry about future workloads. However, previous downturns have taught us that backlogs have a way of evaporating if economic conditions deteriorate. A homeowner may put a project on hold or scale back if nervousness develops over the economic outlook. In extreme cases, a homeowner may even cancel a project. The product orders that these contractors have placed may then also evaporate, catching suppliers off guard. Without much time to adjust, the consequences are typically more severe throughout the industry.