Commercial Market 2016: An uneven market posted modest growth last year - Jun 2016

By Darius Helm

Last year, the commercial flooring market was up an estimated 2.8% to $5.843 billion, according to Market Insights LLC. Hard surface flooring grew at more than twice the rate of carpet. Most of the activity came from shifts in marketshare between the flooring categories, as LVT and carpet tile made inroads into the hospitality, multi-family, senior living and mainstreet sectors.

The corporate market, including both the tenant improvement and owner-occupied segments, accounts for the bulk of commercial revenues. That sector was slow last year and continues to be slow this year, and it has held back the overall market. Most other commercial sectors have shown growth, albeit modest in general. Retail store planning activity has been picking up, hospitality and multi-family have sustained their momentum, senior living business is growing, healthcare is active, and education is up. In general, though, the market has been subpar. This year, more growth is expected, though a poor corporate environment could negate any overall gains.

Across all sectors, the higher end of the market, which has been driving commercial growth through most of the post-recession recovery, seems to have stalled somewhat. Most manufacturers report that the lower price points are where most of the activity has been over the last year, and it looks like that trend is continuing. Wall Street fluctuations, weakness in overseas markets and concerns about the coming presidential election have conspired to keep commercial purse strings tight.

The U.S. GDP in recent months has not indicated a strong economy, with 2015 starting off with 0.6% growth in GDP in the first quarter that climbed up to 2% by the third quarter, only to end the year with 1.4% growth. And the first quarter of 2016, with only 0.8% GDP growth, suggests we might be in store for a similar pattern. For now, end users seem to be in a wait-and-see mode, and that’s unlikely to change until next year.

Overall, the strongest markets have related in one form or another to housing—senior living, student housing, hospitality, multi-family—and a lot of it has been focused on urban environments. In cities across the nation, cranes dotting the skyline have signified not new office buildings but new high-rise apartment towers. In New York City, the tallest building, once you remove the spire off the World Trade Center, is 432 Park Avenue, an apartment building.

Millennials are clustering around urban areas, and that’s part of what’s driving the movement, but so are Baby Boomers, with retirement communities and independent living increasingly heading toward the cities. Residential environments are also infiltrating corporate settings, as homey, casual spaces in offices become more important than ever.

Some manufacturers report that differences between markets are starting to dissolve, and this impacts how products are designed. These days, designs suited for multiple markets are as important as sector-specific designs. Shaw Contract, for instance, for the last couple of years has introduced products at the Hospitality Design Show in May, and then unveiled a version of the same collection at NeoCon, targeting markets like corporate, higher education and senior living. But it can be a tricky balance, because designers generally want products created for their particular sector.

Corporate environments, particularly in the tech industry, have been leading the design community toward flexible spaces that cater to Millennials with collaboration areas, quiet spaces and recreation applications, all interwoven into a fluid, dynamic office environment.

FLOORING CATEGORY UPDATE
The carpet sector accounts for over 60% of the commercial flooring market, and that sector was up nearly 2% last year to an estimated $3.7 billion, including mainstreet business. However, total volume was marginally down, reflecting an increase in average price points. Since prices haven’t been rising, it stands to reason that specifiers are buying pricier product. It’s likely that some of this is due to strength at the high end of the market through the first half of the year, but it’s mostly due to the transition from broadloom to carpet tile.

The transition has been occurring in sectors in the midst of growth, like hospitality, senior living and multi-family, as opposed to the stagnant corporate sector, where carpet tile is already well established and marketshare shifts are smaller every year. However, carpet tile still has plenty of room to grow in tenant improvement, which was fairly robust last year compared to the higher end of the sector.

This year started off with weak commercial carpet business, with volumes down marginally and, in a reversal from last year, revenues down even more. However, the revenue drop seems to be mostly due to an overall pricing reduction, about 3% on average, due to lower polymer costs.

The carpet category has also seen some consolidation in the last couple of years. The Dixie Group acquired both Atlas Carpet Mills and Burtco (B Carpet), Lexmark acquired Northwest, and Tarkett bought Desso, a Dutch commercial carpet mill with a strong position in hospitality. So the only acquisition that wasn’t largely about hospitality business was Atlas.

While there are still a few boutique mills with less than $5 million in sales, there aren’t many new mills entering the market, though one new player, Totally Carpet, which has been around for three years, has estimated specified sales of $10 million.

On the hard surface side, there are two relevant flooring categories, ceramic and resilient. The other categories, which are significant in the residential market, generally don’t have the performance characteristics necessary for significant commercial specification.

Hardwood, for instance, has a 14% share of the total flooring market, but that’s almost all on the residential side—its commercial marketshare is just 2.4%. Hardwood suffers too much surface damage for high traffic areas and it also can’t handle high moisture environments—though acrylic-impregnated hardwood generally fares better. Laminate also has a hard time gaining traction on the commercial side; its share stands at a mere 1.3%. Laminate performs better than hardwood in terms of scratches and dents, but it’s even more susceptible to moisture.

Another flooring category poorly represented on the commercial side is area rugs, a traditionally residential product. But even though it’s a miniscule category on the commercial side, it’s actually growing, driven by demand for environments in sectors ranging from corporate to hospitality to senior living that have a more casual, more residential feel. Carpet producers report that custom cut rug programs are a growing business. However, it’s not a category destined to take the commercial market by storm.

Ceramic tile, however, is a big player in the commercial market, with a 15% share of total commercial sales. Ceramic growth was slightly ahead of total commercial flooring growth last year, up 3.2% for both floor and wall. Ceramic tile is strong in hospitality and retail, both of which have recently shown growth. Several restaurant chains are in the midst of a remodeling cycle, which is boosting sales of tile, though not at the higher price points. Gains in K-12 and higher education are also helping drive sales of tiles for restrooms, locker rooms and the like.

The largest hard surface category is resilient flooring, though it’s really made of several different categories. Overall, resilient flooring has an 18% share of the commercial flooring market, with 2015 revenues up 5.7% from 2014. VCT is steadily losing share, even though it was about flat last year due to growth in the retail sector. Commercial sheet flooring showed some gains last year, and some of that was due to growth in the healthcare market, which is perhaps the strongest market for sheet vinyl, both homogeneous and heterogeneous.

However, luxury vinyl tile (LVT), which now accounts for 46% of the commercial resilient category, has been reliably robust, gaining traction in every commercial market sector. LVT’s commercial revenues were up nearly 12% last year, with strong penetration in most segments.

LVT is expected to continue to take share in all categories for the foreseeable future as an affordable, high performance alternative to natural materials like stone and wood, and also as a medium for commercial design.

A hybrid version of LVT, sometimes called WPC (wood polymer core), notable for its rigid core, ease of installation and dimensional stability, is also trending in both the residential and commercial markets. The new construction has also opened the door for a lot of experimentation in hard surface design, and it’s likely that the next few years will see several new constructions on the market.

STATE OF COMMERCIAL SECTORS
Last year, even though most commercial sectors showed growth, the biggest sector, corporate, was sluggish and uneven. The corporate sector started to slow in the second half of the year, as the high end of the owner-occupied market became unsettled. The tenant improvement side was better, though it still underperformed.

So far this year, the corporate sector is still choppy and subpar. Instability in foreign markets and the hesitant business atmosphere, not uncommon in election years, are among the factors holding back spending. At things stand, it’s likely that the sector will be flat to down for the balance of the year.

The strongest sector, at least for now, is hospitality, where business has been brisk both domestically and internationally for at least a couple of years, and 2016 should be another growth year. It’s a sector in flux, in terms of flooring. While it’s still a major broadloom market, there’s significant growth in carpet tile. The last couple of years have seen a major increase in demand, and carpet tile is starting to accumulate measurable marketshare.

The same is true of LVT. It’s being specified for rooms, along with carpet tile, and it’s also finding a place for itself on the public space side.

Retail is also a growing market overall, though it’s a bit hit and miss. It’s a good market on the hard surface side, with LVT again leading the way. Into 2016, Moody’s Investors Service reports that retail is one of the few sectors showing growth in commercial property prices, with increases in the first three months of the year. The overall trend across commercial sectors has been a drop in prices, driven by the corporate market.

There’s momentum in the education market as well. Lots of manufacturers report that higher education business has been active. And now, following a multi-year trend of reduced funding for K-12 education, there are signs of growth in K-12 as well, as recoveries in many state and local budgets open the door for public funding and bond issuance. But recovery is still on a region by region basis.

Healthcare business is seeing an uptick, again led by hard surface gains. Soft surface has a smaller share of healthcare space, but within it, the shift from broadloom to carpet tile is strong.

The major trend in healthcare has been the movement away from the construction of large-scale medical institutions, like huge hospitals, toward smaller clinics and medical office buildings with narrower specialties.

In senior living, activity is also trending up, with some larger continuing care retirement communities going up, along with new senior living projects in urban areas, drawn by Baby Boomers in search of a more active retirement lifestyle.

The multi-family market has also been a driver of commercial growth. While residential products go into a wide range of multi-family units, the public space side of that sector is generally served through commercial specification. And again, it’s been led by hard surface growth.

The same is true for mainstreet. Mainstreet activity was up last year, with strong demand for hard surface solutions like LVT. On the soft surface side, carpet tile is rapidly taking share from broadloom, but with a smaller piece of the pie.

One of the quietest sectors has been government. That’s fairly typical at the end of a presidential cycle. And it’s also typical for activity to cycle up at the beginning of a new administration, so that sector will likely be up a year from now.

Looking ahead, prospects are mixed. Global instability is likely to continue holding back growth, and it looks like crude oil prices are starting to recover, which can negatively impact investments in renovation and new construction. The Architecture Billing Index suggests modest growth across all regions, but hardly at an inspiring pace.

For a close look at the Top 15 Specified Carpet manufacturers and Commercial Hard Surface manufacturers, see the June 2016 issue of Floor Focus Magazine.

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