Commercial Market 2009 - June 2009

By Darius Helm

There were signs of a slowing commercial market during the first half of 2008, but most manufacturers were still doing a brisk business. Then came the fall, literally, and most commercial business ground to a halt.

Ultimately, commercial business was about flat last year. According to Market Insights/Torcivia, total U.S. commercial business grew by less than a point in 2008, from $6.513 in 2007 to $6.551 billion last year. The corporate and retail store planning sectors suffered the biggest hits, along with hospitality, while institutional jobs were not off as much. In general, manufacturers focused on the education, healthcare and government sectors performed better.

Carpet, which has a strong position in the corporate sector, gained marginal share last year, and within that category, carpet tile continued to take share from broadloom. Carpet accounts for over 70% of all the flooring in the commercial market.

On the hard surface side, vinyl and ceramic have most of the share, and in 2008 ceramic gained ground and vinyl fell behind a little. However, most of 2008 was far more robust than this year, and with all the price pressures this year vinyl may find itself in greater demand. Hardwood and laminate make up barely 5% of the commercial flooring market, and last year they made no gains. In fact, hardwood lost some share.

SECTOR OVERVIEW
The corporate market was hit hardest last year, in part because of the abruptness of its decline. Over the course of a few weeks in September and October, orders dried up at a rate that no one in the business has ever seen. The slowdown had the greatest impact on the high and low end of the sector. Annuity customers like the massive bank chains and major financial institutions stopped on a dime. Big legal firms followed suit. Large corporations paused mid-step. And they’ve largely been in a holding pattern since then.

At the other end of the spectrum is the tenant improvement market, which has also slowed considerably. There’s a lot of uncertainty among small businesses, and they’re understandably wary about commitments, so many are holding off on renewing three or five year leases and going for single year extensions instead. Consequently, they’re holding off on renovating their spaces. And it doesn’t help that financing projects became extremely difficult in the fourth quarter of 2008 and so far shows little signs of easing.

The good news about the high end of the market is that all these mergers, acquisitions and bankruptcies will ultimately lead to pent-up demand. Those banking chains acquired by other banks will eventually need to be renovated to conform to their new brand identities, and new entities will have to use design to convey their own messages. So even though it’s not likely that the return to a healthy economy will mean the level of excess of years past, the first couple of years of comparative wealth will probably create enough demand to keep flooring manufacturers as busy as they want.

The retail sector has also been hard hit, but the downturn was not as abrupt. The housing decline, which will be three years old in a couple of months, had gradually been chipping away at disposable incomes and the consumer credit crunch was already in full swing before last fall, so retailers were already cutting back on expenses like renovations. If it turns out that the housing market is indeed starting to stabilize, and if people stop losing jobs, newfound confidence may help boost retailer business late this year or early next year.

Another sector that was already showing signs of slowing was hospitality, which had four years of solid growth through 2007, in part driven by pent-up demand following slow years after 9/11—severe downturns tend to synchronize business cycles. Even though there were plenty of luxury projects in the works, a natural slowdown was expected to start this year. The credit freeze shortened the cycle, and over the last six months many major projects have been postponed or even canceled.

Hardest hit in hospitality are high end hotels. Hotels in resort destinations have also suffered. Midscale establishments, particularly limited service hotels, have been comparatively strong, and the lower end has also been doing okay. Because hospitality projects are planned years in advance, some flooring manufacturers serving that sector still find themselves with work on their hands, but unless banks start lending again soon and projects that were postponed get the financing they need, the hospitality sector will continue to contract.

Two of the most active markets are healthcare and education, largely thanks to the population spread. Baby boomers are fueling healthcare demand, and their offspring, coupled with the immigrant population, are swelling the ranks of school age children and young adults.

Unlike sectors like corporate, retail and hospitality, healthcare and education have no choice but to grow. A shrinking economy means, unfortunately, that there’s less demand for offices and retail stores, and smaller budgets mean less business and leisure travel, which means lower demand for hotel rooms and entertainment. However, more people than ever need healthcare and places to grow old—the state of the economy has nothing to do with that—and more people than ever need an education. So those sectors will grow, one way or another.

The first baby boomers are reaching retirement age this year, and that’s putting incredible demand on acute care and assisted living facilities. At the same time, the models for those businesses are being transformed.

In terms of acute care, many facilities are obsolete and evidence based design—the proven effectiveness of architecture and design—is driving the creation of new hospitals that significantly improve patient outcomes and increase the efficiency of hospital staff. In addition, new acute care models are changing the face of healthcare. Specialty clinics are becoming more commonplace, and many surgeries no longer take place in large hospitals but in smaller surgery centers.

The assisted living model is also undergoing a significant transformation. Today’s retirees are far more demanding than previous generations, and they’re more active, too. And the numbers of people looking to live in assisted living facilities is growing not just because of baby boomers but also because of the gradual collapse of the extended family model. Fifty years ago, grandparents were far more likely to grow old in the houses of their children than they are today.

All of these factors are leading to a cultural shift as communities for the elderly increasingly become a new part of the social fabric. Nursing homes no longer suffice. Today’s retirement communities require recreational and fitness activities, entertainment, retail stores, and even education, on top of state of the art medical care.

At the high end are the continuing care retirement communities (CCRCs) that offer every level of care from independent living to round the clock nursing, and some are even affiliated with universities—a surprising number of retirees, fueled in part by nostalgia, want their golden years to echo the best years of their youth. There’s a good chance that CCRC development will be slower during these recession years, and the sad truth is that many people on the verge of retirement who were eyeing such establishments have seen the money destined to fund their luxurious retirement vanish into thin air. It will be a couple of years before we see the degree to which this new model has suffered.

The education sector is in the middle of a building boom. More young adults are entering college than ever before, and that is fueling incredible competition among colleges. And these days it’s not just the courses they offer but the lifestyles they accommodate, and design plays a huge role in that. Today’s students require technological amenities, more social spaces, and greener environments. In higher education, a lot of the funding comes from private sources like university endowments, so there’s reason to believe that growth in that sector will slow further over the next year or two. However, many university and K-12 projects take years to plan and execute, so, assuming this recession ends some time next year, growth in this sector may continue to chug along without too much of a dip.

In K-12, public money plays a bigger role, and even though the administration’s stimulus package allocated about $54 billion for schools, how much goes to modernization and new construction is up to state and local governments. However, $22 billion in interest free bonds for just that purpose will hopefully spur the development of new projects.

Another sector that is doing well is government, and a lot of factors are fueling its relative growth. One element is the continuing upgrading of government affiliated facilities, driven by GSA requirements which include, fortunately, a greener model. Another is the priorities of a new administration. There are clear indications that President Obama believes that we’re entering into a new era where endemic societal problems—like security issues, rampant waste and environmental degradation—require governmental support, and that means the growth of government related institutions. It’s too early to tell if this is a long term trend, but it’s fairly clear that the government sector will grow over the next three years at least.

Mainstreet business has been a mixed bag. It’s more competitive than ever because so many residential dealers have been eyeing that sector to make up for their flagging residential sales. And according to some industry experts, carpet from mills traditionally focused on the specified contract market has been making its way into the mainstreet market. But there’s not that much work there, since small business owners have been extremely cautious and credit is so tight. However, projects in that sector have a short timeline so that’s one sector that might rebound quickly when the economy stabilizes.

THIS YEAR AND BEYOND
The tail end of last year was nicked by the recession, but this year the commercial flooring business will face the full brunt of it. Business has slowed in all commercial sectors, and flooring producers are scrambling to target the markets with the most comparative health. While most of the bigger flooring producers should manage to weather this storm, some smaller players will probably not survive. The second half of this year will probably see some mergers and a handful of smaller players shutting their doors.

As projects have dried up, the A&D community has been extremely hard hit and massive layoffs have in some cases decimated their ranks. Like flooring producers, design firms have been looking for new markets for their services, increasing competition in markets that, though comparatively strong, are still shrinking. The projects out there tend to be smaller, or if not smaller, they certainly have tighter budgets, so profits are down significantly.

On the positive side, there are signs that parts of the economy may be stabilizing. The housing market is no longer plunging headfirst toward the depths, the stock market seems less volatile, and here and there signs of confidence are beginning to emerge. While it’s unlikely that business will tick upwards in the second half of this year, further indications that we have indeed hit bottom should still be treated as good news.

Another bright spot is energy prices. Even though crude oil is gradually starting to rise, it’s still half as high as it was in the first half of 2008. However, manufacturers were never able to pass through the full extent of their raw material costs when crude oil was near $150 a barrel, so the net effect is simply to bring their margins back to healthier levels. And as the economy improves, energy and raw material prices will rise further, unless the pace of developing greener fuel sources accelerates and the oil industry is forced into a more competitive position.

Sustainable products and projects are also not as high a priority this year, at least for some customers—although some said it’s a major factor driving their business—but there’s little doubt that going green is still important and its cost effectiveness is more clearly understood than ever. It’s certainly just as important for manufacturers, who continue to make their products greener. The problem is that for customers, sustainability pays long term dividends and many are focusing on short term goals right now. But when banks start lending again and a recovery is in sight, people will again feel more comfortable thinking long term and that movement will get a huge boost.

For a close look at the Top 15 Specified Carpet manufacturers and Commercial Hard Surface manufacturers, see the June 09 issue of Floor Focus Magazine.