Commercial Market 2010 - June 2010

By Darius Helm

The abruptness of the credit crisis telegraphed so quickly to the commercial market that it fell further in four quarters than it did in eight quarters during the recession of 2001. To make matters worse, this rebound is expected to be slower and more fitful than the previous rebound.

The most positive news about 2009 is that it’s now 2010. Not that things are all better now, but this year most commercial flooring manufacturers will be down by single digits, some will be flat, and a handful may even show growth—compared to last year, when contractions of 20% to 30% were all too common, and some players saw revenues shrink more than 50%.

According to Market Insights’ Santo Torcivia, total commercial business (not including rubber) was down about 23% in 2009, falling from $5.91 billion to $4.57 billion. By contrast, the residential market, which has been backsliding since mid 2006, was down less than 17% last year. The residential market is about twice the size of the commercial market, so the total flooring market was still down about 18%. And this year the residential market is expected to grow for the first time in four years.

By late 2008, the course for the following year was already set. Once the credit crisis unfolded, it became clear that sectors like corporate, hospitality and retail would take the biggest hit, while sectors driven in large part by population pressures, like healthcare and education, would fare much better. And with a new administration coming in and a stimulus package on its way, government was expected to be one of the best performing sectors.

What surprised people the most was the suddenness of the commercial slowdown. Billions of dollars worth of projects were stopped dead in their tracks. While this was largely the result of a near-freeze in credit, there’s reason to believe that, following the last recession, corporations have developed new levels of operating control over their financial mechanisms, enabling them to cut off projects very quickly.

The ensuing marketplace has become very competitive, and many manufacturers report that even small jobs that ordinarily wouldn’t have gone to bid are being fiercely contested, and price is more important than ever. Service is also a big component.

Some contract dealers report that they’re facing competition from newcomers to the business, often residential flooring dealers desperately looking for revenues. A lot of these newcomers don’t understand the business, and they’ll submit low bids and undercut jobs, then later find out how much it really entailed. Though many of these dealers end up failing to compete, they’re still taking jobs before they give up.

These price pressures really make life miserable because they come amid steady increases in raw material prices. And even though mills pass on some of those increased costs to their customers, every time raw material costs go up, margins are squeezed before price increases can be instituted, and it all impacts the bottom line.

Industry insiders have expressed frustration at both the banks and the banking system because after all the bank bailouts and despite their apparent return to fiscal health—and absent regulations reforming the system—financial institutions have not yet resumed their normal lending practices.

The good news is that there has been some loosening of credit, and reports of projects coming off hold are finally more than mere anecdotes. However, the pace is still too sluggish to return the flooring industry to a healthy state.

Assuming no more crises, financial or otherwise, hit the U.S. or global economy, the prognosis is for a firming up of the commercial market this year, though it will probably still be down a bit, followed by steadier growth next year. But it won’t be until 2012 at the earliest that the industry will be truly robust.

Internationally, major markets in the Asia-Pacific region are already rebounding, and flooring firms with business in that part of the world are feeling the uptick in business. The European market remains sluggish, however. And parts of Latin America are also generating flooring demand.

FLOORING CATEGORIES
In 2009, with the commercial flooring market down 22.7%, carpet ended up being the healthiest sector, despite contracting 21.2%. Both ceramic floor tile and hardwood flooring were down 27%, and laminates fell 29%. Resilient flooring, including linoleum, was the best performing solid surface product, down 25%.

Carpet, which dominates the commercial market, was the only share gainer last year, going from 69.6% in 2008 to nearly 71%. The other two sizeable categories, resilient and ceramic tile, both lost a little share, with resilient going from 10.7% to 10.3% and ceramic slipping from 14.5% to 13.8%. Hardwood’s share went from 3.8% to 3.6% and laminate went from 1.5% to 1.4%.

Part of why carpet performed so well was because of the continued growth of carpet tile, which again took share from broadloom in 2009. Broadloom strongholds like tenant improvement, hospitality and higher end corporate office were severely impacted last year, while the middle of the corporate market, as well as markets like education and government—where carpet tile is stronger—were generally more active. Carpet tile also holds an advantage over broadloom because a higher proportion of carpet tiles are sustainable. That’s a distinct advantage not only for LEED certified projects but for markets where green mandates exist, and the biggest of those is the government market.

SECTOR OVERVIEW
The hardest hit sector was hospitality, which performed so poorly that people are still trying to figure out exactly how much it was down. Estimates range from 35% to 50%. What is clear is that the market in the U.S. is currently overbuilt, so at least for the next couple of years there’s not expected to be much in the way of new construction.

However, according to Smith Travel Research, occupancy in 2010 will inch upward about 2% to 55.8%, and even though other indicators like average daily rates and revenues per available room are expected to decline slightly this year, by 2.3% and 0.5% respectively, both numbers represent upward revisions from earlier estimates.

For the time being, most of the activity in the hospitality market is in the limited service segment, comprising hotels with amenities but not a lot of services—like room service, for example. A lot of business travelers previously accustomed to full service hotels have been gravitating toward that segment, since it offers the usual business amenities like in-room Internet connections, as well as on-demand and cable TV—and the hotels are generally located near restaurants or provide delivery menus. Leisure travelers have been following suit. And luxury hotels, particularly in major tourist destinations like Las Vegas, have at times been offering cut rates, competing directly with the limited service hotel segment—and sacrificing profit over traffic (and all the opportunities that traffic brings with it).

Carpet has a huge share of the hospitality market, nearly ten times the size of ceramic tile’s share, in terms of volume. Hospitality carpet is predominantly broadloom, though tile’s share is growing on the public space side. The public broadlooms are largely nylon or wool, in Axminster constructions and CYP, and there’s a lot of printed broadloom as well, because of custom design flexibility and the ability to create large scale patterns.

The ceramic in the sector is practically standard in the bathrooms and often the foyer of guest rooms. Higher end ceramic along with natural stone have a share of the lobby and other public areas, and it’s more standard at higher end hotels.

The corporate sector also took a big hit last year. Subsectors like financial services froze up, and a lot of higher end projects ended up postponed or derailed in some way. At the same time, the tenant improvement market (TI) was hit similarly hard. Factors like layoffs and unemployment had a big impact on all levels of the corporate sector, but numbers suggest that the middle of the market lost the least ground. That mid priced part of the market, generally owner occupied, is where carpet tile has the strongest position, and last year it was largely true that the carpet mills with the highest proportions of carpet tile outperformed the competition.

Layoffs and right-sizing itself generated some work for flooring and other interior furnishings firms as spaces were reorganized to accommodate different arrangements.

Retail store planning also lost ground last year, reflecting the state of the residential market and the financial pressures on households. Ceramic tile and resilient flooring both play a big role in the retail market, as does carpet. It’s also been a niche market for laminate flooring.

Many larger scale retail projects, including suburban retail developments designed to capture traffic from newly developed subdivisions, never materialized, largely because those neighborhoods never came to be. Other projects have been severely cut back. Vacancy rates for retail locations in general are high.

The institutional segments have been comparatively healthy. The education market has been fairly active. While many mills have reported that there’s more activity on the higher education side, there have been some reports of a healthy volume being driven through public funding, and most of that tends to be on the K-12 side.

The higher education market in ways resembles the retail store planning market, because appearance and interior furnishings are part of the sell. While students in K-12 tend to matriculate in close proximity to their homes, colleges and universities are actively trying to draw students toward them.

Another pressure on the higher education market comes from the population wave that is currently swelling students’ ranks. Both immigration and a surge from the offspring of baby boomers is putting pressure on the higher education segment.

The healthcare sector has also held its own during this downturn. It seems as if public projects have not fared as well as private ones, and the consensus is that assisted living has been more active than acute care and medical offices.

Like higher education, the assisted living sector is driven by population pressures, with the first of the baby boomers hitting retirement. Right now there are not enough retirement centers to handle the tens of millions of baby boomers ready to enjoy their golden years.

Nevertheless, over the last four years a lot of people of retirement age saw their assets vanish, either through plummeting home values or worthless portfolios, or both, and suddenly they had to change their plans and stay in the workforce. Furthermore, a lot of those who have retired have had to choose more modest digs instead of the Continuing Care Retirement Community, complete with restaurants and recreation centers, that they had their hearts set on.

The best performing sector last year may well have been government. The shake-up that comes with new administrations tends to generate a wave of activity, both in remodeling and new construction, and this time around the stimulus package has added to the volume. Many mills report that work through the General Services Administration (GSA) for government projects involves a lot of bureaucracy unlike most other commercial sectors, but once those procedures are mastered, there are opportunities for a lot of business.

LOOKING AHEAD
Retail is a sector that can’t resist its pent up demand for long. The appearance of a retail store is part of the selling machinery, and as such it can’t afford to look dingy or outdated. The pressure to look current combined with the wear and tear on the flooring tend to keep the product lifecycle to less than five years. Often, it’s more like three.

Over the last couple of months, manufacturers have started reporting an uptick in retail jobs, though nothing dramatic. But there’s evidence that folks are spending more money and consumer confidence has been trending up.

Another market that can’t bear too much pent up demand is hospitality, and while the market is overbuilt, even the lodgings with lower occupancy rates need to keep their facility attractive and clean. Next year should be a growth year in the hospitality market, though it will probably still be sluggish.

Many hospitality carpet producers have been doing a brisker business overseas, in markets like India and China, whose offerings are both lean and tilted too much toward higher end lodgings for the budgets of today’s travelers. Limited service and upscale hotels are making inroads in those markets. Another market that’s showing a lot of activity is Brazil. Even in developing nations facing a tougher economic climate, there is often demand for accommodations, and most of that is grabbed up by the giant hotel chains eager to spread their brand.

Manufacturers also report that some corporate work, including in financial services, is starting to break loose, and some of that is from jobs that were postponed even before the credit crisis. Architect and design firms also speak of signs of life, and here and there enough work is coming up that designers who were laid off are being rehired.

For a close look at the Top 15 Specified Carpet manufacturers and Commercial Hard Surface manufacturers, see the June 2010 issue of Floor Focus Magazine.