Commercial Market 2018: A sluggish market gained strength toward the end of last year - June 2018

Introduction by Darius Helm; Statistics by Market Insights LLC

Overall, the commercial flooring market made marginal gains last year, starting off slow and picking up steam in the latter half of the year. Total commercial flooring sales were up 1.0%, according to Market Insights LLC. However, all the growth was on the hard surface side, while the carpet business was down in both dollars and volume.

While commercial carpet industry revenues fell 3% in dollars-and twice that in volume-the hard surface category grew 6.5%, led by 10% gains in ceramic tile and 4% gains in resilient flooring. And even though LVT was up by more than 8%, both sheet vinyl and VCT were down, by 0.7% and 5.4%, respectively, slowing growth in the resilient category. VCT continues to lose favor among specifiers due to its high maintenance profile and bland visuals, while heterogeneous sheet goods are ceding share to LVT.

LVT is the fastest growing flooring category in the commercial market, but it isn’t growing as rapidly as residential LVT, nor does it have as big a share of its target market. Also, the rigid LVT turbo-boost has mostly been driven by residential demand, though it’s certainly gaining traction in commercial applications.

In the residential market, there are many flooring types that are vulnerable to LVT, like laminate, hardwood, ceramic and sheet vinyl-not to mention carpet. However, in the commercial market, hardwood only has a 3% share and laminate’s closer to 0.5%. Homogeneous sheet goods are largely specialty, for instance, for sterile hospital environments, so that product is buffered from LVT. However, as mentioned, heterogeneous sheet goods are losing share to LVT, including in healthcare settings like patient rooms. And as carpet continues to lose share, LVT, more than any other product, is taking that share. And it’s taking share from ceramic, not so much in prominent, public facing installations, but more in back of house and utilitarian applications.

LVT has become so essential to the growth of the flooring industry that it’s hard to find a flooring producer-any type of flooring producer-that doesn’t have an LVT program of some sort. For instance, all but one carpet mill covered in this commercial market report offers an LVT line, including the hospitality specialists. While many source their LVT, the bigger mills that didn’t already have in-house production (like Mannington and Tarkett do) have jumped right in the deep end and built their own domestic facilities or acquired LVT producers. In fact, the biggest carpet mill, Shaw Industries, is also the biggest LVT player, thanks largely to its acquisition of US Floors, the firm that launched the rigid LVT category.

If it weren’t for the LVT category, it’s likely that all the talk would be about ceramic tile. Driven by the fashion-forward sensibilities and bold innovations of the Italian and Spanish producers, the ceramic tile category has had no problem staying relevant, at the same time that it has aggressively pursued new applications, with outdoor pavers, thin tile for floors and walls, large formats and more. LVT will likely continue to take some share from ceramics, but when it comes to high-profile showcase applications, the ceramic tile category doesn’t have much to worry about. And anyway, it’s too busy taking share from natural stone with its oversized tiles and massive gauged panels that convincingly convey authentic textures and the best cuts of marble, travertine and slate at a fraction of the cost.

In soft surface, two thirds of the market is carpet tile, which continues to take share from broadloom. Now that carpet tile has saturated most commercial market segments, like corporate, education, government, retail, public space and healthcare, it’s not taking share at the same rate. But its gains in hospitality, derided as overblown and anecdotal just a few short years ago, have started to move the needle, to which anyone staying at boutique and soft brand hotels can attest. And it’s also making inroads in senior living, whose decors mirror aspects of both hospitality and residential design. Just about all of the hospitality businesses profiled in this report offer carpet tile programs.

The hard surface trend coupled with the evolution of the modern workspace are creating openings for a range of area rug solutions, and most of the carpet mills report that rugs-machine-made, handmade or bound broadloom-are making gains in the corporate segment, as well as segments like hospitality and education. Numbers are still small, but they’re growing.

When it comes to broadloom, as its share has eroded, the category’s mid-priced products have suffered the most. At the higher end, there’s still demand in the financial services sector and upscale law firms and corporate boardrooms, and carpet tile can’t match its lush, extravagant construction. At the other end, carpet tile can’t match its price points, though the delta between the two has narrowed over the years. And carpet tile is so much more straightforward and convenient in terms of installation that many price-sensitive segments of the market, like tenant improvement and mainstreet, are making the switch.

Broadloom’s strongest sector is hospitality, itself a bifurcated market, with low cost carpet for rooms and higher-end custom designs for public space applications. While traditional hotels and casinos still favor broadloom, including Axminster constructions, both carpet tile and hard surface flooring are steadily transforming the hospitality landscape.

It’s worth noting that another flooring type that is eating up a lot of square footage in the commercial market is polished concrete. In trend-conscious segments like corporate and higher education, polished concrete is in demand for its industrial look-and of course it helps that it’s grey. At the other end is the retail segment, which favors concrete because of its long lifecycle and low maintenance profile. Polished concrete continues to make gains year over year-despite increased moisture challenges-but it’s likely to fall somewhat from favor as design trends away from the gritty, industrial aesthetic.

MARKET CONDITIONS
Last year, real (inflation-adjusted) GDP grew at a healthy 2.3% growth, up from 1.7% in 2016 but down from 2.9% in 2015. And the stock market soared. The Dow Jones Industrial Average closed the year at 24,719, a 25% increase over the 19,762 close of 2016. The S&P 500 climbed 19%, and the Nasdaq jumped 28%. Overvaluation aside, the performance of the companies traded on these exchanges reflects an active and confident economy. And low unemployment, hovering around 4% since last November, has also boosted both the economy and public confidence.

So far this year, conditions remain healthy. Following dramatic early fluctuations-in late January, for instance, the Dow climbed briefly to 26,616 before losing over 2,700 points in less than two weeks-the Dow has become less volatile and started again on an upward trajectory-at press time, it was over 25,000. And unemployment, steady for six months, fell to 3.9% in April. It’s unlikely to fall much further-4% is generally considered to be near optimal-but there’s room for improvement in terms of getting enough work and enough pay.

For the first quarter of 2018, real GDP grew 2.3%, according to the latest analysis.

SECTOR UPDATE
Business in the corporate segment, by far the largest segment in the commercial market, was up marginally last year, with weak carpet sales pulling down strong growth in both LVT and ceramic tile. The continuing evolution of workplace design is helping drive flooring business. Just a couple of decades ago, entire offices would be specified with a single type of flooring (generally carpet), and even a single design, other than a little vinyl flooring in break rooms and utility rooms and ceramic tile in the restrooms.

In today’s office design, flooring’s capabilities are far more fully utilized. There’s comfort underfoot when you need it, or acoustical abatement, or wayfinding cues, and colors and patterns that suit the context of the various zones and echo the values of the institution.

In fact, flooring’s role is far less passive across the entire commercial landscape. Similar design trends are making their way through the education, senior living and hospitality markets, adjusted to accommodate the different functions of the spaces.

The senior living market, which is partway through a long arc of expansion to handle the growing demand of aging Baby Boomers, showed steady but unremarkable growth last year. The segment’s trajectory was interrupted by the recession and housing downturn a decade ago, which not only put a hold on senior living projects but also depressed demand, since it forced millions of Americans on the cusp of retirement to retrench and extend their careers. And for many the anemic rate of recovery (of the economy in general and home values in particular) has ultimately yielded much more modest retirement plans-including moving in with their children.

Another major market is hospitality, which has been strong for a few years. Last year, business was fairly robust, with both renovation and new construction making gains. New construction will wane this year, but even though renovations are anticipated to remain healthy for the next couple of years, gains are likely to slow in this segment.

One interesting sector is retail, which has become somewhat unmoored by the threat of online shopping. As the sector struggles to redefine itself to get in sync with the perceived needs of Millennials, store redesign and new concepts for the shopping experience have brought some activity to what has become a subpar commercial market segment. There’s also some growth in more suburban retail development, creating retail experiences that feel local and community-based-a counter-trend to the anonymity of urban life and online shopping.

The movement toward online shopping has driven construction in one specific building type, though most of its square footage is entirely devoid of floorcoverings, and that’s warehouses. All of this online shipping requires inventory, and that means warehouses. That’s good news for those in the concrete business.

In healthcare, the market has shown modest growth. New construction is up, and the shift from large hospitals to clinics and specialty centers has helped fuel the growth in healthcare flooring in recent years, though the segment also got a boost last year from some large hospital projects. However, the healthcare market remains a little cautious, playing a years-long game of wait and see in terms of the future of the Affordable Care Act and its impact on healthcare needs.

One of the most dynamic market segments in recent years has been multifamily, which has been a powerhouse over the last decade. But there are clear signs that it has passed its peak, at least in terms of the specified side, which is more involved in new construction and full-scale renovations than the low-cost, narrow-margin replacement business. Demand is starting to flag, shifting to the single-family home and condo markets. This is one of those sectors that could be moving into a period of stagnation.

One of the largest commercial markets is education, and over two thirds of the education square footage is in the K-12 segment, which has been underfunded for years despite critical renovation and new construction needs. Schools are largely funded through state and local governments, but the condition of many state budgets has made funding extremely challenging. The good news is that over the last year, several states have started issuing bonds for new construction and upgrades in the K-12 segment. California is leading the way, followed by Texas, and other states with significant bond measures include Colorado, Washington and Oregon, along with several municipalities and cities across the country. It should be a bright spot in the commercial market for the next year or so. However, many states are still in bad economic shape and are doing little to maintain their K-12 infrastructure.

The other big part of the education market is higher education, which relies heavily on endowments. Following a few slow years, there are hopes that the rising stock markets will help fuel another round of endowments, and that should start impacting investments in renovations and new construction in 2018.

LOOKING AHEAD
Following a few years of some of the lowest raw material pricing in recent memory, raw material costs have been increasing across the board. There’s a sense that maybe we’re moving into a period of escalation. Crude oil prices are on the rise, having been held down artificially by strategic production quotas for the last three years. Prices have already climbed to about $72 a barrel, and most analysts predict their continued ascent.

There’s pressure in the market on petroleum-derived ingredients, which account for a lot of the content in carpet and resilient flooring. Pressure on nylon intermediates has led to carpet price increases. And freight costs are going up, not just due to rising gasoline prices, but also because of new regulations for long-haul truckers that are leading to labor shortages, putting pressure on schedules and driving up costs.

The good news is that, starting this year, the commercial flooring industry may well get a boost as a result of the tax reform program adopted into law at the end of last year. There are reports that discretionary income flowing from the corporate tax cuts is enticing companies to release their capital budgets earlier in the year, which will likely drive some funding to renovation and new construction projects.

For a close look at the Top 15 Specified Carpet manufacturers and Commercial Hard Surface manufacturers, see the June 2018 issue of Floor Focus Magazine.

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