Focus 100 Retail - November 2008

By Darius Helm and Brian Hamilton

While the overall picture is decidedly grim, and while a small percentage of the retailers and contractors that serve the residential market will end up going out of business, the damage is not evenly distributed. Once the worst is behind us, some will have incurred huge losses and others huge gains, and most will emerge leaner, smarter and much more efficient.

In some cases, it’s about the region. Retailers and contractors in the less overbuilt regions have fared better, though in many cases that means they’re only down 5% or 10%. But even in the toughest markets, like Las Vegas and Miami, some retailers are managing to post significant growth, taking share from competitors due to everything from aggressive advertising and targeted marketing to product mix and price points.

Diversification is also helping some keep their heads above water. For one thing, the more product categories you carry, the more traffic you can get in your store. Also, some retailers are taking advantage of their diversity by offering multi-category deals or even giving free gifts in certain product categories to go along with flooring purchases.

Niche players, depending on the niche, are also having an easier time of it. For instance, until recently, those targeting the high end had a clear advantage. Others who work in sectors like apartment replacement or even military housing may find themselves insulated from many market pressures.

Over the last year, homeowners have been cutting back on home improvement plans, and when it comes to flooring, they’re often doing one or two rooms rather than the entire house, so both the number and size of jobs has been falling.

While the bailout programs may end up softening the fall and perhaps paving the way for a rebound, the biggest impact to this industry of the fiscal crisis that finally erupted in September will be on the commercial and high end residential markets, the two markets that were holding up well and helping stabilize the industry.

That means that for the first time since around 1981, both sides of the residential flooring business, builder and remodel, will be suffering, alongside the commercial flooring market. The good news is that, barring any new crises or burdens to economic growth, much of the time between now and when the economy starts firing on all cylinders, perhaps in 2011, will be spent making small incremental gains.

However, the first challenge is to survive 2009. Many retailers have already started taking difficult steps, like reducing staff and locations, but the greatest efforts have been reserved for doing anything and everything to get traffic through their doors.

At this point, most people understand how we got in this mess—a combination of subprime loans and rampant speculation led to significant overbuilding, and the inventory was further inflated when rates adjusted up, prices dropped, people started defaulting, speculators fled, everyone else stopped buying, and prices dropped even more. The ensuing credit restrictions combined with a steep drop in existing home sales hammered the residential retail business, and now, with the severe readjustment of the stock markets, baby boomers have seen their savings dwindle and the high end of the market is also closing up, along with the commercial market.

According to the American Institute of Architects, the Architecture Billing Index, a leading indicator of non-residential construction activity that predicts activity nine to 12 months in the future, fell more than six points to 41.4 in September. All commercial sectors, like education, healthcare, government and corporate, have fallen below 50, which indicates contraction, as have all four geographical regions.

A Look at Housing Statistics
Here’s where key data from housing construction indicators puts the market—between 17 and 26 year lows. According to the Commerce Department, construction of new homes fell to a 17 year low in September. Housing starts overall fell 6.3% to the lowest levels since 1991 to a seasonally adjusted annual rate of 817,000 units, while starts of single family houses fell 12% to 544,000 units, the lowest level since 1982. In the same month, building permits overall fell over 8% to a 27 year low of 786,000 units, while single family housing permits were down nearly 4% to 532,000, a 26 year low.

However, one piece of potentially heartening news is that pending home sales rose from July to August by 7.4%, putting the seasonally adjusted index of the National Association of Realtors at 93.4, its highest reading since June 2007. But there’s a chance these numbers won’t be realized, since pending home sales are based on sellers accepting an offer. It takes a month or two for the deals to close, and it’s not yet clear what impact the fiscal crisis in the following month has had on completed sales.

In fact, there have been anecdotal reports all summer long of some regions firming up, but the credit crunch has probably neutralized most of those gains.

New single-family home sales rose 2.7% in September to a seasonally adjusted annual rate of 464,000 units, according to the Commerce Department. However, that’s still over 33% below last year’s level, and the small rise in September followed a 12.6% drop in August. In addition, the median price for new homes declined 9.1% in September to $218,400, the lowest price level since September 2004.

Existing home sales were also up in September, by 5.5%, following a 2.2% decline in August. With a seasonally adjusted annual rate of 5.18 million units, including single-family homes, condos, co-ops and townhomes, that puts sales just above last September’s pace. While single-family home sales are up nearly 4% from last year’s pace, condos and co-ops are down 15.7% from last September’s pace.

Median existing home prices continued to fall, going down to $191,600 in September, down 9% from where they stood last September at $210,500.

According to Lawrence Yun, chief economist for the National Association of Realtors (NAR), existing homes sales are forecast to fall to 5.04 million this year, with a modest increase anticipated for 2009, while new home sales should be about 503,000 for the year, but will drop further next year to 471,000. Total housing starts are forecast to drop about 28% this year to 973,000 units, and next year they’ll decline to 843,000—down another 13%.

Yun’s forecasts help clarify the flooring industry’s prognosis. With an inventory of about 4.25 million homes available for sale, which is about a ten and a half month supply, demand for new homes will remain depressed at least through 2009. The first signs of life should be in the existing home market, and that will be reflected in an uptick in business for retailers catering to the residential remodel market. And it won’t be until the backlog of homes is slowly cleared—it’ll take a while—that the builders will start to get busy and the flooring contractor will see business grow again.

Foreclosure activity continues to build. According to Realty Trac, September foreclosures were down 12% from August’s record high number of filings, making it flat with the July figure. September numbers are 21% higher than numbers from September 2007, and third quarter numbers—a total of 765,558 foreclosure filings nationwide—were up 71% from the same period last year. The daily rate is about 10,000 foreclosures a day. California, Florida and Arizona account for more than half of the nation’s foreclosures, and other hard hit states include Michigan, Georgia, Ohio, Colorado, Illinois and Indiana. States with the lowest foreclosure rates are West Virginia, Vermont, South Dakota and North Dakota.

While some states and municipalities are currently rolling out emergency legislation to slow foreclosure rates—which may explain the dip in September—the anticipated rise in unemployment is likely to push rates higher. The situation is so bad that it’s actually been a boon to some retailers. For instance, Flooring Design Group, based in the suburbs of Atlanta, compensated for its loss of builder business by doing work on foreclosed homes now owned by banks and other entities.

Regional Challenges
Most of those heavily overbuilt markets, like Florida, Las Vegas, Phoenix and large swaths of California, along with economically depressed regions like much of Michigan and parts of Ohio, continue to suffer. However, some of the biggest markets in the country, like parts of Texas, which were driven largely by organic growth have not fallen as hard. Another market widely reported to be holding its own is Oklahoma. Another is North Dakota. Mind you, those are two fairly small markets.

Until the last few months, the Pacific Northwest was one of the best regions, but business has now slowed there as well, though it’s not predicted to slow as much as neighboring regions.

According to HousingPredictor.com, as of midyear, the list of the 25 markets with the biggest drop in housing prices includes eight California markets and four Florida markets, along with Las Vegas, Reno, Detroit, Phoenix, Cleveland, Atlanta, Boston, Indianapolis, Portland, and Grand Rapids. The worst market is Ontario, California, with prices forecast to be down 24.5% this year. Las Vegas is close behind, at 23.7%, followed by Miami at 22.1%, Detroit at 19.7%, Phoenix at 19.6%, Sacramento at 19.1% and Anaheim at 17.4%. Grand Rapids, which is number 25 on the list, is forecast to be down 8.9%.

HousingPredictor.com’s list of the top 25 markets includes three markets in Mississippi, North Dakota, Utah, Texas and Idaho, along with two markets in Oklahoma, New York and Washington, as well as Salem, Oregon, Grand Junction, Colorado, Mobile, Alabama and Albuquerque, New Mexico. The top market is Biloxi, Mississippi, forecast for 4.9% growth in housing prices. Lubbock, Texas comes in at number 25, with 2.3% projected growth.

What stands out about these two lists is that most of the worst performing markets are large metro markets, like Las Vegas, Los Angeles, Phoenix, Detroit, San Diego, Cleveland, Atlanta and Indianapolis, while the best markets are generally much smaller places like Bismarck, North Dakota, with a metropolitan population of 100,000, or Pascagoula, Mississippi, population about 30,000. However, it’s worth noting that there are a handful of large metropolitan markets on that top 25 list, including New York City, Salt Lake City, Boise, Oklahoma City, Mobile and Albuquerque.

The National Association of Realtors reports that sales are picking up in some of the regions that posted the most severe pricing declines, including parts of Arizona, California, Florida, Nevada, Rhode Island and the Washington, D.C. metro market.

The NAR’s Pending Home Sales Index shows the most activity in the West, where the index, based on contracts signed in August, was up 18% over July—and up 38% from a year ago. It was up 2% from a year ago in the Northeast, up 6.6% in the Midwest, and up 2.1% in the South.

Existing home sales in the West were up 16.8% from August to September, and that put them up 34.4% from September 2007. The picture is worst in the Northeast, with sales from August to September falling 1.2%, down 7.7% from where they were in September 2007. In the Midwest, sales were up 4.4%, though down 2.5% from last September. And in the South, sales also rose, by 2.2%, but were down 7.8% from last year’s level.

In terms of new home sales, the Northeast had the toughest time, with September numbers down 21.4% from August. Sales in the Midwest were not down by as much, falling 5.8%. In the South, sales were up 0.7%. However, the real surprise was the West, which contains many of the hardest hit regions. Sales in the West were up 22.7%.

Flooring in the Residential Market
There’s a lot of significant trading of share going on between the flooring categories. Most notably, area rugs and vinyl have been performing well, while hardwood and carpet are suffering. Ceramic is a mixed bag but it’s mostly down, as is the laminate category.

A large part of why the hardwood business is off is because of slow builder business. Hardwood flooring dominates that market, and it’s suffered heavily on the base grade side because of the slowdown in tract homes. Custom homes have fared better, relatively, though there are plenty of reasons to expect that market to also weaken further next year. However, many high end homes in both the builder and residential replacement markets, especially those on the West Coast, are opting for distressed and hand-scraped planks, and consequently that part of the market has not fared as poorly as standard ” strip.

Vinyl has performed well for a number of reasons, and one of them is luxury vinyl tile and plank. The product competes with both laminate and ceramic, and it’s gaining share because of a combination of price, performance and styling. Also, glass backed vinyl flooring has made some gains in the residential market. However, sheet vinyl is also gaining share in many markets as a low cost replacement for products like ceramic in kitchens and bathrooms. Not only is it more affordable to consumers but it performs well, making it a good conservative choice.

While most area rug retailers are doing well, some higher end dealers and importers have suffered, both from the weakness of the dollar and the weakness of the economy. Lower priced machine made area rugs are turning out to be a popular option for redecorating. It’s a lot cheaper to buy a few area rugs than it is to put down a new hard surface floor or new carpet.

Many have been expecting carpet to do better in this downturn, largely because it is, like vinyl, an affordable alternative. However, retailers in most regions report that carpet is performing poorly. Laminates are also not performing well, with most of the activity at the high and low end of the market.

The shifts in flooring share impact retailers, particularly when they find themselves selling less expensive flooring or when the trend is away from categories they carry, but the damage is just as significant to flooring producers. While multi-category producers like Shaw, Mohawk and Mannington may find themselves somewhat insulated from the shifts in demand, those who manufacture only a single category of flooring, like hardwood, could find themselves in a truly precarious situation.

Another significant issue impacting retailers, distributors and producers is the size of homes. During the first few years of this century, the trend has been toward bigger homes—and it’s been a large scale movement, mostly on the higher end custom home side. However, flooring contractors report that home sizes are, at least for now, shrinking. That means less flooring per housing unit. So even if units go up, flooring sales won’t climb at the same ratio to units as they did in the past. And that could mean that the flooring industry will rebound more slowly than the housing market.

However, some industry experts believe that once American consumers regain confidence and the economy starts to grow again, they’ll be asking for bigger houses again. Others believe that large houses may wane in popularity, like SUVs in recent years, particularly as green homes gain traction. In general, smaller homes are more energy efficient and environmentally sound than larger dwellings.

For highlights and a list of the top 100 Retailers, see the November 2008 issue of Floor Focus Magazine.

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