Since 2020, the home improvement sector has been booming. Some of this growth was pulled forward due to pandemic-induced demand, a period of low interest rates, COVID stimulus packages, and the exponential rise in home prices. After over two (2) years of this extraordinary post-pandemic demand on top of a constrained supply chain, 2022 will be remembered as the year of ‘inflation’. The Federal Reserve was late to react, and we currently find ourselves in a heavy-handed response to tame rising prices. Consequently, U.S. interest rates have exceeded levels not seen in two (2) decades prompting fears of a U.S. recession plus downward pressure on consumer sentiment, real income, and housing at-large. It is evident the U.S. housing market is already in midst of a recession, as existing home sales and housing starts have dramatically fallen from this time last year. Despite the challenging market environment, the home improvement sector remained resilient throughout 2022 due to its exposure to repair and remodeling spending and is expected to fare better during this cyclical downturn before returning to its long-term growth trajectory.
When thinking about 2023, it is easy to be concerned about the bleak headlines, but the story so far says otherwise. For example, home improvement spending peaked in the third quarter (Q3) of 2022 according to the Leading Indicator of Remodeling Activity1, but, in the stock market, there was a resounding consensus across the sector of a bullish 2023 outlook after the Q3 earnings releases. Feelings on the market among industry executives is steadier, as most feel 2022 sales growth was clearly driven by higher prices as volumes were down. However, almost to a person, executives felt the sector historically would have experienced a more dramatic pull-back when confronted with the market headwinds we are experiencing today. For us, as we are giving advice on how to think about the current market dynamics, the answer is more nuanced than ever before as mitigating factors have formed a near-term backstop for home improvement retail:
- Excess consumer savings of over $2 trillion was accumulated during 2020 and 2021 which provides the U.S. economy a spending buffer of approximately one (1) year as consumers absorb declining real incomes (due to inflation).2
- Record home equity levels with low subprime exposure concentrated in high income households (incomes greater than $100 thousand) are driving two-thirds (2/3) of home improvement spend.3
- Declining household mobility rates encouraging ‘improve in place’ spending:
- Mortgage rate lock-in-effect keeping homeowners in place;
- Exasperated buyer’s remorse of the home fit and finish due to recent bidding wars and unavailability of quality homes; and,
- Changes in durable product mix as homeowner’s plan to stay in the home longer.
- Evolving lifestyle trends incentivizing immediate comfort, privacy, and functional home design needs:
- Work-from-home flexibility continuing post-pandemic;
- Pandemic-driven baby boom altering the family requirements; and
- Emphasis on home entertainment is creating multi-purpose interior and exterior spaces.
Q4 2022 and Q1 2023 public company earnings releases will be important indications of the direction of the home improvement sector as we move into 2023. We expect this year will be a return to normalcy after a period of unsustainable growth. But the question is how much will Home Improvement Retail be impacted as the full effect of the Federal Reserve policies work through the economic system? We encourage independents to pay close attention to the volatility of the leading indicators to insulate your business on the way down, while preparing for the growth bounce on the backend. Deferred remodeling projects during this cyclical slowdown will be pushed forward materializing when prices stabilize. This cyclical period is forecasted to last 12 to 18 months, which is much shorter than the 2008 Great Recession. Like prior troughs, the home improvement sector’s resiliency will make it more attractive than other sectors who have more exposure to new home construction. We believe most retail businesses are in a great spot as the underlining long-term fundamentals ideally position them to return to a long-term growth outlook for years to come.
Many economists indicate we are at the beginning of a decade long period of home improvement growth with one reputable economist, Todd Tomalak at Zonda, coining this period as the potential, ‘Golden Era of Remodeling’. In addition to the mitigating factors highlighted above, we believe the underlining long-term fundamentals support such bold growth claims:
Increase in household formation via millennials forming homes.4 As the market corrects, sidelined homeowners will return to the market. Some are incentivized more than others due to the recent baby boom of college-educated couples in their 30’s. Deferred projects of new homeowners from the 2020 to 2022 period will restart as sentiment improves.
The median age for an owner-occupied U.S. home is 39 years old and gradually aging.5 In regions such as the Northeast, the median age is over 60 years old. Comparatively, the median age of U.S. housing hasn’t been this old since World War II, as more than half of all homes were built before 1980. New construction just has not been able to keep up with housing needs, igniting a surge in remodeling spend. By 2025, a cohort of outdated homes built in the early 2000’s will enter the prime age for big ticket repairs. This major project repair and remodeling spend will be a necessity in the coming years and drive growth for industry participants.
Extraordinary housing price appreciation has influenced home improvement spend.6 The 40% rise in the average U.S. housing price from 2020 to 2022 unlocked $11.5 trillion in tappable home equity nationwide or $300,000 of equity per homeowner. Even though home prices are moderating and will continue to correct through 2023, home prices are not expected to fall below 2020 levels – leaving homeowners with plenty of available home equity to invest into their homes. Further, as interest rates decline, mortgage rates will taper, and equity refinances will return – increasing the potential dollars available for remodeling projects.
Remote and flex work schedules are likely to endure post-pandemic.7 Going forward, economists estimate 20% of full workdays are to be spent at home which is five (5) times higher than pre-pandemic levels. Home designs will continue to be under pressure to reflect this new way of working, living, and entertaining. The increased use of homes will also add to annual home wear and tear spend.
Mergers & Acquisitions (M&A) Outlook
In tandem with the recent high growth period, M&A activity has increased substantially in home improvement retail when compared to historical periods. With over ten (10) active strategic serial acquirers in home improvement retail, the industry now has more options than most industry sectors for those seeking to transition out of their business. We expect M&A activity to continue its upward trend during the slowdown and beyond. Investors of all types (financial and strategic) are attracted to the sector’s resiliency and long-term growth fundamentals compared to other sectors. Since the cyclical slowdown is forecasted to be relatively short compared to prior cycles, expect investors to continue to grow through acquisitions to better position themselves to capture the growth upswing after this period. In our next article highlighting the home improvement M&A environment, we will dive into the nuances for buyers, sellers and the M&A financing environment.
If you are home improvement participant, please consider Anchor Peabody a resource. Anchor Peabody has a dedicated Home Improvement M&A advisory practice where we seek to know who is doing what to who and why more so than anyone else. We consider ourselves part of the fabric of this community, and welcome conversations on any front from owners and executives interested in discussing the strategic and financial alternatives and/or the impact of M&A on their business.
1 Joint Center for Housing Studies of Harvard University.
2 Bureau of Economic Analysis.
3 Federal Reserve.
4 US Census Bureau.
5 US Census Bureau.
6 S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index.
7 National Bureau of Economic Research.