Key Trends In Housing Impacting The Home Improvement Market

The U.S. home improvement industry is highly concentrated with Home Depot (NYSE:HD) and Lowe’s (NYSE:LOW) accounting for 58% and 39% of total revenues respectively ^[1]. The industry tends to be highly cyclical, since trends in the home improvement industry are highly correlated with that of the housing market. Post the recession, stock prices for both Home Depot and Lowe’s recorded growth mainly due to improved prospects in the U.S. housing markets and renewed construction activity. In the last year alone, S&P’s Home Improvement Retail Index climbed approximately 35%. Considering the high degree of dependence on the housing market, this article aims to elucidate some trends that could impact Home Depot and Lowe’s performance going forward.

We have a price estimate of $100 for Home Depot’s stock, which is slightly below the current market price.

Our complete analysis for Home Depot’s stock

We have a $55 Trefis price estimate for Lowe’s stock, which is below the current market price.

See our complete analysis of Lowe’s here

Higher Existing House Sales To Drive Demand For The Home Improvement Industry

The sale of existing houses is one of the most important drivers for the home improvement industry. This is because existing homeowners usually make home improvements before putting a house up for sale or rent. This is usually followed by further changes made by new homeowners. According to the National Association of Home Builders, the cumulative spending by both the current and new home owners on property alterations stands at $1800. ^[2] In 2014, the overall sale of existing houses displayed a declining trend. The National Association of Realtors (NAR) recorded a 6.6% fall in existing home sales in the first quarter, hurt by severe winter weather conditions and tepid economic activity, followed by a 4.6% and 3.8% decline in the following two quarters. ^[3] However, a turnaround is expected in 2015 with the NAR and Home Builders Group projecting sales growth at 7.7% and 7% respectively, over positive economic growth and better prospects in the labor market. ((In Need of Housing Improvement)) According to the IMF, the U.S. economy is expected to grow at 3.1% in 2015 guided by higher demand, better consumer confidence, and a reduction in fiscal deficits. ^[4] Furthermore, the unemployment rate is expected to trend downward to reach 5.6% in 2015 from 6% currently. ^[3] This could result in higher house sales and home improvement spending in the future.

Apart from a better economic stance, changes in the demographic composition is also suggestive of higher house sales in the future. So far, the proportion of Baby Boomers (ages 51 – 69) has been the largest in the population. These individuals have already established themselves and usually do not look to relocate, dragging down the demand for houses. As per population projections released by the U.S. Census Bureau, 2015 marks the first year when the “Millennial” generation (ages 18-34), projected to reach 75.3 million, is expected to outweigh the number of Baby Boomers in the population, who are expected to reach 74.9 million. ^[5] The Census Bureau further suggests that presently, the proportion of 23 year-olds in the population is the largest followed by 24 and 22 year-olds. Going forward, these individuals can be expected to start families leading to higher housing demand and consequently higher home improvement demand. Based on these factors and more, the Joint Center for Housing Studies (JCHS) has estimated the home improvement industry to grow at a 3.5% average annual rate. ^[6]

Higher Mortgage Rates In the Future To Trigger Sales in the Short-Run

The general macroeconomic landscape and monetary policy also plays a big role in the housing market. Post the recession, the U.S. adopted quantitative easing (QE) and maintained near-zero interest rates to stimulate economic activity. With the winding down of QE, analysts expected mortgage rates to rise in 2014. However, contrary to expectation, sluggish growth in China, Japan, and Europe, a crisis in Russia, and unrest in Ukraine, led investors to safer U.S. treasury bonds and government-backed mortgage bonds contributing to lower rates. Moreover, the poor world economic conditions coupled with a fall in oil prices maintained the dollar’s strength and precluded inflationary pressures in the U.S. from making any rise in interest rates necessary.  As a result, mortgage rates ended 2014 at 3.87%, way off the 5% mark predicted by analysts. With oil prices expected to remain low and increasing concerns over global growth, it seems unlikely that interest rates will rise in the short term. However, many analysts have projected mortgage rates to attain the 5% mark towards the end of the year. The expectations of higher interest rates in the future has also helped in triggering house sales. According to the Mortgage Bankers Association, home loan applications jumped 49% in the first week of the new year, the highest jump recorded since 2008. ^[7].  These higher sales on account of monetary policy measures and the general macroeconomic environment in the U.S. can also be expected to drive business for Home Depot and Lowe’s.

Home Price Appreciation And New House Sales Surge To Aid Growth

Improvements in the U.S. economy post the recession translated into recovery in the housing market as well. Both pent-up demand and demand driven by higher economic growth contributed to price increases in the housing market. In 2013, house prices witnessed a 10.3% increase followed by a 6.4% increase in 2014. Although at a slower rate, the NAR expects prices to continue increasing in 2015 at 5%. The appreciation in home prices is expected to drive sales for Home Depot and Lowe’s as customers continue investing in their homes.  Moreover, according to the NAR, new house sales are expected to increase by 30-40% in 2015. The huge increase in sales is also expected to bring in considerable business to the home improvement industry going forward.

One caveat to the growth in the housing market may be the question of affordability. In part, the deceleration in house price increases may be a consequence of reduced affordability since 2013. Affordability can be expected to be affected further going forward. This is because, although overall GDP is growing and unemployment rates are declining since the recession, wage growth has remained constant at around 2% per annum. ^[8] Moreover, a possibility of higher mortgage rates and the “millennial” affinity for housing in expensive metropolitan areas is also expected to put pressure on affordability. As per NAR forecasts, the Housing Affordability Index is expected to reach 141 and 110 in 2015 and 2016 respectively, which could stifle demand for housing and home improvement, to some extent.

A Move Away From Owner-Occupied Houses Towards Rentals

Yet another problematic trend has been the shift in preferences away from owner-occupied houses towards rentals. Home ownership rates have been steadily declining since 2004. According to Census Bureau data, home ownership rates were recorded at 67.6% in 2009 and have declined to 64.4% in 2014. ^[9] This trend is expected to continue going forward with an increase in the millennial population. This is partly because the younger population prefers living in metropolitan areas where affordability is low. Another factor contributing to this development is a change in mortgage origination activity. According to Mortgage-Finance giant Freddie Mac, 2014 witnessed a shift from mortgage refinance activity towards purchase lending. According to their projections, the increase in purchase lending will fail to offset the decline in refinance activity, contributing to a further decline in home ownership. ^[10] A decline in the number of homeowners can be expected to impact the home improvement industry. This is because homeowners on average tend to spend more on their houses, particularly by undertaking huge remodeling projects. Rentals on the other hand tend to spend only on maintenance and mostly defer or completely avoid spending on remodeling. The Joint Center for Housing Studies (JCHS) suggests that home improvement spending by rentals has averaged a 2% CAGR even during the recession, predominantly due to maintenance spending, which is undertaken irrespective of fluctuations in the business cycle. Yet, total home improvement spending declined by 12% between 2007 and 2009 primarily because homeowners deferred spending on improvement projects. ^[11] This illustrates that a higher degree of rentals in comparison to home owners can impact Home Depot and Lowe’s by dragging down spending on large improvement projects.

While factors such as better economic prospects, an increase in house sales, changes in demography, and a low interest rate environment are suggestive of growth for home improvement companies such as Home Depot and Lowe’s in the short term, a slowdown in terms of affordability and a surge in the number of rentals is expected to weigh on this growth.  One way or another, the U.S. housing market and the home improvement industry is clearly on the upswing, but the question of sustainability  still remains.

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More Trefis Research

1. The Home Improvement Retail Industry [↩]
2. In Need of Housing Improvement [↩]
3. U.S. Economic Outlook [↩] [↩]
4. World Economic Outlook [↩]
5. This Year Millennials will overtake Baby Boomers [↩]
6. New Decade of Growth for Remodeling [↩]
7. Low Mortgage Rates drive up Home Loans [↩]
8. Job Growth Rebounds but Wages Lag [↩]
9. United States Census Bureau [↩]
10. A Look Back at Five Predictions for 2014 [↩]
11. New Decade of Growth for Remodeling [↩]