Economic Indicators 2017

How will the Kitchen & Bath Industry be effected?

Economic Indicators Update: 2/1/17 (Nationally)

New Home Sales fell by 10% to an annual rate of 536 thousand homes in December. Existing Homes fell by a more modest 2.8% to a 5.49 million rate. Despite these declines, sales in December were above prior year levels. Sales for existing homes were 6% higher compared to the three months ending in December 2015; and 28% higher for new homes. So in both cases sales activity has been improving.

High-priced new homes, those sold for half a million dollars or more, also fell by 10% in December to a total of 18 thousand sold in the fourth quarter. For the year, high-end homes reached a total of 89 thousand sold, up 17% from 2015. Coincidentally, last year’s high-end new homes accounted for 17% of all new homes sold. This is the highest share they’ve taken since 2002. High-end home sales have increased significantly since the economic recession, when they accounted for only 8% of all new homes sold.

Last week the fourth quarter GDP growth data was released.  At 1.6% for the fourth quarter of last year, that is the lowest growth rate since 2011. Although the GDP data will be revised over the next two quarters, it’s unlikely to bring 2016 growth to a level above that of the preceding two years.

GDP is the presumed value of all goods and services provided by the economy in a year; it’s also the most comprehensive measurement of a nation’s economic activity. GDP growth over the last 11 years has averaged well below two percent as illustrated in the above chart. This average is brought down by the sharp decline in 2009 as well as the modest fall the prior year.

Exports of American goods and services and imports of foreign goods and services had the most negative impact on fourth quarter GDP growth. The table below shows the contribution in percentage points of the major components to the fourth quarter GDP growth.

Another factor driving some sectors of our businesses, mortgage rates, reversed course last week. After consecutive declines for the first three weeks of this year, the 30-year fixed mortgage rate rose eight basis points to 4.19%. We expect they will continue to rise, particularly in light of the Fed’s policy to impose two or more interest rate increases this year. According to Bankrate.com, the average national rate for a 30-year fixed mortgage was just over 4.15% in mid-December, around 85 basis points higher than the 3.3% lows of September. This means that a home buyer purchasing a new home with 20% down at October’s median home price of $304,500 would now have to pay $1,187 per month at a 4.17% rate, versus  $1,070 at a 3.32% rate—an increase of $117 per month.

If the US economy revives from the slow growth pace maintained since the turn of the century, we may see demand pressures driving mortgage rates higher.

As mortgage rates increase over the next few years, home improvement activity is likely to increase with them. This may seem counter intuitive, but you can expect two somewhat opposing effects: one highly positive and one slightly negative.

Negative Effect

The negative effect will stem from an expected slowdown in the growth of home sales. When mortgage rates increase, we expect to see slower growth in the volume of homes being bought and sold. As an aside, in the immediate term, there can be an uptick in sales as people who were “on the fence” jump to buy before rates go significantly higher. But that effect does not persist for very long.

We would expect a negative effect on the rate of growth of home improvement spending to accompany a slowdown in sales volume growth. That said, 92 percent of home improvement spending — spending on projects such as kitchen and bathroom remodels — comes from people who are not moving. So, this drag on spending drives only a small fraction of the overall outlook for home improvement growth. And, it will be greatly outweighed by more powerful positive forces like home appreciation, consumer confidence and the sheer age of the housing stock, combined with the tailwind from years of deferred maintenance and improvement during 2008-2012.

Positive Effect

Now for the positive effect. Many people who managed to secure a mortgage with a fixed rate in the 3 to 4 percent range will be somewhat reticent to sell and buy after rates get up near 5 percent. Such a move can have an outsized percentage impact on a homeowner’s monthly payment. Some of those people will decide it’s better to improve their existing homes than lose their low fixed rate. Think of it this way: Going from a 3.5 percent rate to a 5 percent rate means a 16 to 20 percent increase in the total monthly payment (depending upon assumptions regarding taxes and insurance). And that’s just making a lateral move from one $300,000 house to another $300,000 house. The prospect of such a significant monthly payment change may be enough to encourage people who don’t have to move, people considering relocating for a job, for example, to update, improve or even add on to their current homes instead of moving. Not to mention the fact they will also save the costs associated with selling their current homes. Of the two opposing effects, the positive effect—people choosing to stay in current homes as a result of rising mortgage rates—will outweigh the negative effect coming from a lower level of churn.

Looking Forward

The bigger question is this: Will home equity keep rising strongly, or will it slow down? It will certainly slow, partly because higher interest rates translate into lower asset values (including home values), all other factors held constant.  My expectation, though, is that home equity will remain a strong-though-slightly-diminished tailwind for home improvement for the next several years. There are a lot of complicating moving parts in this equation, but the outlook for the home improvement industry growth is bright, even (or especially) with the prospect of higher mortgage rates around the corner.