by Kermit Baker, PhD, Hon. AIA,
Chief Economist

Even with the ups and downs of the broader economy, growth in spending on residential remodeling and repairs has been remarkably steady. In fact, the home improvement industry has not seen a major downturn since the early 1990s. Remodeling expenditures by homeowners and rental property owners totaled $233 billion in 2003, accounting for 40 percent of all residential construction and improvement spending and more than 2 percent of the U.S. economy.

Despite this impressive performance, manufacturers and distributors of building products in the U.S. have only recently come to view the remodeling industry as separate from home building. The targeting of professional remodeling contractors as a key market segment of the residential construction industry is also a fairly recent development. Moreover, it is only in the past five years that federal government agencies have reported labor categories for the remodeling industry or collected information on remodeling business establishments.

The remodeling industry has the baby boomers to thank for putting it on the economic map. Once that generation entered the housing market, expenditures for remodeling projects tripled between 1970 and 1980 and then jumped another 250 percent between 1980 and 1990. At that point, there was growing recognition that the home improvement industry had a major role to play in the economy—a fact borne out during the 2001 recession, when the strength of housing construction and home remodeling helped to prevent the downturn from being even deeper and more prolonged.

Most signs point to continued spending growth. Favorable home mortgage rates, together with the overall aging of the population, have pushed the homeownership rate to over 68 percent from under 64 percent in 1993. Most analysts expect the ownership rate to continue to rise over the coming decade. Since owner-occupants on average invest more on home improvements than renters, a higher homeownership rate should translate into even stronger remodeling and repair expenditures.

At the same time, the nation’s inventory of homes numbers some 120 million units, with about 1.5 million homes added each year to this base. At an average age of 32 years and rising, the stock of homes is in constant need of maintenance and upgrading. Fortunately, significant increases in house prices over the past decade have given owners not only an incentive to protect their housing investments, but also the rapidly growing equity to finance those improvements.

Spending breakdown
After factoring in both homeowner and rental-property owner spending, the home improvement market has grown to nearly one-quarter trillion dollars. Homeowners contribute more than 75 percent of all remodeling expenditures, with the vast majority devoted to “do-it-yourself” or “buy-it-yourself” projects and payments to professional contractors for improvements. Maintenance and repair expenditures, in contrast, represent just over 20 percent of homeowner spending.

Spending on rental properties makes up the other 25 percent of total maintenance and improvement dollars. Although more volatile than homeowner spending, remodeling expenditures by rental property owners have generally been on the upswing in recent years. This trend may reflect the relative weakness of multifamily construction over the past decade and the increased importance of an aging inventory in meeting rental housing demand.

Homeowners undertake remodeling projects to modernize or otherwise improve the livability of their homes. Indeed, nearly 45 percent of homeowner spending involves changes to interior space (such as kitchen remodels, bathroom additions and remodels, and room additions) and other structural alterations. These project categories have been among the fastest-growing segments of the owner improvement market, with expenditures approaching $60 billion in 2003.

Replacements to exteriors (including roofing, siding, windows and doors) and interiors (such as flooring, wall finishes, and ceilings) represent about 28 percent of spending. Replacing or upgrading systems and equipment—from electrical systems to built-in appliances—accounts for another 11 percent of home improvement dollars. The remaining 18 percent of homeowner spending goes toward general improvements to the property, such as driveways and retaining walls.

Regional trends
Home improvement activity has been heavily concentrated in the Northeast and Midwest. Given the older housing stock, generally higher household incomes, and scarcity of land for development in prime locations, households in these regions have traditionally contributed a disproportionately high share of spending.

Even so, growing shares of homes in the Sunbelt are now old enough to require upgrades and improvements. As more metropolitan areas in these regions are developed to the point that older homes nearer economic centers are in more demand than newer homes at the urban fringe, improvement spending is becoming a larger share of housing investment.

In 2003, the value of remodeling permits in the South and West increased at a double-digit pace, but only about half that rate in the Northeast and Midwest. These regional trends are mirrored at the metropolitan level. Of the top 25 markets for homeowner improvements, the areas experiencing the most growth in 2003 are primarily in the Sunbelt states.

Looking ahead
The U.S. home improvement industry is poised for continued expansion. To realize this growth, however, contractors will have to respond strategically to several emerging trends—the increasing importance of the high-end market, the evolving structure of the industry, and the changing demographic environment.

Earlier in this decade, much of the growth in home improvement spending was prompted by a unique combination of rapidly rising house prices, historically low financing costs, and limited investment alternatives. These forces encouraged many homeowners to refinance their mortgages and to use the savings—as well as cashed-out equity—to reinvest in their homes by making high-end improvements. Continued low financing costs, growth of high-income households, and rising house values have all helped to keep the market for high-end projects growing.

For several decades, the baby boomers have been the backbone of the remodeling market. This generation, now in their 40s and 50s, is aging beyond the prime remodeling years. Coming behind them are the members of so-called Generation X, who are fewer in number and more unknown in terms of their home improvement behavior. Complicating the outlook is the fact that minority and immigrant households—groups with potentially different home improvement goals—make up a large share of this generation. The challenge to the industry is thus to keep the aging baby boomers involved in making home improvements while at the same time finding ways to appeal to younger, more diverse homeowners.

Although the home improvement industry is emerging as one of the major forces in the economy, its organizational structure is locked in the past. This is particularly true of remodeling contractors, who largely lack the efficiencies gained through consolidation. With the home builder industry rapidly consolidating, building product suppliers are beginning to focus more on that industry segment. To achieve its growth potential, the remodeling segment must therefore ensure that manufacturers and distributors of home improvement products, as well as firms providing financing to this industry, continue to serve its contractor base.

The key threats to continued growth, however, are a sharp drop in home prices or a spike in mortgage interest rates. A rapid home price decline could prevent homeowners from tapping their equity to fund high-end home improvement projects. And even if home prices do not fall, rising interest rates could dampen the pace of home sales, thereby reducing the home improvement spending generated by housing turnover.

Nevertheless, income growth at the high end of the distribution has kept pace with rising home prices in most metropolitan areas, leaving room for continued strong spending gains. Without an unexpectedly large run-up in mortgage rates or an unanticipated shock to the economy, the remodeling sector should be able to sustain the 3 percent annual inflation-adjusted growth it has averaged since 1995.

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