2007 Industry Forecast: Hidden opportunities in 2007

As the market corrects, industry players take the time to focus on innovation, differentiation
By Christina Lewellen
January 1, 2007
FEATURE ARTICLE

The window and door industry (and the residential building market in general) is catching its breath. Mainstream media outlets are telling scary ghost stories to the country and its arguably shaky consumers, with a message that house prices are tumbling, existing home inventories have spiked and new home construction in some areas has come to a screeching halt. Most economists, on the other hand, are suggesting that the story isn’t so scary. Coming off record-high residential starts in 2004 and 2005, the market is correcting itself to a sustainable level in an orderly fashion.

No one seems to be arguing that the industry is going to be down again this year, with some even foreseeing a double-digit percentage drop. There appears to be some dichotomy, however, when it comes to the outlook for the year. Some doom-and-gloomers are bracing for the worst in 2007 and beyond, but others, while acknowledging a slower market, are looking for opportunities this year to be successful despite the economic environment.

NAHB Housing Forecast - Fig. 1

“I see 2007 as the year to move the market-share needle,” says John Anderson, national sales manager for the Peachtree Cos. “From an outlook perspective, I think there’s a reason to be conservative with the new construction situation, but I think market share opportunities are out there. I’ve never felt more confident going into a year than I do this year about gaining market share.”

Other companies intend to focus on new product rollouts and market education. “It takes time to get a product out into the market and have everyone understand that it’s out there,” says Milgard’s Maureen Faccia, manager of marketing communications. “I think now is the terrific time to do it—get everyone to focus on innovation and what types of things we can offer the industry.”

Basically, feedback from the industry indicates that 2007, on the heels of a record 2005 and the fall-off of 2006, may be the year to slow down and take inventory of product offerings, service plans and supplier relationships. Among many peers, that’s what Plastpro will be doing, according to Franco An, president. “All of the different manufacturers need to think about themselves and say, ‘How can we be more effective? What different types of resources do we have to bring value to the U.S. consumer?’ That’s our goal for this year.”

Executives are not sugarcoating the reality of the marketplace—some expect this year’s numbers to be down 10 to 15 percent or more from 2006. But most companies, as well as economists, are looking at 2007 in its historical context. “We like to step back and take a look long-term,” says Dave Haddix, senior vice president of the residential business unit of Therma-Tru Doors. “This is a not a bad market. Household formation, affordability—all of those are positive, long-term. The 2005 levels were unsustainable; that doesn’t make 2007, 2008 and even 2009 levels a bad situation.”

HOW LONG WILL IT LAST?
Looking right into the eyes of the proverbial elephant in the room, the big question is how long will this last? When will the charts and graphs start posting positive numbers and show lines creeping northward?

Economists don’t suggest a quick and easy recovery from sagging numbers, but most believe the correction will be orderly through 2007 and the start of 2008. “The housing market correction is now a little over a year old and I think we have another 6 to 12 months left,” says Mark Zandi, chief economist for Moody’s Investor Service’s Economy.com.

“Clearly we’re not on a soft landing—we’re past that—but I wouldn’t call it a hard landing...,” adds Bernard Markstein, director of forecasting for the National Association of Home Builders. “...maybe a bumpy landing.”

David Seiders, chief economist for the NAHB, says he believes a sustainable level for single-family housing starts is 1.5 million units per year. Starts in 2004 and 2005 were well above this threshold, resulting in an eventual drop and correction in the market, which we saw in 2006 (Fig. 1). He forecasts a continued drop in housing starts in the early part of 2007, a leveling-off through the mid- and end of the year, and some eventual upward growth as we head into 2008. “We’re through the worst of it,” he contends.

Zandi agrees, “We need to see below-trend single-family and multi-family housing for the next couple of years” to match supply with demand.

As the market levels out, Zandi adds that single-family housing prices, which have traditionally posted year-over-year growth, will slow substantially in certain areas of the country, with a possibility of hitting negative numbers in terms of percentage growth. “In ’07, I expect an outright decline in house price growth,” he says. “It’ll be the first decline since the Great Depression.”

David Berson, vice president and chief economist of Fannie Mae, says excess housing inventory needs to be burned off for housing prices to stabilize. “Inventories are essentially at record levels,” he points out. “Starts need to slow or the inventory will continue to climb. There are just a lot of homes out there to be sold…and that’s putting downward pressure on prices.”

On the multi-family side of the market, Seiders predicts a similar curve, though not as dramatic a drop-and-recovery as in the single-family segment. He expects recent levels of about 350,000 starts to dip down to around 300,000 in 2007, before turning around in 2008.

Ron Witten, president of Witten Advisors, notes that the national rental market has been in a “nice upswing” the last 18 months because of the challenges with homeownership. “2005 and 2006 have been gangbusters for leasing,” he says. “Home buying, which was competition in 2001, 2002 and 2003 is now, frankly, a good friend to the rental market today because home buying is so expensive.”

Residential Windows - Fig. 2

REGIONAL ADJUSTMENTS

Most metropolitan areas in the country will see a significant decline—in some areas as much as 20 percent—in residential construction, Zandi points out. “The only areas that will hold up reasonably well are Texas and the Pacific Northwest,” he predicts.

Many of the major metropolitan markets in the U.S. have been affected in recent years by an influx of real estate investors. Zandi estimates that out of 379 metropolitan areas, nearly 100 are overvalued, “meaning there’s froth in these markets from speculators,” he says.

Florida, California and Nevada, in particular, are “investor infected” and still suffering from high housing prices because investors are hoping these markets will bounce back, he says. “We still need another 9 to 12 months to ring out investors, especially in Florida, California and Nevada,” he says.

THE INDUSTRY’S TAKE
For an industry that is directly dependant on the health of the housing market, window and door executives are watching forecast numbers closely. Like economists, most expect 2007 to level off, and perhaps start posting growth later in the year or early in 2008.

According to Fred Wallin, vice president of marketing for glass producer AFG Industries Inc., the best forecasting data available for residential windows might be a little optimistic based upon the housing-starts numbers. But, for example, if the largest decline in housing is in the starter segment, which is smaller homes with fewer windows, the overall forecast for windows might be close, he notes. Total sales is forecast to drop from 70 million to 69 million units. The decline is all in new construction, as the repair and remodeling segment is forecast to gain in both share and total to 39 million units.

Simonton Windows, headquartered in West Virginia, expects to see a decline in the market through the second quarter of the year, with first and second quarter overall industry numbers down compared to 2006, according to Chris Monroe, vice president of marketing. By the time the third quarter rolls around, the market should begin to pick back up for manufacturers, he says. “By the fourth quarter, we’ll be back up to year-over-year normal levels,” he predicts.

Simonton is, however, a pretty balanced company, serving both the new construction and retrofit markets and gaining increasing market share in the impact realm. Monroe points out that the new construction market’s brakes were pressed primarily by larger production builders dealing with excess inventory. “Fortunately, a lot of our business is with mid-sized builders, so we don’t feel the impact as much as others do,” he notes.

But even for the industry overall, Monroe expects the silver lining in the current dip to be a pretty quick turn-around once the market has hit bottom, and perhaps it already has—he and many others in the industry do not expect the residential construction numbers to hover at below-average numbers. “I think the key thing is that we’re pretty confident that it’s going to be a v-shaped situation,” Monroe says. “The decline will go down and then back up, versus more of a recession. We won’t see that lasting for more than a few quarters.”

Dave Koester, brand manager for Weather Shield Windows & Doors, agrees that this year will be marked with a turn-around at some point, possibly about mid-way. “The doom-and-gloomers say 2007 will be a pretty weak year, and then the wine-and-roses sector say we’re already on the way out of it,” he says. “I’m sort of middle of the road, I guess. I think by mid-year we’ll start to see a recovery.”

Like many, Koester is quick to point out that historical perspective is a good way to bring the industry back to reality. “I think we need some perspective on this,” he says. “For the last four or five years, we’ve set housing records in all sorts of categories. We were spoiled for quite a while so we need to ask what exactly a ‘recovery’ is.”

Therma-Tru’s Haddix pegs housing starts at 1.6 million for most of next year, and he expects an up-tick as we approach year-end. His prediction mirrors economists’—Moody’s is forecasting 1.7 million starts in the first half of this year with an adjustment down to 1.6 in the second half, NAHB as well says 1.7 million is the magic number for starts in 2007, and Blue Chip says the same. These numbers are down from the record 2.1 million starts in 2005 and the 1.8 million estimates for last year. “I think an orderly correction is the most likely scenario [for the new construction market],” Haddix says. “We’ve got inventory corrections to go through, but long-term, with the population growth and baby boomer influence, we just can’t imagine this not being a long-term growth market.”

Like Simonton, Anderson is looking at Peachtree as being in a good position to endure the downturn, being spread out among several sub-categories of the industry. “I think it’s difficult to forecast the duration,” he says. “But the way I look at this, we’ve got a lot of customers ranged over a lot of categories in the business. That gives us a certain measure of flexibility across different market segments.”

Faccia says Milgard is prepared for the new construction market to be down about 15 percent this year compared to last year, but the company expects some increases on the commercial side of the business as activity will have to continue to sustain some of the communities that have been built in the last several years.

For the remodeling market, she says some increases are likely, though the company is operating under the assumption that growth will be relatively small—maybe a 10 percent hike.  That’s actually pretty good, not relatively small. “The windows will probably follow what the residential market is doing,” she says. “People usually replace windows when they’re buying or selling a home.”

A YEAR OFF? HARDLY. 
So window companies expect 2007 to be softer. But that’s not to say they’re sitting around, planning to wait it out. If anything, many expect they’ll be working harder in this “off” year. “Times like this sometimes you end up working harder than when things were robust,” says Scott Henderson, president of NuAir Windows, Tampa, FL. “We’re looking at other markets, looking at expanding our customer base. We are looking at other products we might be involved in and looking at internal operations as far as efficiencies to try to streamline. If you’re going to do anything on the manufacturing side, you certainly want to do it in time you’re a little bit slower.”

“I do see business picking up in the middle of the year but in the meantime, we have to take what we have and run with it,” says Koester.

And what some companies plan to run with is the remodeling side of the market, as the new construction side levels out. While the traditional remodeling markets in the Northeast and Midwest are still running strong, others such as the Sunbelt and coastal markets are coming online and should see significant growth this year, most agree. “When you look at the aging housing stock, there’s a sweet spot there in the 15- to 20-year-old houses,” says Haddix. “People there put money into the replacement and remodeling aspects. It’s an opportunity for us, and we’re trying to focus on putting more people on the street and having the right product offering for that.”

Residential Remodeling - Fig. 3

Haddix says Therma-Tru will tout its fiberglass performance message in the replacement market as homeowners start sizing up options for their entry and patio doors. “We think it’s a tremendous opportunity for the marketplace to take underperforming steel and wood products out and put fiberglass in,” Haddix says.

Anderson agrees that the entry and patio door category will see some growth this year. “I think there’s a lot of opportunity in the replacement category specifically with doors. I think that’s a very underserved market with respect to the fashion card and energy card.”

If the October Remodeling Show in Chicago was any indication of what this year will bring, doors will be the story of the year. Many manufacturers’ booths on the floor, traditionally packed with new introductions in window lines, were instead showcasing grand entry doors with unique options (see Remodeling Show report on page 34).

For NuAir Windows, a Florida company with a long history in the new construction, impact-window market, this year will be the year to look at new product offerings, including replacement window products and doors. We’re looking at the full fenestration package,” says Henderson. “We want to provide everything from entry doors, to swing doors to windows—we’re trying to do a fenestration package and make our product line more valuable to the user.

With both windows and doors, 2007 will be a year marked with focus on energy efficiency and high performance products, industry representatives say. “I think that energy efficiency has become simple table stakes for the game,” says Anderson. “You have to have an energy efficient product to even play.”

Simonton’s Monroe says the attention energy efficiency gets usually fluctuates with the price of gas, which causes the issue to be top-of-mind with consumers. “It’s amazing how short everyone’s memory is,” he says. “The minute the fuel pumps go down in price, they seem to forget about it, and yet the cost to heat the house is twice what it was last year.”

Still, the interest at the consumer level is starting to pull through various channels of distribution, Monroe notes. Even on the new construction side, where builders still make most of the product decisions (some of Simonton’s research says builders hold as much as 85 percent of the purchasing influence), energy-efficient glass packages are growing significantly. “It is interesting because we’re seeing a significant shift in sales and I doubt the consumer is pulling that through,” he explains. “Builders are pulling in those packages so they can talk about selling a more energy-efficient house.”

Haddix believes energy efficiency products will be a mainstay in the marketplace, regardless of short-term energy cost fluctuations. “I think most people don’t think long-term energy costs will be coming down,” he says. “Energy efficiency plays really well in the marketplace.”

A key growth area that seems to be immune to the national slowdown is the impact market. Monroe says Simonton expects growth in the coastal arena, regardless of what is happening in the rest of the industry. “We’re not going to see the slowdown in that area that we do with our core business,” he says. “We’re pretty confident we’ll still see coastal growth continue.”

Koester points out that besides the obvious driver—mandated building codes along the coastline—the insurance industry is also pushing growth upwards in the impact product category. “The insurance industry is saying to people, ‘Your insurance is going to rise by 30 or 40 percent unless you take actions to make your homes more hurricane resistant,’” he says. “Homeowners can say, ‘Well, I can pay the insurance company 30 percent more or I can invest that money in impact products.’”

Peachtree’s Anderson expects that the slowdown on the new construction side of the market could result in some significant shifts in the selling channel on the replacement side. “What’s interesting is that a lot of customers, when new construction softens, they turn to the remodeling category,” he explains. “I think it’ll get crowded with a lot of merchants playing in a category that they may not have a lot of expertise with.”

But the good news for established replacement retailers is that architects and consumers are far more educated and feature-savvy, thanks in part to the Internet, which should help experienced companies stand out in the crowd. “With the more savvy, techie customers we have, the dealer that embraces that opportunity and uses a sale as a forum to coach up their customer—they stand in a position to gain market share,” he says. “The market has never been more open to those types of sales approaches.”

On both the new construction and retrofit sides of the market, the slower pace of sales and overall growth will have longer-term benefits, in the eyes of Anderson. Homeowners will continue to become more educated on their window purchase decisions and builders and architects will have time to evaluate the products they specify and buy. “Because the market is softening, I prescribe to the old notion that recessions and slowdowns return money to the right owner,” he says. “Builders and owners can take the time to shop, and it doesn’t always mean for price. It tilts the playing field in favor of the more capable suppliers. And that’s why the market share needle moves.”

Milgard’s Faccia agrees. “When people get any kind of pause in the market, they will look at their value propositions and look at their partnerships and say, ‘Are they as strong as they need to be?’”

What Happened? The Economists’ Take
There’s no arguing that the residential housing market became overheated in the last couple of years (2004 and 2005 especially), but what was it that triggered the cooling that followed last year and leading into this year?

NAHB Chief Economist David Seiders points to plummeting affordability rates as one of the primary culprits to the sluggish housing market. Seiders refers to the National Association of Realtor’s composite housing affordability index (Fig. 4) to show how affordability has reached record-low levels. While the chart shows slight up-ticks in certain months of 2005 and 2006, the numbers are still far below historical trends. “It’s the decline in affordability that’s behind this housing decline,” he asserts. “And I don’t know [referring to the affordability index] whether this baby has hit bottom or not.”

Contributing to declining affordability are several known factors of the recent housing boom, including excess inventory of new and existing houses, a weakening of home prices in many areas of the country, and a spike in the number of short-term investors, or, “flippers,” in the real estate market, Seiders says. “The result of all the investing for normal people is that it ruined affordability,” he says. “The housing price topic is so central to how this housing adjustment is going to play out.”

Mark Zandi, chief economist for Moody’s Investor Service’s Economy.com, contends that creative lending also contributed to the current housing market’s woes. The Fed’s attempt at tightening monetary policy was delayed as lenders turned to alternative mortgages to keep buyers—especially first-time buyers—entering the market, he says. “That circumvented the Fed’s attempt to slow the housing market and regulate the economy,” he points out.

Ultimately, the Fed won out with consecutive interest rate hikes, but that too may need some corrective action in the coming years, he notes.

Standard & Poor’s chief economist David Wyss agrees with Zandi, pointing out that what the Fed does today affects the economy 12 to 18 months down the road. After 17 hikes in a row (until October, when the Fed announced no change in rates), the governing body may have to reverse course and adjust as it moves into the future. “Even a mule gets the idea after being hit in the head 17 times with a 2x4 to slow down,” he jokes.