by Tanta on 2/19/2008 09:52:00 AM

One of the regular battles we'd get into in the comments on this blog in 2005-2006 was the "Good MEW/Bad MEW" thing. It would go like this: CR would post some data on Mortgage Equity Withdrawal and its impacts on consumer spending. Immediately, folks would pipe up to disagree with a claim CR never, actually, made, which is that "MEW" is "bad spending." The favorite "justification" of MEW was that it was being spent on "home improvement," which was--you see--an "investment," not "consumption." This was always opposed to those "bad spenders" who blew it on TVs or something.

So we're pretty thoroughly past that historical moment when the "investment" argument could be unproblematically deployed. My own interest in the subject, like CR's, was not to make some moralistic claim that consumption via MEW was intrinsically "bad," just that it was unsustainable, and the extent to which consumer spending was being brought to you by mortgage debt rather than disposable income did not bode well for the economic future. But I did think--and still do--that is worthwhile to try to distinguish between rehabilitation/renovation of elderly housing stock; luxury modifications of perfectly serviceable newer housing stock; financing routine repair, maintenance, and decorating; and cosmetic fixing-upping (generally a kind of correction for delayed maintenance or decorating, like paint and carpet) for the purpose of flipping the property. All of those things can fall under the rubric of "home improvement," but only the first and to a lesser degree the second really count as capital improvement in my mind. Insofar as these projects truly do increase the value of the real property, they are not MEW, even if they are financed with a cash-out refi or HELOC money; conceptually, MEW is an increase in mortgage debt greater than the increase in value of the property.

The trouble, then, was dealing with that group who were financing repair and maintenance and telling themselves they were doing "home improvements." First, homes require regular repair and maintenance merely to hold value: it's a carrying cost. Second, it becomes clear that too many owners financed repair and maintenance because they simply couldn't afford the cash outlay. Now that cheap interest-only HELOC money is harder to get, and old HELOC debt rolls into its adjustable rate/principal-payment period, some people are realizing that repair and maintenance are recurring costs they simply cannot afford to pay. You Californians get green pools; we Yankees get leaf-choked gutters; Georgians apparently get critters.

In that rather nebulous category between improvement and consumption somewhere in the middle, which we shall call "granite countertop syndrome," we're finally catching up with the reality of what lenders and appraisers call "overimprovement." In essence, overimprovement is cost in excess of value created; the problem can range from the McMansion thrown up on a postage-stamp lot in a neighborhood of 1,200 square foot older homes, to the decreasing marginal value of luxury materials. Every home needs flooring in the bathroom, but hand-painted imported tiles don't always increase the sales price of the home to the extent of their cost. My own belief is that a lot of sellers are setting "unrealistic" sales prices not just because they expect to get 2005-2006 prices, but because they expect to be reimbursed, dollar-for-dollar, for luxury "improvements." Sadly for them, one of the reasons we're all subprime now is that, frankly, we've all got granite countertops now. Why pay retail to an existing-home seller for that when the builders are discounting the wholesale price?

All that's by way of looking at some actual data on "remodeling":

ORLANDO, Fla. – Those fancy home fix-ups touted in cable TV shows and home magazines are losing their luster with consumers.

With the shakeout in the housing market, homeowners are worried they won't get their money back from high-dollar redos.

And lenders are less willing to finance pricey home improvements.

That has caused a decline in nationwide remodeling.

"We saw a downturn in 2007, and 2008 looks every bit as tough for the industry," said Kermit Baker, a researcher with Harvard University's Joint Center for Housing Studies. "After some almost record-breaking growth, the market has stalled."

Per capita home remodeling expenses in the region that includes Texas jumped almost 50 percent between 1996 and 2006. But since then, spending for home upgrades has fallen.

In a quarterly comparison, nationwide home remodeling expenditures have fallen about 10 percent since their high in 2006.

Researchers blame the downturn in the overall housing market for dampening the desire for home redos.

"Homeowners have been scaling back on their remodeling plans as the overall market has weakened," Mr. Baker said.

"Homeowners are concerned that they may be overimproving their homes relative to their neighborhood and prices in the market."

Studies back up those concerns. Average returns on a home remodeling project have fallen from 82.5 percent in 2003 to 70 percent last year.

With home prices depressed in many neighborhoods, homeowners are especially worried that they won't get the bucks back they spend on luxury features such as saunas, European cabinetry and imported tile floors.

"There are some signs that the emerging weakness may be greater at the upper end of the market," Mr. Baker said. "We are seeing more of a return to basics."

That means less costly improvements and standard maintenance, he said, rather than "some of the sexier kitchen and bath projects."

A 70% "return" on remodeling hurts even when you didn't finance the cost with a loan facing a steep increase in the interest rate. When you did . . .

by Calculated Risk on 2/03/2008 04:06:00 PM

This is a follow up to the previous post regarding investment in home improvement.

This data is from the Bureau of Economic Analysis (BEA), supplemental tables. (see Section 5: Table 5.4.5AU. Private Fixed Investment in Structures by Type, near the bottom)

This graph shows the major components of residential investment (RI) normalized by GDP.

Click on graph for larger image.

The largest component of RI is investment in new single family structures. This includes both homes built for sale, and homes built by owner.

The second largest component of RI is home improvement. As I noted in the previous post (using inflation adjusted dollars), investment in home improvement has held up pretty well. This investment could be seriously impacted by declining mortgage equity withdrawal (MEW) over the next few quarters.

The third largest category (at least in recent years), has been broker's commissions. This is the only component of existing home sales included in residential investment, and the decline in broker's commissions follows the decline in existing home sales.

The only other major component of RI is multifamily structures. This includes apartments and some condo projects.

Most of the focus has been on declining investment in single family structures (declining new home sales) and broker's commissions (declining existing home sales). But so far, with strong MEW, home improvement has held up well.

Rob sent me this description of what he is seeing in the housing market in Western Washington state:

I want to echo the observations of the Bay Area home shopper.
...
In nearly every middle class house listing I view, I see upgraded kitchens with granite (usually slab) counter tops . I also see matching stainless steel appliances and high end cabinets.

Now, these houses and condos are all less than 15 years old, so the owners were not generally replacing worn out or really out-of-style stuff. And these houses did not come equipped like this. I also see living rooms and family rooms that have complete, matching sets of furniture, probably from places like Pottery Barn. Not just one or two pieces, but _every_ single_ piece_. It's like all living, dining and family room furniture was swapped out at exactly the same time. I contrast this with how houses used to be furnished: a piece here, a piece there, a gift from relatives, etc., gradually over the years. No more. Everyone is going for the "showroom" look. ...

I even see this phenomenon in the low-end condo development where I bought my "starter home" back in 1993. ... when I sold my unit in 2006 after renting it out for a few years, it was "stock." No new cabinets, appliances, granite counter tops, wood or laminate flooring, simple fixtures, etc. And it was in great shape. Well, I have found that many of the units in that development have also been "pimped out" with "designer paint schemes," granite counters, new kitchen cabinets, $300 faucets and appliances, pergo flooring, fancy new mill work, etc.

These condos were built in 1993 and 1994. The counters, cabinets, mill work and most appliances should have been in reasonably good condition and not too dated in appearance. Since those folks have very modest incomes, I know where the money [probably] came from.

I'm sure these "pimped out" homes are all across the country. And MEW has probably been the primary source of funds for many of these homeowners. Now that it appears MEW lending is being tightened - especially for Home Equity Lines of Credit - this will probably impact home improvement spending.

by Calculated Risk on 9/24/2007 02:44:00 PM

From The Times: Wolseley's fresh alert on US housing market

Wolseley, the plumbing and heating engineer, which makes half its income in America, gave warning today that revenues of its US building materials business have collapsed by almost 75 per cent.

It has eliminated 3,500 staff and shut 46 branches.
...
Chip Hornsby, the chief executive, said that there were no signs of a turnaround in the residential housing market and that "the repairs, maintenance and improvement market is now beginning to soften".

Real spending on home improvement has held up pretty well so far. If this housing bust is similar to the early '80s or '90s, real home improvement investment will slump 15% to 20%.

Click on graph for larger image.
This graph shows real home improvement investment (2000 dollars) since 1959. Recessions are in gray (source: BEA)

Although real spending declined slightly in Q2 2007, home improvement spending has held up pretty well compared to the other components of Residential Investment. With declining MEW, it is very possible that home improvement spending will slump like in the early '80s and '90s.