The last time inflation was as high as it is today, Ronald Reagan was in his second year as president, and the coolest new technology was a personal computer, the Commodore 64, which had 64 kilobytes of memory.
It was 1982 and the rate of inflation was just under 10 percent as the new year started. Back then inflation was headed down. Since then, the average rate of inflation from February 1982 to February 2022 has been just 2.79 percent. Today, it stands at 7.5 percent.
Almost nobody running a remodeling business today has any memory of how to operate in a high-inflation environment. It’s unknown territory, and no one is responding the same way.
Some remodelers are pulling back. They are telling clients to wait until supply-chain delays and prices begin to moderate. But who knows how long that will be?
Others are running and gunning. They are driving leads and selling as many jobs as they can while demand remains strong, and they are betting that they can still turn a profit even though nearly 8 percent of what they earn this year will have evaporated by the end of the year, lost to inflation.
In today’s financial environment it will be relatively easy for remodelers to set prices too low and lose money in the process. This is particularly true for large jobs that unfold over many months.
According to the fourth-quarter reading of the U.S. Remodeler Index, large-scale remodeling projects remain the strongest part of the market. The reason is clear. The supply of homes for sale is low compared to demand. Prices for new and existing homes are still rising. Homeowners, spurred by the pandemic, remain focused on home improvements. They want an extra bedroom or updated kitchens and baths. They want an in-law suite over the garage. They want to settle in for the long haul, so they are willing to invest in their current homes to make that happen.
With that in mind, Mischa Fisher, chief economist for Angi, has one piece of advice for all contractors big and small: “Raise your prices. Then raise them even more. Be comfortable raising prices,” he says.
“If I were a remodeler today, I would remember one key principle above any of the other details—if you don’t get price right, you lose profit,” Fisher explains in response to a question about the rising cost of doing business today. “If you get price right, it is pure profit. All other optimizations, the gives-and-takes don’t really matter as much as price. Inflation is very, very dangerous. So, if you’re a remodeler, don’t get lost in all the details. Focus on getting the price right.
“Escalator clauses in your contracts are an important way to protect against it. Also think about communicating price changes to your consumers. Focus on your relationships with suppliers. All that is important. But make sure you get the price right. If you set prices correctly, it becomes pure profit. If you don’t, it becomes pure loss.”
There is evidence that remodelers are heeding this advice. The same U.S. Remodeler Index report asked remodelers about their plans to boost prices in 2022. Nearly all respondents to the survey, which is produced by John Burns Real Estate Consulting and Qualified Remodeler, said they plan to raise prices. When asked the percentage of price increase they will pass along to clients in 2022, the average was 16 percent. Thirty-four percent of contractors said they plan to raise prices by 21 percent or higher. Only 1 percent of respondents said they would keep prices the same as 2021.
Raising prices by 16 percent may not be enough. With inflation at nearly 8 percent, that does not leave very much room to accommodate the other profit-busting challenges contractors face this year. For remodelers focused on maintenance-and-repair or smaller-ticket projects, the impact on demand will be felt immediately, says Todd Tomalak, an economist and principal with John Burns.
“Where we’ll see softness in remodeling will be at the lowest tier of projects,” Tomalak notes. “We call them mini projects that are under $1,500. There’s a different demand curve for those smaller projects. From our survey work, over 50 percent of households said they would completely reconsider a project if it was below $1,500 once you hit 5 to 6 percent inflation, which is what we’re seeing right now.”
Tomalak cites a recent research note put forth by his colleagues at John Burns that examined economic and housing market parallels between today and the late 1970s and early 1980s. Back then home prices were growing at a double-digit pace, like they are today. For most of the late 70s, home-price gains exceeded the rate of inflation. This is the exact same situation as today.
The Burns team’s conclusion was that as long home prices outpace inflation, the demand for higher-priced home improvements will hold strong. This is what the John Burns team is forecasting for 2022 and into 2023: Demand for remodeling will remain strong because on a relative basis there is “still that old signal to consumers that housing and remodeling is gaining ‘wallet share’,” Tomalak explains. He notes that small-project remodeling retracted in the late 1970s and that big-project remodeling experienced 5 percent compounded growth during the same period.
“Where things got concerning was after 1979. Between 1979 and 1982 inflation grew significantly faster than home prices, signaling that the home in general was losing wallet share. Big project remodeling declined by 12 percent a year for that period. We’re definitely not seeing that now, but that kind of mark is important. How well will home prices perform relative to CPI or consumer prices?”
Time Is Money
Setting aside any overriding concerns about increases in core inflation and their impact on consumer prices, remodelers must continue to contend with lingering issues from 2020 and 2021, namely higher costs of building materials and finishes, long delays in materials deliveries due to supply-chain problems, and an ongoing shortage of skilled labor, which has led remodelers to raise pay to keep existing staff and to attract additional workers.
According to Abbe Will, associate project director of the Remodeling Futures program at Harvard’s Joint Center for Housing Studies, the labor market for residential construction has largely resumed its chronic undersupply pattern that has persisted since 2008. Back then, at the start of the Great Recession, more than a million workers left the residential construction industry, and they have not returned.
“There are a number of tailwinds fueling growth this year,” Will says. “But we think these headwinds are meaningful, too, and could very well crimp the growth that we are projecting and dampen it to some degree. Labor and materials, the cost of them, the availability of them, they go hand in hand. They are the big headwinds and discounts that we are expecting to see this year.”
A research note by the Remodeling Futures new program director, Carlos Martin, addresses this topic directly, and some of the note’s related charts can be found in this article. On the labor market front, data suggests that employment rates have returned to pre-pandemic levels, but job openings in the construction have risen in recent quarters. The upshot, Will notes, is that the labor problem is not getting better even with anecdotal evidence of productivity gains due to better software and technology.
“Realizing that the labor problem before the pandemic has not changed, and if anything, it’s worse,” Will explains. “For example, we still don’t have the needed pipeline for skilled trades. So, yes, we think technology can lead to these efficiencies in production and productivity gains. We do think that’s part of the story, but historically these gains have been really hard to measure.”
Design-build and full-service remodelers who regularly take on a small number of very big projects will perhaps have the most difficult job setting prices and managing profits in 2022. Jobs that could once reliably be completed over several weeks are now regularly slipping well beyond normal timeframes.
Ultimately, this is reducing the number of jobs that can be completed in a year. This lowers the throughput for a company, which will likely be billing those fewer jobs against more costs. Even with the same labor and capital levels, the amount of overhead for each job must go higher because overall billings will, in many cases, go down.
Raising prices now is what many remodelers say they are doing. The open question is whether they will raise them by enough to compensate not only to counteract the impact of rising inflation, but also to account for persistently high labor costs, rising materials costs and the cost of slippage in project timelines.
It has been 40 years since remodelers have had to face business complexities like the ones they face in 2022 and beyond. The good news is that there is no end in sight to the rise in home prices, which is forecast to exceed inflation and other costs. The right answer seems to be to complete as much business as possible at the right price. Indications are that homeowners today are willing to pay those prices.
“For the last 18 months input costs have been linear, you could raise prices and maybe even add some,” Tomalak says. “And depending on all of your other costs of goods, you might even have possibility to grow your margins. We saw that for some of the companies. But consumers have a finite amount of money. And one thing that we know inflation does is it eats away at the number of real options that consumers can afford to buy.”