Brace for a home improvement slump as consumers battle inflation, debt, and pressure on house prices, Home Depot warns

• US home improvement surged during the pandemic as many people had spare cash and little to buy.
• Home Depot warned the boom may be over as higher prices and borrowing costs squeeze consumers.

American homeowners invested heavily in renovating and expanding their dwellings over the past three years. Here's a closer look at the US home improvement boom, and why Home Depot warned this week it might be over.

Why did people splurge on their homes?

The COVID-19 pandemic spurred authorities to restrict travel and shutter non-essential venues like restaurants, stadiums, and casinos.

The virus also drove the federal government to offer financial aid to businesses and mail out stimulus checks to consumers, leaving many households with more money but fewer places to spend it.

Homeowners, buoyed by a 45% rise in house prices between the end of 2019 and June 2022, poured money into improving their living spaces as part of a wider shift in spending from services to goods.

The demand spike helped Home Depot grow its sales by $47 billion between 2019 and 2022 — a 13% compound annual growth rate — and its earnings by 60% during that period.

Why might the home improvement boom be over?

The pandemic threat has now receded, freeing homeowners to revert their spending from goods to travel, live entertainment, and other services.

Moreover, historic inflation has led the Federal Reserve to hike interest rates from nearly zero to upward of 4.5% today, and pencil in further increases.

Higher rates help to slow price growth by encouraging saving over spending or investing, and making credit cards, mortgages, and other kinds of debt more expensive.

The value of people's stocks, homes, and other assets have declined in recent months too. Rate hikes and recession fears have fueled an exodus from riskier assets to cash, bonds, and other havens.

The upshot is that consumers are spending less on goods, battling rising prices and borrowing costs, and feeling less wealthy.

Against that challenging backdrop, Home Depot warned on Tuesday that it anticipates flat sales and a 5% drop in diluted earnings per share. Investors sent its stock down 7% in response.

"There's heightened inflation and rising interest rates, a tight labor market, and moderating equity and housing markets," CEO Edward Decker said on the company's fourth-quarter earnings call, according to a transcript provided by Sentieo/AlphaSense. "So given all that, we do expect moderation in home-improvement demand."

The company expects flat real economic growth and consumer spending this year, after seeing transaction volumes normalize over the course of the past seven quarters, finance chief Richard McPhail said.

"We believe that if this shift continues at its current pace, the home improvement market would be down low single digits," he said.

Decker also flagged greater price sensitivity among consumers, primarily for big-ticket, discretionary items like patios, grills, and appliances.

"While we don't love the moderation, you can't fight the tide, if you will, with personal consumer expenditure going back to services, people traveling and whatnot," Decker said.

Could the boom continue?

Decker emphasized that consumers are still in good financial shape, and said he remains bullish on long-term demand for home improvement due to a housing shortage, an aging housing stock, and a growing US population.

Meanwhile, McPhail pointed out that over 90% of American homeowners own their home outright or have fixed-rate mortgages under 5%. Many have balked at selling and signing up for much higher mortgage rates today, and opted to invest in their existing homes instead, he said.

"There just aren't the willing sellers out there to the degree that they have been in past eras," McPhail said. "That incentive to sell and move to a higher-rate mortgage just isn't there. And in fact, the incentive is really there to improve in place."