Home Depot and Lowe's cite strong demand in earnings reports, but softening could be ahead

Spending on home improvement doesn’t appear to have taken a big hit with the slowdown in the U.S. housing market, but analysts say the strength may not last.

Home Depot and Lowe’s this week cited strong second-quarter sales from professionals such as contractors, plumbers and electricians. The retailers said those customers have a healthy backlog of projects and plenty of pent-up demand for home improvement.

The companies are chalking up the continued strength coming out of the height of the pandemic to housing market conditions because, they say, people staying put in their homes longer could spur renovations. Since the start of this year, the average rate on the 30-year fixed mortgage has nearly doubled and housing starts have declined significantly. This month, the National Association of Homebuilders/Wells Fargo Housing Market Index dropped into the negative territory for the first time since early in the pandemic.

“Oftentimes, what is bad for the home builder is not necessarily bad for the home improvement,” Lowe’s CEO Marvin Ellison told CNBC.

Ellison said low housing starts and high mortgage rates could incentivize homeowners to stay where they are and choose to renovate their current homes. He noted more than half of U.S. homes are over 40 years old. 

Home Depot’s chief financial officer, Richard McPhail, also noted that the rise in home prices is “probably the strongest underpinning” of home improvement demand. 

“We’ve seen home prices appreciate by almost 40% over the last two years, which has really transformed the balance sheet of the North American homeowner,” McPhail told CNBC. “When you see your home increase in value, you are more likely to invest more in it.”

Appreciating home prices can also allow for larger home equity loans, which homeowners use to fund renovations. KeyBanc analyst Bradley B. Thomas noted that Home Depot cites home prices as “one of the most important leading indicators of home improvement demand.” The median price for a home sold in July was $403,800, which is nearly 11% higher than during the same month a year earlier.

But with interest rates now higher, home equity loans are falling after hitting their highest level since 2007 in the first quarter of the year, said Piper Sandler analyst Peter Keith.

“There’s a bit of a lag effect,” Keith told CNBC. “We do think this drop off in home equity extraction will eventually show up in the pro spending.”

Keith said the drop off could hit contractors and other home improvement professionals by the end of this year or the beginning of next.

Bobby Griffin, an analyst from Raymond James, sees the risk to home equity extraction, but similarly has most of his focus on home prices.

“Rates go up, it’s not as attractive to take money out of your home anymore,” Griffin told CNBC. “But you still have that equity, so it is still attractive to invest.”