Is the Residential Services Boom Sustainable?

The following article is based on the personal views of the author. Mid-Atlantic Partners is not liable for those that make decisions based on the information contained herein. The information contained in the following article was obtained from research and publicly available data and was relied on by Mid-Atlantic Partners without assuming responsibility for independent verification as to the accuracy or completeness of such information. Rather, the purpose of this article is to simply provide a perspective as it relates to market trends and observations. It is our hope that you enjoy the content and continue to read The Northeast Sentinel. Accordingly, this material may not be reproduced, disseminated, quoted or referred to, in whole or in part, or used for any other purpose, without the prior written consent of Mid-Atlantic Partners LLC.

Callus Hands Rule the Day

German Economist Karl Marx was famous for many things. Mostly his negative view of capitalist systems where his writing often predicted working class labor revolutions taking back the means of production. Unfortunately for Karl he was not around long enough to witness the boom of the US residential services industry. Assuming he was here today, he would be (slightly) vindicated in the fact that today’s plumbers, roofers, exterminators, and landscapers are in high demand based on their specialization and comparative advantage. In fact, the businesses these laborers represent are seeing very high multiples on the earnings for this specialization. Departing from Marxian economics, the real question we aim to address is whether the high valuations associated with residential services companies are here to stay and why.

Market Emergence

`Since the COVID-19 pandemic, services such as residential landscaping, plumbing, HVAC, pest control, and roofing have become fast-growing end markets for consumption. A figurative gold rush has presented itself in the form of homeowner wallet share whose standard of living is dictated by limited patience pertaining to quality service. As a result, consumers have demonstrated a high willingness to pay for home services that they either don’t want to do or flat out cannot do. This new paradigm has begun suggesting these expenses have become less discretionary, and potentially as durable as the weekly grocery store trips.

In 2024, it sounds like a broken record attributing most market dynamics to the Pandemic externality. However, when economists refer to “externalities” it is referring to specific components that constitute spillover effects, in this case the increase of residential service demand. These spillovers can be labeled pecuniary externalities which occur when individuals demonstrate actions that directly affect market supplies or prices. For many, a shortage in home supply created a spillover demand for aging homes with inept labor skills that Mr. Marx once praised. As these new buyers settled for older homes, renovation and home improvement expenditure continued to grow.

Change in Housing Starts vs. Change in Home Improvement Spend

Source: U.S. Census, JCHS, HUD Data, William Blair Equity Research.

The divergence of Housing Starts and Improvement Spend has created a discernible tailwind for the value uplift to regional providers possessing the labor supplies required for these functions. Once considered a very fragmented market, residential service providers are expanding through various means and investments allowing them to go after not only new zip codes and counties, but new states. Winning strategies for these providers present themselves in the way of high marketing budgets, scalable labor models, quality service emphasis, and same-day appointments. A once simple market that’s value was debated based on the do-it-yourself (DIY) consumer, seems to be a cash flow engine as less sophisticated millennials are finally entering the homeowner arena. Nobody possesses a crystal ball. However, drilling into the consumer who underpins these markets is the first step in knowing what the future holds.

Evaluating the Consumer

At Mid-Atlantic, we often find that resorting to basic economic concepts helps ‘humanize’ the target consumer for developing value-based strategies. Consumer wants are limitless but the means to attain these wants are not. This means that for today’s average consumer an inelastic demand has developed forcing them to explore various tradeoffs and opportunity costs necessary to attain an optimal home life. Gone are the days where sleep quality will be sacrificed due to sub-optimal temperature settings on the boiler or HVAC. Gone are the days where the neighbor flaunts their exquisite landscaping across the front yard without a competitive emulation. Tradeoffs are always going to be required, but the good news for the small residential service business owner is that there is a long line of sacrifices to be made before your service enters this discussion. When determining if the lower income zip codes are worth marketing to, remember that opportunity costs imply sunk costs. For sunk costs, this may be larger foundational issues with the selected home where frequent servicing is the only option versus a complete reinvestment. That old Carrier HVAC may simply be too expensive and viewed as a sunk cost to replace any time soon. This opens the recurring ‘floodgate’ for the professionals able to sufficiently and expediently service.

Source: Mid-Atlantic Partners LLC; internal analysis.

In the lower pockets of the market, the term efficiency requires examination. This term is best understood as a relationship between ends and means. The target consumer does not act as efficiently as we may or may not give them credit for. An example would be selecting a more expensive Dave’s Pest Control with lower ratings than Platinum Pest Control (fictitious names) because we like the brand of Dave’s being a cooler and elegant symbol that we choose to associate our home with. Essentially, for our average consumer, choice may or may not be efficient and far too often we observe choosing the cheapest means to bring about that end.

Will we ever Learn to Fix a Toilet?

For those of you who used to mow lawns in the Summertime, don’t quit your day jobs just yet. Consumption trends unfortunately can be unpredictable and unfortunately, in some industries, counterintuitive. But trust that the folks at Mid-Atlantic are not arrogant enough to select an industry where the consumer is understood to be overly complex and/or counterintuitive. The reality is for me to learn how to fix my HVAC requires time. Time that could be allocated to writing more articles like this. And in the event I cannot fix it, there will be unpleasant sleep patterns from all who live under my roof. Post-pandemic trends have presented the Northeast with consumers that are more cognizant with their time. They may not be the most efficient thinkers, but they behave in patterns that optimize their time outside of their day jobs. Simply put, specialization needs have been increasingly more recognized for services that have become increasingly more durable.

On the macro-economic front, consumer spending appears to be holding strong in areas that are far more discretionary than the items discussed in this article. Restaurant food prices remain high and still the volume is there. Meanwhile, residential services required to make an aging home feel more modernized are becoming a vital portion of the average consumer’s budget and expected to be well into the future. Typical with the lower-middle market, the highest valuations have been seen with those able to generate profits of over $5 million supported by mature brands. Since 2020, various investment banks have reported precedent transactions as low as 5x and as high as 20x for select residential service assets. How’s that for growth implications?