After watching its sales to homebuilders soar over the last five years, Hahn Systems of Indianapolis got a nasty surprise earlier this year. The market, it seemed, was cooling off and seeing a drop that has directly impacted the 120-employee industrial and construction supply product distributor's sales by 10 percent.

While some of the decrease can be attributed to winter weather issues in the Midwest and Northeast, Doug Hahn, company president, isn't convinced that the homebuilding market will get back to 2004 levels anytime soon. With half of its customer base made up of residential contractors in Indiana, Michigan and Kentucky (and the other half mainly industrial manufacturing), Hahn Systems could be in for a bumpy ride this year.

"For about five years, the Midwest economy has been strong, posting record-setting housing starts year after year," says Hahn. "This year we're definitely seeing a fall-off in those numbers."

To deal with it, Hahn says he's looking into just how much of the downturn was weather related, and how much of it can be attributed to a pullback on the new housing market's reins.

"Based on estimates from builders and other market suppliers, it looks like growth is going to be softer," says Hahn, who expects the market to be "flat to a slight downturn" over the next 24 months.

Not willing to stand by and watch his firm's sales erode along with the market, Hahn plans to sell deeper into existing customers, and encourage them to purchase more of the firm's product offerings. He also plans to keep an eye on new products on the market—particularly those that have been improved by technology—while selling a more diverse array of products to residential builders.

"We'll explore the possibility of selling MRO-type products that we're already selling to our industrial manufacturing customers," says Hahn, "to the residential contractors."

In 2005, the housing market started out with a bang, with total housing starts for January posting a 21-year high; single-family starts climbing to a record high; and issuance of building permits threatening the records set in May 2004. According to the National Assn. of Home Builders, all of this took place despite the unusually bad weather in the Northeast, Midwest and West.

As the year progressed, the NAHB/Wells Fargo Housing Market Index continued to ride high in both January and February as builders maintained an upbeat view of buyer traffic, current home sales and sales prospects for the future. NAHB's forecasts for the economy and the financial market environment paint a friendly picture for housing in 2005 and 2006. The group expects "modest" 3 percent to 4 percent declines in home sales and housing starts, countered to some degree by persistent growth in residential remodeling and an evolving upswing in manufactured home shipments.

The National Assn. of Realtors, which tracks existing home sales, is also positive on the outlook. A January 2005 from NAR, for example, predicted that home sales would "ease" but remain close to record levels in 2005. Following an estimated 8.9 percent jump to 6.64 million existing-home sales in 2004, says NAR, "activity will remain strong." NAR predicts that 1.11 million new homes will be sold in 2005, down slightly from a record 1.19 million for 2004, but up 9.5 percent from 2003.

"No one expects home sales to set a record every year, with some ebb and flow normal as market conditions and needs shift," says David Lereah, NAR's chief economist. "Even so, home sales will stay well above what was considered to be a healthy level in the late 1990s. The population has grown, household formation is strong and demographics tell us this trend will continue. In addition, a similar mix of economic conditions is expected in the U.S. for the foreseeable future."

If the residential construction industry is indeed in the early stages of a pullback, Jack Hurley, Jr., certainly hasn't seen any signs of it. As president at Brockton, Mass.-based manufacturer's rep firm, Jackson Sales Co., he often works with the residential construction market and says that sector is still booming.

"It's very busy," says Hurley, who points to a recent Journal of Light Construction trade show as proof. "That show is a very good barometer for what is going on, and everyone from the small remodeling contractor to the midsize homebuilder said business is just booming."

Such reports translate into "business as usual" for industrial distributors in the Northeast, who have watched sales to homebuilders rise over the last nine years, says Hurley, who credits a mix of low interest rates and an influx of new biotech, insurance and financial services firms with helping to drive that growth.

As the number of people buying homes has increased, so too has the size of those homes, according to Hurley, who says the numbers bode well for suppliers to the residential construction trades.

According to the NAHB, the average square footage of a new, single-family home for 2002 was 2,320, up from 2,057 in 2000 and up 22 percent since 1987, when the average square footage was 1,905. The NAHB also breaks down the areas of the home that have experienced the most growth. In 1987, for example, just 23 percent of homes had four bedrooms or more, and 36 percent of homes were built that way in 2002. Two-car garages (or larger) are also growing in popularity, with 65 percent of new homes built with them in 1987 and 82 percent having these garages in 2002.

Fueling the trend is an American consumer who's willing to shell out more of their household income to pay for housing. For 2001, housing accounted for one-third of spending by U.S. households, twice the amount spent in 1972, reports the Urban Land Institute. The number reflects a rate of homeownership that's much higher than it was in 1972 (62.9 percent in 1970 versus 70 percent in 2003), as well as the trend to buy larger, more elaborate homes.

Those trends are positive for industrial distributors, whose opportunity to serve those markets with materials has grown along with the homes.

"The amount of materials used to build those homes has doubled and even tripled in some cases," says Hurley. "The sheer volume of material being used has made homebuilding a very lucrative market for distributors."

Also active, says Hurley, is the remodeling market. In need of a change but unwilling to sell their homes, more consumers are taking advantage of low interest rates by refinancing and/or taking out home equity loans, then pouring that cash back into their homes.

"A lot of homeowners are putting on additions and redoing their homes," says Hurley. "That's been a good trend for construction distributors who specialize in that sector."

Greg Drouillard, president of Target Building Materials in Windsor, Ontario, has seen a similar trend north of the border. Despite predictions of a slowing housing market in Canada, Drouillard says he's seen a "huge increase" in home renovations. After years of riding the home-building wave, Target Building Materials is adjusting its strategy to take better advantage of that growing segment.

"We're actually changing our business to deal more with the renovation contractor, who operates a little differently than the general homebuilder in the sense that the renovators are more receptive to new products and innovations," says Drouillard.

In his line of work, Harry S. Dent, Jr., hears a lot of opinions about whether a real estate bubble exists, and when it might pop. As chief economist at High-Street Financial in Tampa and author of The Next Great Bubble Boom, Dent says that while homes sales actually peaked back in late 2003, the rate at which they're now declining is fairly slow. He says interest rates will be the determining factor, and expects them to trend downward at least one more time in 2005.

"As much as home prices themselves have gone up," says Dent, "interest rates have stayed low enough to make homeownership affordable for most."

For distributors looking to gauge their opportunities in the market, Dent says the best approach is to look at real estate not as one market, but as a diversified sector where opportunities range from commercial office buildings to apartment buildings to single-family homes.

"Diversify into different areas of real estate," says Dent, who sees good opportunities in the multi-family, vacation home and retirement community markets, "and don't put all of your efforts into one sector of the residential market."

Hahn says the softening market will undoubtedly pose challenges for distributors who have been riding high on the residential construction market. "We're going to have to step up our level of diligence and understanding of our own individual account profitability," says Hahn. "At the same time, distributors will need to look at selling more to their existing customers while using new technology and product opportunities to open up market segments that we haven't been strong in historically."