It’s not exactly a secret that 2022 was a tough year for home furnishing retailers. With rising mortgage rates, slowing home sales, broader inflationary headwinds, and difficult comparisons due to the COVID-related pull forward in demand and government stimulus efforts, it’s not surprising home furnishing was one of the weakest categories among discretionary retailers in 2022 (below). The start of 2023 saw the home furnishing category narrow the gap with other discretionary retail categories, and benefit from inventory clearance events that we’ve discussed in recent weeks across other retail categories.
It’s clear that management teams are setting the bar very low for 2023, with those across the sector calling out a weak housing market, layoffs, and a possible recession as the rationale behind tempered expectations for the year. Due to “macroeconomic uncertainty”, Williams Sonoma offered a wide guidance range for 2023, with net revenues expected to be in the range of -3% to +3% (with the first half of the year expected to be materially tougher than the second half) and negative comparable sales (factoring in year-over-year demand comparisons and last year's high back order fill). Even last year’s home furnishing retail standout–Arhaus–called out “uncertainty of the macro backdrop” as the reason behind a wider-than-normal demand comp for full year 2023 that includes a “normalized mid-single digit demand comp growth at the high end of our net revenue range and a slightly negative demand comp decline of approximately 1% at the low end of the range.”
Against this cautious backdrop, where does the category go from here and what does it mean for the commercial real estate market? We believe the category will likely follow the department store category, where we’ve started to see consolidation and a movement to explore smaller format stores/showrooms. Placer.ai has already taken a detailed look at the ongoing trend of store fleet optimization and the benefits of smaller format stores across other categories, but we expect this to be a more active discussion topic in the coming years for retailers in this sector.
While we’ve started to see some home furnishing retailers rightsize and move to smaller format locations through relocations (including Ethan Allen), Arhaus’ design studio format has become a blueprint for home furnishing (and other) retailers looking to maximize their reach with a smaller footprint. When we last looked at Arhaus’ Design Studio location in Burlingame, California last June, it was driving almost 2X the visits compared to the chain average. For the full year, the Burlingame location ended up driving almost 60% more visits than the chain average (below).
Arhaus recently opened its seventh design studio in Asheville, North Carolina, and plans to open an eighth in Naperville, Illinois later this year. Management has noted that "design studios will be part of our showroom expansion plans going forward", and expects to open 100+ design studios format locations in addition to its plans for over 165 traditional format showrooms. While not every design studio is going to outperform the chain average the way the Burlingame location has, it’s clear that a smaller format design studio approach may work for other home furnishing retailers. Arhaus’ traditional showrooms average approximately 17,000 square feet, and the company targets net revenue of $10 million and showroom contribution margin of approximately 32% by year three of operation and with a targeted payback on investment in less than two years. With the smaller new design studio format showrooms that average roughly 5,000 square feet, the company has a lower net revenue target, but a higher Year 3 average showroom contribution margin of 35% and targeted payback on investment in under two years. With strong unit economics, we expect other home furnishing retailers to adopt a small but potentially more economically-viable model during the current period of softer consumer demand.