I’ve been preparing for a conference this week held by the investment bank DeSilva & Phillips. The concept is intriguing: the principals, Reed Phillips and Roland DeSilva, have invited eight CEOs of mid-market media companies to talk about the transformations in their business to an audience of about 100 members of the private equity and media banking community.

Ironically, the context for transformation is crisis, as the publishing segment of the media sector has been under extreme duress during the recession. While this duress has taken a toll on the capital structure of media companies, it has also forced business to focus, identify where their customers are and develop more flexible and web-centered business practices.

In preparing for my presentation, I’m forced to answer two basic questions: what is attractive about our company, Network Communications, Inc., and what is attractive about our market.

When you are positioned squarely against the housing market it’s easy to fall in to the trap that your market is a problem.

Perhaps the best way to disabuse people of that notion is to show them two charts.

The first looks at home prices since 1970. It is the simplest way of capturing the impact of the housing bubble. For a short period of time,home prices soared irrationally. What we know now is that the loans made against those soaring house prices helped fuel a fever in lending to the entire building market — resale, new homes, multi-family and commercial — that created an unimaginable glut of capacity just when demand was going to decline.

When we take a long view of prices, it is easy to conclude that the market has fallen back close to the norm, and that with a little more correction, the housing market will be where it need to be.

The drama of the price drop over-simplifies the dynamic impact the housing market has on the economy. The best way to measure that impact is to look at the effect of housing on Gross Domestic Product over time.

The second chart captures all components of housing as a percentage of GDP since 1970 and plots the ratio against the logarithmic trend. This analysis shows that housing as a percentage of GDP is significantly below its trend over the past couple of years.

Closer analysis of the number shows that the driver for reduced production in the housing sector is the overhang of excess capacity, coupled with conservatism in the lending markets.

The most volatile component of the housing sector is residential fixed investment, which includes the cost of building new homes and multi-family units, improving existing homes and paying commissions on the sales of homes.

From 1995 to 2005, residential fixed investment increased $319 billion to more than $700 billion.

Between 2005 and 2010, residential fixed investment declined $424 billion.

Historically, residential fixed investment has been about 5% of GDP. Currently it is at 2.7%. At the normalized rate, residential fixed investment would be around $650 billion, or 85% higher than current levels and 15-20% below the peak.

Has anything happened to change the long-term structural dynamics around residential investment? Not really. There are more efficient building techniques, and the overall size of structures is likely to diminish, but the demand for residential fixed investment is driven by the population’s housing need. Population grows, existing housing stock ages, bylining costs come down, and new capital pours in as part of a virtuous cycle.

The current challenge of the housing market is that the alignment between supply and demand still is not set. Demand is suppressed because of the weak employment market and frozen lending channels; supply is too strong because of the overhang of building during the housing boom.

Each quarter the housing market regulates a little bit more, and a recovery in the housing market is not that far away.

At that point, it will be clear that housing is a good market opportunity, with steady growth characteristics that will distinguish it during a particularly challenging decade for our transforming economy.

I found myself wondering the other day about the economic impact of the decline in the real estate market on agents.

The reason for my curiosity is pretty clear: The Real Estate Book business depends on the income of real estate agents. The agents who are going to invest in high-visibility, high-impact marketing tools like The Real Estate Book are going to be among the high-earners. Over the past three years, the scale of our business has dropped dramatically and rapidly. How much is a decline in income driving that decline, I wanted to know.
A lot.

Fortunately, the National Association of Realtors is exceptional at gathering a lot of information consistently. The association does several different annual surveys and is smart to keep their questions consistent, so that you can compare trends over time. While their Survey of Home Buyers gets a lot of attention, they also do an annual survey of realtors that has a lot of rich detail on how realtors are managing their business.

So I dug into the NAR data to try to scale the market. There were three clear conclusions: Commission income has dropped dramatically; the number of high-earning agents has dropped just as dramatically; and marketing spending has dropped dramatically.

First, commission income. To extrapolate trends in commission income, I took the average home price and total number of transactions from 1996 to 2009. I then applied a uniform commission rate over the series. (One could argue that average commissions are down the past two years because of the influx of bank-owned properties in the market.)

Using this formula, commission income peaked in 2005 and dropped like a stone to 2009. About 10 years of commission growth was lost in the 24-month period.

Commission income should be roughly flat in 2010, based on NAR home sales projections and a 15% drop in average price. The good news for top earners is that there should be fewer agents competing for the commission dollars, and that consumers are likely to gravitate to agents who have reliable track records and are clearly in the business full-time.

How many agents is that, I wondered? That led me to create another extrapolation to estimate the number of high-earning realtors. To calculate this number, I used the percentage breakouts from NAR’s realtor survey and applied them to the total number of realtors in each year, according to NAR.

According to this approach, the number of high-earning realtors has declined by more than 40% from the peak of the real estate market. All told, there are about 178,000 agents that make over $100,000 per years, compared to 312,000 in 2006.

This is an incredible loss of earning power. The drop in commission revenue has been accompanied by a drop in marketing spend. All told, the number of realtors that spend more than $2500 a year on marketing and advertising has declined 45% to about 200,000.

A couple of interesting trends surfaced when I dug into the distribution of annual marketing spend over the past few years, according to the NAR survey.

First, the median marketing spend was down 31%, less than the drop in commission income over the same period. This is a byproduct of realtors trying to keep up a subsinence level of marketing. The larger marketers cut their spending by 50%.

Second, realtors have not expanded their investment in online media, keeping it at about 10% of overall advertising and marketing spend.

I’m a glass-half-full kind of guy, so when I look at these figures, I’m struck by the opportunity for higher-earning realtors to increase their investment in marketing in order to increase their share of the market. But, by any account, the contraction in marketing spending by real estate agents over the past two years is difficult to process, it is so large, pervasive and complete.

The flush of this Spring’s economic activity is wearing off and the American consumer is being realistic about the economy’s prospects.

One indicator can be seen in the muting of the consumer outlook from BIGResearch in June.  Sentiment about the chances for a strong economy were down from May and unchanged from a year ago.

Sentiment is up a long way from the dark summer of 2008, the mood of the last year has stayed relatively unchanged, despite renewed economic activity.

The embedded caution about the economy is reflected in how Americans describe their approach to spending.  74.1% of Americans say they are living a simpler life, according to BIGResearch.   On balance, they are happy about this increased simplicity.  For sure, they are redefining luxury:  84.1% say they aren’t ready to spend on luxury items.  The way luxury gets defined is shifting also, as demonstrated in people’s responses.

This sentiment puts some of the recent economic reports in context.  As summarized in the blog Calculated Risk’s weekly update, the momentum in retail sales is lagging and underlying economic activity is steadying after a rebound to refill inventories that had been allowed to diminish during the initial slump in consumer spending.

These observations were echoed last week in the release of the Federal Reserve Beige Book, which looked at economic activity through May

Economic activity continued to improve since the last report across all twelve Federal Reserve Districts, although many Districts described the pace of growth as “modest.” Consumer spending and tourism activity generally increased. Business spending also rose, on net, with employment and capital spending edging up but inventory investment slowing. By sector, nonfinancial services, manufacturing, and transportation continued to gradually improve. Residential real estate activity in many Districts was buoyed by the April deadline for the homebuyer tax credit. Commercial real estate remained weak, although some Districts reported an increase in leasing. Financial activity was little changed on balance, although a few Districts noted a modest increase in lending. Spring planting was generally ahead of the normal pace, while conditions in the natural resource sectors varied across the Districts. Prices of final goods and services were largely stable as higher input costs were not being passed along to customers and wage pressures continued to be minimal.

The signs suggest that consumer has recovered, but that the recovery is marked by a wide-eyes pragmatism about a weak economy with little momentum for growth.

• Experts Talk Beige Book, Bernanke Testimony (businessweek.com)
• Beige Book and Flow fo Funds Overview (fivethirtyeight.com)
• Economy improving modestly: Fed’s Beige Book (financialpost.com)

Yesterday we announced that our company,  Network Communications, Inc. , had opened conversations with its creditors in order to restructure its balance sheet.  The  development was reported in Business Week and has appeared in numerous news outlets across the web.

The Business Week reporter did a balanced job in describing the situation.  I think one quote sums it up pretty well.

“It’s not a company with a fundamentally broken business model,” McCarthy said. “It’s a company that’s gone through a radical adjustment in size.”

I’m not going to comment on the restructuring process.  A lot of media companies, such as  Reader’s Digest and Freedom Communications,  have gone through restructurings the last two years, emerging successfully as viable businesses with manageable capital structures.

Right now we’re focusing on communicating clearly with our core constituents about what the announcement means for our business.  The short answer is, It’s business as usual.    NCI is in the enviable position of generating more than enough cash to fund its day-to-day operations.

To help spread that message, we sent out copies of our press release and a detailed Q&A to our employees and business partners.  I’ve held a series of webinars to review the materials and address any specific questions.  We’re also reaching out to our key vendors and customers.

I’ve also focused on another message:  Our future is what we make of it.

The difficult market conditions of the past two years have driven us to be more disciplined, more resourceful and more innovative.  This approach has borne tangible business results:  We have expanded our customer relationships, we have built new products, we have strengthened existing products and we have managed in such a way that we’ve been able to sustain our business model.  We’ve been able to do this because of the remarkable focus and commitment of the people who make a difference every day:  The employees and independent distributors associated with the company.

Right now we are facing two basic facts.  Unquestionably, an economic recovery is underway.  Unquestionably, our customers have been shocked by the changes in their business and are reluctant to increase their marketing spend.

To rebuild our business, we need to help resolve the contradiction between those two facts.  We can do this three ways:

• We have to be in front of our customers and help them see that market has improved enough for them to feel confident that they will get a return on increasing their marketing spend;
• We have to be fluent in explaining why our traditional businesses continue to provide value to our customers, in terms of visibility, leads and business results.
• And we have to be energized in showing our customers how our innovative new services, particularly in Internet and social media marketing, can give them powerful ways to expand their brand footprint and build their business.

Executing on these three activities is the most important thing that we can do right now.  That is how we will make our future.

A note:  I have closed comments on this post because of the sensitive nature of this dialog.  If you have any questions you can e-mail me at dmccarthy@nci.com.

Sometimes it’s worth taking the long view: we can see just how far we’ve come in a relatively short period of time.

The first decade of the 21st Century marks a pivotal point in the modern technology revolution: digital information become portable, storable and easy to get. A world that had been defined by computing and software applications expanded to include uses that were considered to be futuristic fantasies just a few years before.

This graphic from Mashable tells the story of the iPod, the single most influential digital device of the past 20 years.

Interesting data point: TV’s per household grew at the fastest in a decade last year, according to Nielsen.

The TV is at the core of the multi-media experience. And, as The Economist points out in a recent special report, TV programming is being consumed across more platforms than ever before.

Compelling argument for the power of TV.

I do wonder, though, how many of those TV sets per household increased because of people combining households and brining their favorite TV with them….

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• Question for Nielsen: What the Heck’s a Television Set? (adage.com)
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The housing market is recovering. At least, 1 million people think so.

That’s the number of people who bought homes in the first three months of 2010. And that’s more people than have bought homes in the first three months of the last two years.

Let’s throw out caveats and the concerns and step back for a moment. It’s easy to point to a lot of different reasons why the home sales figures are inflated, or why home prices continue to have risk.

The two charts below show the sustained trend in recovering home sales over the past two years.

The first chart plots the number of homes sold in the first quarter over the past decade.

The 1 million home buyers in the first quarter don’t measure up to the levels of the real estate boom. But that’s not what a recovery means.

A recovery does mean changes in momentum. The second chart looks at how the market pacing has looked at the start of each of the last four years. This first quarter of this year was up 12% in sales versus the year before, breaking a decline that started in 2006.

The resale market is clouded by a lot of external factors that are driving price and inventory, but the actual number of homes sold show that there is an underlying increase in demand. From it we can infer that consumers feel good about buying homes. And that’s what the recovery will look like.

The U.S. economy lost more than 1 million households during the recession, even as the population grew more than 3.5 million, driving down home ownership and increasing rental vacancies at a rate that hasn’t been experienced in more than a generation.

Just as economic distress reduced households, economic recovery will increase households, concludes USC professor Gary Painter in a paper sponsored by the Research Institute for Housing America, a mortgage industry-backed think-tank.

As you read through What Happens to Household Formation in a Recession?, it becomes clear that the rebound in household formation will greatly benefit the rental market, while the impact to the residential real estate market will be more muted.

Finally, it will be important to observe a turnaround in home ownership rates before the housing market is likely to stabilize. This is because increases in initial household formation will disproportionately come from renters, which may cause home ownership to fall further. In addition, former homeowners who lost their homes due to foreclosure have had their credit damaged and will likely take time to repair their scores and secure a down payment. Once both of these classes of renters make the transition to home ownership then we would expect the housing market to stabilize.

Painter provides one of the most complete analyses of available data to capture what happens to households during changes in the economy. The graphic below illustrates the dynamic of households. During periods of economic stress and increased unemployment, more people combine households and fewer people leave existing households.

Declines in employment and increases in the unemployment rate during periods of recession reduce household formation rates. Specifically, a national recession suppresses the formation of new renter households, while higher unemployment rates suppress the formation of both new renter and owner households.

The remarkable thing is how much those numbers add up: in all, a net decrease of 1.2 million households during the recession, Painter estimates.

The model…using data covering 6 recessions, predicts that rental household formation likely fell by 2–4 percentage points due to the current recession and that the formation of owner households likely fell by about 1 percentage point. Confirming these predictions, data from the ACS shows that formation of native-born households in a sample of 80 of the largest metropolitan areas has fallen by about 3 percentage points overall and by nearly 4 percentage points in the largest immigrant gateway metropolitan areas. This translates into a reduction of nearly 1.2 million households nationwide during a period where the population in these metropolitans grew by 3.4 million.

These figures help to explain the significant pressure on the residential home market and on the rental market.

As the table below demonstrates, the drop in home ownership that began in 2004 was accompanied by a sharp increase in vacant homes.

At the same time, occupancy of rental units has decreased to generational lows, leaving one to wonder, Where have all these people gone?

Last month, Pew Research Center released data showing that multi-generational households — two or more generations sharing a home — had increased to 16% of the population during the recession. In raw numbers, this means that 7 million more people were living in multi-generational households in 2008 than were in 2000.

That creates a depression of demand. Add in the glut of inventory that was created to satisfy the temporary demand of the housing bubble, and you’ve got the kind of discontinuity that drives down prices and disrupts the orderly progression of markets.

Interestingly, Painter shows that the elimination of households was disproportionately concentrated among native-born Americans, and particularly among households that had moved in during the recession.

The good news in Painter’s analysis is that the signs of a rebound in household formation are apparent in his model.

The model suggests household formation should increase by about 2 percentage points from current levels by 2012, as people find jobs and recession-induced anxieties abate. That would imply that by 2012, normal rates of household formation should reappear (roughly 1–1.5 million new households per year), but it will take even longer before the U.S. completely recovers from the deficit in household formation caused by the severe recession.

As noted above, the first market to benefit from the gain will be rentals. The residential home market should recover more slowly, Painter argues.

To the degree that the economy rebounds more strongly, the recovery will be more rapid. The mystery of increased demand isn’t unsolvable: the dynamics that drive household formation need to reassert themselves, and the core drivers are jobs and incomes.

You can find the full report available for download here.

The January home sales report from NAR felt to some people like a letdown — the annual rate of home sales dipped from 5.4 million in December to 5.04 million in January. Some pundits, citing the wildly wrong consensus projections from economists, characterized the results as a bad turn for the housing market.

Step back and you’ll see some encouraging signs of a normalization of the existing home market.

The chart below shows the percentage change in January home sales versus prior year for the last 10 years. (This figures are not seasonally adjusted, reflecting the actual number of transactions in each period.) Since 2006, January sales had been down from the year before. January 2008 was the deep point of the housing slump, with the market coming to a screeching halt that winter. Last January improved somewhat, but still declined from a much lower base. This January, home sales were up 7% over last year. That is forward momentum.

2009 was a year of two halfs: Home sales were down versus the prior year each of the first five months, and then posted increases in each of the following seven months.

The huge year-over-year increases of October and November were anomalies, driven by buyers hurrying to take advantage of a tax-credit that they believed was expiring.

The composition of the housing market was highly unnatural in 2009. First-time home buyers made up close to 40% of the market; distressed sales made up close to 30% of the market. The jumbo mortgage market was essentially closed down for the year, putting intense pressure on the high-end.

And, many of the macro dynamics that contributed to the unnatural composition of the market continue to weight it down today. The job market is fragile and a high number of bank-controlled properties comprises a shadow inventory that puts pressure on home prices.

Despite those conditions, the market appears to be in the midst of a recovery.

The recovery is choppy, but it is being driven by a reasonable impetus. People are looking to buy homes, and sellers are reading the market more rationally, pricing homes in order to transact. The sheer human momentum of housing — families forming, expanding, contracting, moving — is creating the underlying energy for home sales. This activity is what has always been the foundation of a rational housing market.

This recovery in the home market isn’t going to lead the economy out of its slump, as in other recessions. To generate strong economic activity, we need an upswing in home building. For the foreseeable future, there is a surplus of existing housing stock — including bank-controlled properties that are held off market — and new construction isn’t needed to satisfy excess demand.

But a recovery in the existing home market is critical to helping to bolster the feeling of security, opportunity and flexibility among the American consumer. And that recovery is clearly underway.

Real estate advertising is set to rebound in 2010, after a devastating decline in 2009, and traditional media such as newspapers and print catalogs will be a surprising beneficiary, according to a forecast released this month by Borrell Associates, a long-time observer of the local advertising market.

Borrell has been in the business of analyzing local advertising trends since the 1980′s. I actually competed with Gordon at Communications Trends, Inc. in the late 1980′s, when both our companies began to look at the emerging competitive trends in the yellow pages industry. Gordon’s work is solid, and his firm has been on target more often than not with their forecasts. He accurately forecast the scale of the shift to online in the real estate business, for instance.

As a result, I was particularly interested in seeing his firm’s forecast of real estate advertising for the next year. There are three big take-aways from the analysis and surrounding discussion: An over-correction in ad spending disproportionately hit traditional print media; the share shift between print and online is essentially over, with a slight correction back to print in the year ahead; and a new secular shift is underway moving real estate marketing dollars out of media and into other promotional spend.

Overall, advertising by real estate agents and brokers is set to increase 2.7% in 2010 to $8 billion, following a 19% decline to $7.8 billion in 2009, according to Borrell. Newspapers and other print (including home catalogs) are set to have strong rebounds in 2010, following dramatic declines in 2009. In fact, in 2010 traditional print media will recover a small percentage of the share that it lost to online media over the past several years.

In a webinar discussing the forecast, the Borrell team addressed the factors driving the recovery of print. Agents and brokers recognize that the Internet has become a free source of distribution, but that investing in internet media provides only a minimal lift in business activity. Print advertising remains the most effective way to stand out in a local market and drive leads, Borrell’s research with agents and brokers shows, and in the next a number of realtors will return to using print in order to help drive their market presence.

Since we publish The Real Estate Book, the forecast obviously was music to our ears. But more importantly, it was confirming to what we’ve been hearing from a lot of our customers and consistent with what our internal research was showing. While print advertising doesn’t deliver the total market, like the Internet does, it does deliver a responsive market, giving our customers market recognition, brand awareness and a valuable source of leads.

To reinforce their observation that the market shift between print and online is essentially complete, Borrell presented a projection through 2014 of the relative share for both media across all real-estated related ad spending, including realtors, financial services, multi-family and commercial.

A third market shift is occurring, Borrell cautioned.

Within online real estate advertising, money iis moving into marketing activity that do not rely on a media company to bring buyers and sellers together. Thanks to the proliferation of inexpensive database marketing tools and techniques, real estate advertisers are developing direct, one-on-one relationships with their prospects and customers through e-mail marketing, social networking and various promotions and public relations efforts.

You can order the full report, with detailed forecasts of each category, a demographic analysis of the home shopping consumer and local observations and projections, here.