Big drop in construction of starter homes of under 1,400 square feet

For younger adults looking for smaller homes to purchase as their first home, there at least one reason they are not easy to find: few have been built in recent years.

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The supply of entry-level housing, which Freddie Mac defines as homes up to 1,400 square feet, is near a five-decade low, and data on new construction from the National Association of Home Builders shows that single-family homes are significantly bigger than they were years ago.

Homeowners from previous generations had access to smaller homes at the start of their financial lives. In the late 1970s, an average of 418,000 new units of entry-level housing were built each year, according to data from Freddie Mac. By the 2010s, that number had fallen to 55,000 new units a year. For 2020, an estimated 65,000 new entry-level homes were completed…

“What was really striking to me was the consistency in the decline in the share of entry-level homes, irrespective of geography,” Mr. Khater said. “The thing that struck me the most was that really, it’s all endemic. It’s all over the U.S. It doesn’t matter where.”…

Homeownership leads to greater wealth for those who buy earlier. An analysis from the Urban Institute estimates that those who became homeowners between the ages of 25 and 34 accumulated $150,000 in median housing wealth by their early 60s. Meanwhile, those who waited until between the ages of 35 and 44 to buy netted $72,000 less in median housing wealth.

Three things stand out to me from this article:

  1. The decline in the construction of these smaller homes is real. The numbers cited above suggest roughly 15% of these smaller homes are constructed now compared to the late 1970s.
  2. At the same time, the definition of an entry-level homes is contingent on square footage. These days, 1,400 square feet is not that large for a home. These standards have changed over the decades; new homes in the 1950s in Levittown were more around 1,000 square feet while many new homes today are over 2,500 square feet. As builders construct larger homes (presumably making more money) and some buyers want larger homes, what is now an entry-level home may have changed.
  3. The final paragraph above considers the wealth implications about being able to buy a home earlier on. This is important: homes are one of the biggest generators of wealth for Americans. Yet, this also marks a shift in viewing homes as investments as opposed to good spaces for people to live.

A growing shortage of starter homes

Those looking for smaller homes to purchase are facing a limited supply:

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The first rung on the homeownership ladder has long been an affordable “starter home.” These houses, with their smaller footprints and selling prices, allowed young homeowners to build wealth and upsize as they started their families…

Supply of “entry-level housing”—which Freddie Mac defines as homes under 1,400 square feet—is at a five-decade low.

Surging prices and stiff competition mean there aren’t enough smaller, more affordable starter homes to go around in many regions. The pandemic and subsequent recession, along with the student debt crisis and delayed family formation, contributed to frustration and despair among younger house hunters…

Lately, data from the National Association of Home Builders shows new construction is again giving priority to higher square footage for single-family homes, a trend likely spurred by the widespread shift to working from home and house hunters’ need for more space.

This has been building for years now with the factors cited above (and more – and it may not be the fault of millennials). Builders prioritized larger homes as they can profit more from each units and buyers wanted more features and/or larger homes.

I wonder about the role of local governments. How many urban neighborhoods and suburban communities allow for or encourage the construction of smaller homes. It might take some extra work for a community to work with a developer who is willing to construct smaller and cheaper homes. At the same time, some of the existing members of the community might not be happy about the change as smaller homes are often interpreted as dragging down values and the character of the community. At the least, wealthier communities are unlikely to encourage such homes unless they are at a higher price point – and then it is no longer a starter home.

The article also mentions the financial ramifications of not getting into a house earlier: on average, this lowers the amount of house wealth generated decades later. Might then then shift the emphasis of recent decades away from seeing homeownership as a financial nest egg or requiring a necessary return on investment?

Mismatch between the slightly smaller homes millennials want and bigger homes builders want to construct?

Some data from recent years suggests builders and younger homebuyers may not see eye-to-eye on what kinds of homes they want:

A new survey from the National Association of Home Builders suggests that millennials — the demographic that should be the big driver of home buying over the next decade — is growing increasingly pragmatic about size. In 2018, one-third of millennials said they would trade smaller size for greater affordability; in 2007 just one in five millennials found that tradeoff palatable.

Indeed, in its most recent annual report, Harvard’s Joint Center for Housing Studies notes the builder vs. buyer mismatch. “With millions of millennials moving into their prime home-buying years, demand for smaller, more affordable homes seems poised for a surge,” the report stated.

Yet builders aren’t interested in ponying up the supply.

The JCHS says that in 2017 small homes represented just 22% of new homes, compared to an average of 32% between 1999 and 2011. And to be clear, the JCHS is not talking about tiny homes for millennials. It defines small as 1,800 square feet or less. That is still bigger than new homes’ median size a generation ago.

Just how much smaller are the homes that millennials desire? The median new home size decreased last year to around 2,300 square feet. What exactly is the range of home size millennials most desire (and how does this size interact with other important factors such as locations or features of the home)?

On the other side, builders are likely interested in constructing larger homes because they can make more money off each unit. Additionally, there is still some demand for larger homes though this could change in the coming years with more millennials in the housing market alongside older residents who are no longer buying homes or who are looking to sell their own large homes.

All of this is of interest to the housing industry (and other related observers): will millennials kill McMansions? Where are the newly constructed starter houses? On the whole, Americans still have large homes on a global scale and an intertwined set of social and cultural factors that keep that going. There is both money to be made here and new dwellings younger homebuyers would like to explore (if they can afford them).

At least 12 reasons Americans have the biggest houses in the world

Why do Americans have the largest houses in the world? A lengthy list of reasons:

  1. Americans like private homes. This often means they desire detached single-family homes in the suburbs. So why not have a lot of private space? Similarly, Americans place a lower priority on pleasant public spaces or spending time in public.
  2. The trend toward larger homes really took off in the postwar suburban era. At the time, this could be linked to growing family size with the Baby Boomer generation. (Interestingly, as household sizes decreased in recent years, homes continued to get bigger.)
  3. Americans like to consume. With relatively large amounts of disposable income, Americans need space to store their stuff, ranging from clothes to media to new technological devices to cars. The answer is not to get rid of stuff but rather to have a big house to store bulk goods. Garages are important parts of homes since driving is so important.
  4. Americans have increasingly viewed housing as an investment rather than just a place to live and enjoy. If the goal is to get a big financial windfall later in selling the home, it could pay off now to buy as much as possible.
  5. Compared to some countries, Americans have a lot of land to build and sprawl. Americans have also made different land use decisions to prioritize lower densities and sprawl.
  6. There are regional differences regarding large homes. McMansions are everywhere in the United States but more culturally acceptable in Dallas than in New York City. Many metropolitan regions have housing prices that make having a big house possible (compared to New York, San Francisco, LA, and Seattle).
  7. Developers and builders are less interested in constructing starter houses as there are more profits in bigger homes.
  8. A number of communities will only allow homes of a certain size in order to maintain their character and status.
  9. The government has provided funding and support for mortgages, suburbanization, and driving over the last century.
  10. Americans have a bigger is better mentality as well as believe that growth is good. This applies to population growth and also applies to houses.
  11. McMansions are popular with some but America has plenty of large homes that would not qualify as McMansions. From large urban condos and homes to large rural properties, Americans can find plenty of big homes to purchase.
  12. The space in homes does not have to be used to be desirable. For some owners, the space itself is just worth having.

(This post was inspired by this recent article. Also, see this earlier post “Explaining why Americans desire larger homes.”)

“Millennials may (or may not) have killed” starter homes

A list of items millennials may have affected begins with starter homes:

Statistically, the generation that coined the phrase “adulting” has put it off longer than previous generations (see marriage, kids, home ownership). According to Zillow, millennials are currently the largest group of homebuyers, but CEO Spencer Rascoff notes that “starter home” inventory is limited, forcing millennials to rent until they can afford the bigger, more expensive crop of houses. On the bright side, chances are their Pinterest and DIY skills have their rentals looking lovely.

Many of the underlying economic factors limiting the number of and access to starter homes is out of the hands of millennials. Additionally, Americans as a whole are conditioned and pushed purchase and live in larger homes.

Theoretically, millennials could push back more on the delayed adulthood that is now common – but that has its own confluence of factors pushing adults toward achieving adult milestones later.

In the long run, it appears millennials still want to buy homes and are interested in a suburban life. However, this might look different: the process will be pushed back, homeowners may own fewer homes, and the homes themselves could be larger and have specific features. There will still be many smaller homes in the United States but they may require a good amount of renovation, may be fairly pricey to acquire, and Baby Boomers may be in them for a while. The homeownership process does not have to look the same in the future and there might even be some positive twists along the way even as it can be difficult to move away from established patterns.

Developers give reasons why they won’t construct starter homes

Here are some of the reasons given by developers regarding their lack of interest in starter homes:

The market for new “starter homes” is drying up, mostly on the supply side. As credit markets recover, there are more and more people who could be buying their first homes … if only builders could build them. But for a host of reasons, they can’t:

  • Materials costs have risen.
  • They lost a lot of their labor force during the economic downturn.
  • Communities entitled large lots during the boom, and now they won’t zone them for smaller parcels.
  • Cash-strapped local governments have raised permitting and other fees.
  • Building codes and other requirements make it harder to build cheap.

This makes it extremely difficult to build a house for less than $200,000 in many places, which is a hefty multiple of local median incomes.

Three quick responses:

1. I know this doesn’t get much discussion in many industries but when they say it is difficult to build for less than $200k, what exactly does this mean? A home at that price won’t meet their profit goals? What kinds of profits do developers and builders make at the lower end of the housing market as opposed to the higher end? Builders can’t make any money off new started homes or they can’t make enough money for them to see it as worth their time?

2. As noted, communities have some influence on this process. How many are really willing to zone for starter homes and/or have different guidelines for starter homes?

3. Isn’t this an opportunity to construct homes more efficiently? It sounds like there is some turmoil in costs – material, more uncertain labor, higher fees and requirements – but this is where the housing industry could find some new solutions.

The reasons behind and consequences of the possible extinction of the starter home

Why are fewer builders constructing smaller starter homes that first came to prominence after World War II?

It’s several things. Land is too expensive to put the more modest house on it. Municipalities’ fees are another reason. And then there’s this phenomenon: Entry-level buyers just don’t want a starter home — they want something fancier…

From the time that high-production builders gained traction in the ’40s and ’50s and into the last part of the last decade, they were able to access inexpensive land and get labor and materials in ways that allowed them to produce an accessible and affordable entry-level home. But the Great Recession didn’t cause land to decline in value the way that houses did, and the lots aren’t widely available. When they are available, there are multiple bidders for them, which pushes the price up. Builders also downsized during the recession, and they don’t have the same capacity to build in volume that they once had. Today, if you’re building a $300,000 or $400,000 house, you’re going to make more money than if you were building two or three $150,000 houses.

Some of the sticker shock for buyers of entry-level homes comes from the local entitlement and permit fees that effectively ward off entry-level neighborhoods from established communities. These fees get baked into the cost and may add 20 to 25 percent to the cost of the home, for schools, infrastructure and support services. Municipalities seem to be doing everything they can to prevent lower-cost housing from being developed. They want property values and, in turn, property taxes, to be higher…

The startup of household formations is lagging the generation earlier by a few years. They’re becoming couples later and having children later. In some seismic way, we’re seeing that age group that we call the millennials buying their first homes at age 35, 36, 37. Because that generation grew up in what are really the nicest homes that ever existed in any society, they’re not going to want to go back to a very modest first home that will set them back, in terms of what they’re used to. They have a whole different mindset about that than we did. Certainly, some percentage of this group is going to want (the simple starter), but most will want what they’ve become used to — even in student housing, it’s like major apartment amenities. “Modest” is not what they have in mind.

It sounds like there are issues on both the supply and demand sides:

1. Consumers now expect more from their first homes. With demographic shifts (later marriage and kids) plus higher standards of living over time, homebuyers want more. This is something that also works against downsizing arguments: once people have a standard (and in this case, it comes from their earlier years and not even from something they have owned yet), it is hard to step back from those features.

2. Builders just can’t make as much money off of starter homes. Land is more valuable – think of all those suburbs that have expanded in recent decades – and fees have gone up so they need to construct more expensive homes to make up the difference. How many established communities, particularly wealthier ones, want cheaper starter homes constructed which might lower their own housing values as well as contribute more children to the school system and possibly require more funding?

A few side effects that might emerge:

1. Those who do want starter homes will likely have to go to less wealthy and older communities with older housing stocks.

2. This might limit particular groups, such as lower-income workers, from buying a home as they will have a harder time making the leap to a more expensive new home.

3. This could keep rental prices higher if people have to save larger amounts for more expensive first homes.

4. Those same communities that want to protect their housing values may find they have precious few places for people they might want in the community – such as recent college graduates or downsizing older adults – to own homes.

Argument: “Why more McMansions are bad news for first-time home buyers”

McMansions may be good for builders but not so much for people looking to purchase their first house:

Home building has been steadily picking up this past year after taking a sharp nosedive during the recession, although production is still far below historical norms. Orr said home builders are moving forward with cautious optimism, being wary of their pre-recession mistake of overbuilding.

So to help make up for the slowdown, builders are now making homes larger once again. Bigger homes means bigger sales revenue — and for only a minimal bump in construction costs, Orr said.

The trend has been to the detriment of first-time and lower-income buyers, who are finding both the new and existing home markets offer them very few options today.

“They (home builders) have kind of abandoned that sector,” Orr said.

The existing home market nationwide — but particularly in Phoenix — has been facing a chronic shortage of homes for sale, and the problem is most severe in price ranges below $200,000.

Many buyers have thus turned to new construction out of frustration. But given the sharp price hikes of new homes recently, lower-income buyers aren’t finding the same relief, Orr said.

In other words, builders can make more money on the bigger homes for those who still have money to play with. But is this just about builders? I wonder if there are two other things going on here:

1. The article hints at a depressed existing house market, suggesting that there isn’t enough movement in the housing market for these older smaller homes, what might be called “starter homes,” to become available in large numbers.

2. In addition to not much existing inventory opening up, perhaps there simply aren’t enough buyers for smaller houses for builders to take notice. What numbers are we talking about – how many first-time home buyers in the Phoenix are not able to find a home they want? This reminds me of recent data from the Chicago area: while housing starts may be up a large percent, the housing market is still not operating at normal.

That all said, if people want to get into purchasing a home can’t do so or are delayed, this could contribute to more long-term problems for the US housing market.