Aug232016

New houses will be smaller over the next decade

As Millennials buy new homes, builders will provide smaller houses Millennials can afford.

cozy houseFor years, academics in planning circles touted the rise of the small, high-density housing alternatives near mass-transit hubs. While this product might be the future of housing, it won’t be due to any preference by Americans for smaller digs. People will substitute down to smaller properties conveniently located near mass transit, but they will do this because the more desirable McMansions in the suburbs will become too expensive.

Builders aren’t concerned with what academics think they should build; builders will provide whatever product buyers in the market want. Very few entry-level buyers are active in the market because Generation X is trapped in their starter homes, and the Millennials are not yet in a position financially to complete a sale.

Right now, the only group of buyers with the cash and credit who can close the deal are move-up buyers who didn’t HELOC themselves into oblivion during the housing bubble. Move-up buyers don’t want small condos near transit stops; they want McMansions, so builders focus their attention on what’s selling and build bigger homes.

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For the last few years I expected the average home size to retreat, but as Millennials delay buying, the move-up market dominated new construction, and the average home size went up consistently. At some point, Millennial demand will pick up, but they won’t be able to afford McMansions. To meet this demand, homebuilders will shift from larger McMansions to entry-level housing, and when they do that, the average home size will fall.

Why houses in America are getting smaller

Diana Olick, August 23, 2016

Size matters, especially in housing, but preferences can change quickly, and that is the case today. Small is happening in a big way.

For the first time since the recession, home size is shrinking. Median single-family square floor area fell from the first to the second quarter of this year by 73 feet, according to the National Association of Home Builders (NAHB) and U.S. Census data. That may not sound like a lot, but it is a clear reversal in the trend of builders focusing on the higher-end buyer.

(See: Americans don’t want small houses)cozy

An increase in home size post-recession is normal, historically, as credit tightens and more wealthy buyers with more cash and better credit, rule the market. As with everything else in this unique housing cycle, however, the trend this time is more profound.

This pattern was exacerbated during the current business cycle due to market weakness among first-time homebuyers,” wrote Robert Dietz, NAHB’s chief economist. “But the recent small declines in size indicate that this part of the cycle has ended and size should trend lower as builders add more entry-level homes into inventory.” …

Considering how high home prices are today and how difficult it’s been for Millennials to find high-paying jobs, if houses don’t get smaller, many Millennials may never become homeowners.

At 3 to 3.5 percent mortgage interest rates, you’d think they would be very affordable, but all of the financial requirements for higher FICO scores and larger down payments and all those other things and income ratios have made it harder, even with a low interest rate,” said Stephen Paul, executive vice president of homebuilding operations at Mid-Atlantic Builders, also in Maryland. “In our market it’s been financing is driving the deals and builders are adjusting their product to meet the affordability issue.”

Very low mortgage rates would make houses more affordable if we hadn’t reflated the old housing bubble. Houses are not affordable today because lenders still need to recover from their bad bubble-era loans. For these houses to be affordable to the Millennial generation, prices need to come down, wages need to go up, or interest rates need to go even lower.

Don’t be surprised if mortgage rates fall below 2%. As crazy as that sounds, it’s the only reasonable path forward.

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