The Big Squeeze: The housing market is so unaffordable that builders have no choice but to build smaller homes

May 17, 2023, 1:39 PM UTC
Two hands encompass a home model, showing how small it is.
Strained affordability has seen many homebuilders turn to smaller units.
Getty Images

The Pandemic Housing Boom, which pushed national home prices up over 40%, coupled with last year’s mortgage rate shock, has resulted in a deterioration of housing affordability.

“Fundamentally, every major housing market in the country is overpriced right now,” Matt Saunders, senior vice president of building products research at John Burns Research and Consulting, told Fortune, adding that this is generally true if you’re looking at it from a housing-cost-to-income ratio.  

In order to address the affordability crunch, many builders are reducing home size.

“There’s really this active response by the builders to address these affordability concerns head-on, and one of the main kind of levers that they’re pulling is reducing home square footage,” Saunders said. 

In several markets across the nation, housing just doesn’t feel attainable. Look no further than a couple earning around $225,000 annually but feel as though owning a home in Los Angeles is “hilarious,” and a business owner renting in New York City despite earning over $200,000 annually. According to Bank of America’s annual millennial housing survey, the lack of affordability is why “attaining the American dream is becoming more challenging than ever.” And not only are builders addressing affordability for buyers, but they’re also doing so for themselves. Relative to 2019 levels, costs for builders are still up around 35%, Saunders said. By reducing the size of the homes they build, they’re also reducing their material costs.

Interestingly enough, it’s not a “uniform reduction in square footage,” Saunders said. Instead, it’s sort of a tradeoff within the home, and that can be seen in John Burns Research and Consulting’s annual survey of architects for homes built last year, shared with Fortune. Kitchens and ground-floor outdoor space, for instance, were considered a top priority leveling up in allocated share within homes. Meanwhile, upper-level outdoor space, secondary bedrooms, and shared family areas were considered low priorities, declining in physical home share. That all means that buyers would rather have a larger kitchen space and larger backyards or front yards, than extra bedrooms and additional living spaces. In order to do that, builders and architects are choosing to reduce the size of the latter options to give way to the former. 

“What we’re seeing in the data is that, for example, kitchens are growing by cannibalizing formal dining spaces,” Saunders said. “And so there’s this trade between larger kitchen sizes, cannibalizing the formal dining spaces of the home.” 

The same can be said for ground-floor outdoor living spaces, amid a growing appetite for outdoor living, as Saunders put it—a trend that predated the pandemic but accelerated with the pandemic. This survey, he said, is a leading indicator of what we can expect this year and over the next few years.

“It’s all to address these affordability constraints,” Saunders told Fortune. 

In particular, builders are shrinking secondary bedrooms and shared family areas. The pandemic changed a lot of things, but mostly how people work and live at home—and that’s reflected in what buyers are prioritizing in their homes. 

Close to half of the survey’s respondents anticipate that projects will be even smaller in square footage this year compared to last year. With that, Saunders said, there’s an increase in production of entry-level homes. As Fortune previously reported, the share of projects under $300,000 is declining all across the country, according to Zonda, a housing data and consulting firm. Zonda’s chief economist, Ali Wolf, explained that the decline of the $300,000 starter home has a lot to do with the Pandemic Housing Boom, which sent home prices up 41% on a national level. Therefore it’s possible that builders reducing home sizes to increase affordability could essentially bring back starter homes, or homes under $300,000 that should be considered “attainable housing,” according to Wolf.  

“Affordability is a broader issue that needs to be reset, and the builders are right now solving for affordability,” Saunders said.

Reducing home size is a way for builders to make housing more affordable. Builders want to address affordability constraints so they can sell homes, it’s as simple as that. And it’s the same reason builders are offering rate buydowns, temporarily bringing a buyer’s rate from, say, 6.5% to 4.5%.

As of right now, incentives like rate buydowns are making the difference. However, Saunders said, there are early signs that builders reducing home sizes is working too.

“Our forecast right now, in terms of average square footage, is for single-family starts to decline by around negative 3% this year, and then around negative 2% next year,” Saunders said. “So I think this is a multiyear trend we’re seeing right now and confirmed by this architectural survey…a crystal ball of what’s coming in the pipeline.”

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