Why shrinking U.S. homes may be a boost to homebuyers

Since the housing collapse 10 years ago, home builders have been largely focused on serving the high end of the market, building larger homes for deep-pocketed buyers who are more likely to qualify for a mortgage, if they need to get a mortgage at all.

The lack of entry-level construction has often been cited as one of the causes of the current housing affordability crisis, but recent construction data from the U.S. Census suggests that things may be changing.

According to analysis by the National Association of Home Builders, the average and median home sizes have been steadily falling for the last few years, indicating that builders are turning their focus to more entry-level home production.

In the third quarter of 2018, the one-year moving average of new single-family home sizes fell to 2,564.5 square feet, while the one-year moving median fell to 2,369.75 square feet. Both numbers peaked in the second quarter of 2015 and have been steadily falling ever since.

But these numbers may say more about who is buying houses than individual home size preferences. In the aftermath of the housing collapse in 2008, many homeowners lost their homes, their jobs, and had their credit wrecked in the process. With the economy in tatters, the only reliable homebuyers were the wealthy.

Homebuilders responded in kind by producing housing for this demographic, and it shows in the home size data. By the summer of 2011, the one-year moving average and median home size had matched pre-crisis peaks, and the next four years saw home sizes reach new all-time highs.

Mortgage lenders have been historically cautious since the financial crisis. More than 95 percent of mortgage originations are sold to government-sponsored enterprises Fannie Mae, Freddie Mac, and Ginnie Mae, and those entities have strict guidelines for what they’ll buy. This means people with even a slight credit problem may not qualify for a mortgage.

At the same time, the cost of home construction has risen rapidly, as have the prices of lumber, gypsum, construction labor, and land. Shortages of lumber have been a common complaint among homebuilders thanks to a years-long trade dispute with Canada over softwood lumber. Although it’s dropped in recent months, lumber prices have been steadily rising for years.

These issues have contributed to home builders focusing on the high end of the market, and the precious few entry-level homes that were often bid up because they were so scarce. This has fueled to the housing affordability crisis that’s kept many would-be homeowners out of the market.

Some of these dynamics are starting to cool, however. Lumber prices have started to drop. The economy has recovered and unemployment is shockingly low. Wages haven’t kept up with the pace of home prices, which is causing home prices to crest on the West Coast, but wages are rising. These all point to the potential of entry-level construction being more attractive to builders, which would be a welcome change for affordable housing advocates.

National Association of Home Builders economist Robert Dietz notes that a rise in townhouse construction and a drop in high-end custom home building also points to builders turning to entry-level homes. But he also notes that home size drops tend to come during or before an economic recession, predictions of which have come fast and furious, particularly in light of the recent stock market selloff.