By Clare Trapasso| May 15, 2023
(Travis Dove/Bloomberg via Getty Images)
Millions of Americans would love to become homeowners—if they could only find an affordably priced home to purchase, that is.
Cue the builders. After years of focusing on the more profitable move-up, custom, and luxury homes, they are finally figuring out how to put up starter homes that first-time and other cash-strapped homebuyers can afford.
“Buyers should expect that over the next 12 to 24 months there will be a notable increase in the number of entry-level homes available,” says Ali Wolf, chief economist of Zonda, a building consultancy. Homebuilders have begun to focus on this group in the wake of rising mortgage interest rates dramatically cooling off the housing market. Many current homeowners who don’t have to trade up into a new home at a higher monthly rate are choosing to stay put. And that’s left much of the demand for housing coming from first-time and other buyers who aren’t finding the kinds of homes they want on the resale market.
Before the COVID-19 pandemic, about half of all new homes cost $300,000 or less, according to Zonda. However, lumber prices soared over that period and global supply chain snafus led to high prices and long delays in receiving materials, appliances, and other building components. In the first quarter of this year, just 15% of new construction was available at that price range.
To produce housing more inexpensively, builders downsized the median new-home footprint about 3% year over year, to about 2,270 square feet in the first quarter of this year, according to the National Association of Home Builders. The logic goes that smaller homes on less land typically cost less to construct than larger residences on more acreage. So builders can sell these properties at lower prices.
Townhome construction has also risen as builders can put up more residences on less land. Two years ago, townhomes made up 11.5% of all single-family construction, according to NAHB. It has since risen to 15% in the fourth quarter of 2022.
“Whenever you see an increase in interest rates and a decline in housing affordability, the market shifts a little bit toward somewhat smaller homes,” says NAHB Chief Economist Robert Dietz.
However, buyers shouldn’t get their hopes up too high.
Builders are expected to erect just 6% more entry-level homes this year compared with last, according to the May homebuilder survey from John Burns Research and Consulting.
“Builders will increase their supply of entry-level homes, but it won’t be enough,” says Dietz. This kind of home “will probably remain undersupplied. That’s frustrating news for first-time buyers.”
Why builders aren’t producing more starter homes
Fixing the housing shortage might seem simple: Builders need to put up more homes. But like most things, it’s easier said than done.
In the run-up to the Great Recession, builders erected homes at what seemed like a breakneck pace. But when the housing market went bust in the 2000s, many builders went belly up. Construction workers found other jobs, and sites sat fallow. Even as housing demand has soared over the past decade, builders have struggled to ramp back up. They have also been more cautious this time around, preferring to construct homes they are confident they can sell.
More new construction did go up during the pandemic, and many builders profited from the increase in home prices. But the challenges to putting up more affordable homes aren’t exaggerated.
The shortage of skilled construction workers has persisted, supply chain issues have caused delays and pricier building materials and appliances, and there is a lack of land in many parts of the country. Builders must also contend with zoning restrictions and community opposition to smaller homes. Many local governments also charge builders impact fees, which can total tens of thousands of dollars in some places, to pay for new roads, schools, and water and sewer lines.
Then throw in higher mortgage rates hampering demand for these abodes and a banking crisis that’s likely to make it harder for builders to get loans to erect new homes.
“There is a desire and an acknowledgment of the need for more entry-level housing, but there are also a lot of constraints that prevent that from happening,” says Wolf.
Where are starter homes going up?
While there is a need for starter homes across the country, not every community will see them rise. Builders will focus on areas where there is more land available and fewer costly regulations. They include states such as Texas and Florida in the Southeast as well as swaths of the Midwest.
Starter homes will still be built in the Northeast and West, but costly land, labor, and regulatory expenses tend to push construction prices out of reach of cost-constrained buyers.
“Where the zoning permits it, you are seeing builders trying to provide more affordable homes,” says Dietz.
How homebuilders are making starter homes more affordable
About 42% of builders plan to reduce the square footage of the homes they produce.
The trade-off that buyers will face as more affordably priced, new construction goes up for sale is that it likely won’t be as luxurious as new homes have traditionally been.
“The home probably won’t feel particularly premium at a low price point right now,” says Wolf.
More than half of builders are changing things on the exterior or in the interior of their homes to bring down costs, according to the John Burns survey. This could be vinyl countertops instead of granite and carpeting instead of hardwood floors. About 42% of builders plan to reduce the square footage of the homes they produce, 22% will offer smaller lots, and 20% will construct more attached homes, such as townhomes and duplexes, according to the survey.
For example, the nation’s largest homebuilder, D.R. Horton, is shrinking the average square footage of its homes by 2% in the second quarter of this year to address affordability concerns, according to a company spokesperson.
“When affordability gets stretched, buyers will accept smaller square footage and less expensive finishes in order to purchase a home,” says Devyn Bachman. She is the senior vice president of research and operations at John Burns.
Another tool that builders have at their disposal is buying down mortgage rates. Many have their own financing arms, which allow them to offer buyers savings through temporary and permanent mortgage rate buydowns.
The 2-1 buydown allows buyers to shave 2 percentage points off of their mortgage in their first year of homeownership, 1 percentage point in the second, and then it reverts to whatever the rate was when the borrower took out the loan for the rest of the mortgage. That means if rates are currently 6.5%, borrowers would have a 4.5% rate in the first year, a 5.5% rate in the second, and then the rate would revert to 6.5% for the remaining 28 years of a 30-year fixed-rate loan. “When housing demand pulls back, builders try to provide a more affordable product,” says Dietz.
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