Can Small Homes End the Inventory Shortage?

It’s sometimes said that little things lead to big results, a thought which brings us to today’s real estate marketplace. We have become a land of McMansions, homes of vast size, when what much of the population needs and wants is something smaller.

The typical new home sold in 2020 had a median size of 2,333 sq. ft. and cost $336,900, according to the Census Bureau.

But what if you want to buy a smaller new home, a less expensive property, one with not more than 1,400 sq. ft? Good luck. Between 1970 and 2020, the population grew from 203.2 million to 331.4 million. Meanwhile, Sam Khater, Freddie Mac’s Chief Economist, said that “entry level construction fell from 418,000 units per year in the late 1970s to 65,000 in 2020.”

According to the Census Bureau, 912,000 new homes were completed in 2020. Smaller new homes represented just 7.1% of the total.

Opting for less

The point here is not that bigger homes are somehow “bad,” but rather that growing numbers of potential buyers want smaller options. Like today’s car and truck buyers, consumers are ready to try something different.

There are several factors that make smaller homes attractive.

Finances. It follows that a smaller home has fewer square feet and thus a lower price tag, however the cost savings are not entirely proportional. For instance, if a typical home with 2,333 sq. ft. costs $336,900 that’s $144.41 per square foot. A property with 1,400 sq. ft. would seem likely to cost $202,175. That’s a savings of almost $135,000.

In practice, there will be savings, but the cost reductions will not be proportionate. The reason is that both properties are likely to have a kitchen and two or more bathrooms, the most expensive spaces to build.

Smaller homes generate long-term savings. There is less cubic area to heat and cool, so monthly utility bills are reduced. Property taxes are smaller because the valuation is lower. There is less need for furniture. The construction cost is often much lower than the expense of new construction because the property is already owned.

Size. A “smaller” house with 750 to 1,400 sq. ft. is not a “tiny” home. A study by Porch.com found that “tiny homes are usually under 600 square feet, though the average size of a tiny house for sale in the US measures just 225 square feet.”

Value. “Converting a garage or basement without heat or air conditioning to a year-round living unit provides additional living space,” said Rick Sharga, RealtyTrac’s Executive Vice President. “If rented, the unit can produce a stream of income. A new and higher value can mean the property is worth more when it comes time to sell or refinance.”

“However,” said Sharga, “property tax and insurance costs can also go up with higher values. Speak with local real estate brokers, insurance agents, and appraisers for specifics.”

Habitability. While the median-sized home today has 2,333 sq. ft., past generations lived in smaller spaces. The typical 1950s home had just 983 sq. ft., according to the University of Michigan.

That 1950s house was typically occupied by 3.54 people, meaning the home gave each individual 278 sq. ft. of living space. By 2020, the typical household had 2.53 people and their home offered 922 sq. ft. per person. A modern small home with 1,400 sq. ft. provides 553 sq. ft. per person for the typical household.

One-person households have become far more common in recent years, and that too adds to the demand for smaller homes. There are now more than 35 million such households.

Inventory. We generally see an end to the housing shortage as a situation that involves the construction of more units. But, as Freddie Mac points out, it’s possible to get more housing even without the addition of new builds. It says there were 1.4 million ADUs (accessory dwelling units) in place as of 2020.

Builders increasingly see the opportunity. In 2019, according to the National Association of Home Builders, “one-fifth of remodelers undertook projects that created an ADU by converting an existing space over the past 12 months, and close to that percentage created an ADU by building a new addition.”

Smaller houses are with us – and more are on the way

Smaller homes sometimes take the form of ADUs. With 750 sq. ft. or less, these are increasingly allowed in jurisdictions where single-family zoning rules are changing. With relaxed zoning rules, the traditional quarter-acre lot with one home can evolve into a property with two and sometimes more units. The units can be carved out of existing homes or added to the property as separate dwellings.

According to Freddie Mac, “close to 70,000 properties sold in 2019 had ADUs (4.2% of all homes sold), compared to 8,000 in 2000.  However, there is no need to build new housing on properties with existing basement units or detached garages or structures that can be converted.”

More small homes may not end the inventory shortage but additional units can be one part of the solution. For real estate investors and property owners in general, it can pay to check the latest zoning rules, requirements, and market trends. After all, there could be an ADU in your future, especially if your future involves a little-used two-car garage or a larger lot.