The answer to rising home prices: smaller homes

With the prices of homes remaining stubbornly unaffordable, the number of available home listings shrinking, and record high mortgage rates, potential homebuyers are increasingly looking to newly constructed homes to fill the gap. Builders are expected to meet the rising demand for new homes while also dealing with soaring construction costs. The solution? New homes are being built smaller and much closer together than before.

Rising sticker prices and mortgage rates

The housing market seems locked in a cycle that is driving the affordability of homeownership down. The average mortgage rates are at the highest they've been in over a decade, driven by the Federal Reserve's efforts to avoid a recession, The Wall Street Journal reported earlier this summer. The rates keep potential buyers out of the market while simultaneously "discouraging homeowners from selling, limiting the supply of homes for sale," the outlet added. At the same time, the high demand and low supply are keeping house prices high.

With the market shrinking, home builders are trying to find ways to make housing affordable in order to entice more customers to buy new homes, and shrinking the size of newly built single-family homes has become a popular way to do that. Reducing the size of new homes helps "cost-constrained buyers" and can "boost the bottom line for builders who are contending with spiraling labor and construction costs," per a more recent report from the Journal. Data from Livabl by Zonda, a listing platform for new construction homes, showed the average unit size for newly constructed homes decreased by 10 percent nationally, the Journal summarized.

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During the pandemic, the number of detached single-family homes increased, but a "succession of economic shocks" has "caused builders to change course," Zillow reported. Construction starts for typical single-family homes declined 10.1 percent between 2021 and 2022, but starts for houses with less than three bedrooms increased 9.5 percent in that time. Zillow found that "the homes that builders opted to begin work on became smaller, more likely to be attached and more likely to be built offsite." Attached properties such as condos or townhouses also saw a 2.9 percent increase, compared to detached homes, which fell by 12 percent over the same period.

A cultural and lifestyle shift

With builders trying to limit the square footage in new construction, houses are beginning to have a different layout than people are accustomed to. Builders are "slashing some bedrooms and bathrooms," and removing separate dining areas. "Lots in the neighborhood are smaller too," the Journal explained, "but the builder is working with limited acreage by landscaping to create privacy."

The trend toward smaller homes is becoming "pretty consistent nationally," Mikaela Arroyo, director of the New Home Trends Institute at John Burns Real Estate Consulting, told Market Watch. "We're seeing a lot of deletion of separate, defined spaces," Arroyo said. Builders are eschewing the kitchen, dining, and living room setup for one kitchen and one "great room." The kitchens are larger than they used to be "because we're taking away the dining room," she added. And while smaller homes are "not solving the affordability crisis," they are "creating opportunities for people to be able to afford an entry-level home in an area," Arroyo said.

Shrinking home sizes are also impacting the furniture market, per the Journal. Companies such as Bob's Discount Furniture are designing more pieces suited for smaller spaces, Carol Glaser, the executive vice president of merchandising, told the Journal. "If they are in smaller homes," she noted, "they need their furniture to work harder." The company also has increased demand for multi-functional items, like sleeper sofas or kitchen islands with extra storage.

With the size of the typical family shrinking and many older Americans potentially looking to downsize, "the shift to smaller homes is likely to persist," Zillow predicted. While the decline of new single-family starts "does not bode well for housing affordability," Zillow continued, "builders' ability to pivot quickly amid the higher interest rate environment" should be good news for hopeful home buyers.