Is Entry-Level Construction on the Rise?

Due in part to limited lot availability and increased buyer competition, builders have been making more homes that fall within the mid- to higher-end price tier. According to recent data, however, more and more builders may be moving toward less expensive, starter homes. Here’s how this potential trend could affect your residential construction business.

Signs of Change?

Increasing mortgage rates and rising property values have priced many buyers out of most major real estate markets. A lack of entry-level construction is a big part of the current housing affordability crisis, and one of the big reasons younger buyers have been hesitant to buy homes.

While many reports suggest that home affordability will continue to be an issue in the coming year, there is some evidence that things could be changing. According to the National Association of Home Builders (NAHB), the average, new, single-family home size has been declining over the past three years. The NHAB suggests that this incremental move points toward additional entry-level home construction, which may be pulling down median home prices.

Not Unexpected

While we still have a long way to go before entry-level construction is able to satisfy the widespread demand for affordable starter homes, a trend does appear to be developing. The NHAB reports that post-recession increases in single-family home size is a routine outcome anytime the country comes out of a recession. Immediately before and during recessions, new home sizes tend to fall, as buyers face serious budget limitations. On the other hand, once recessions end, buyers are typically empowered by rising incomes and fewer credit constraints. Faced with an increasing pool of prospective buyers, builders tend to respond by going bigger with their builds.

This pattern has been exacerbated in recent times by supply-side constraints and market weakness among first-time home buyers. That said, the current decline in new, single-family home size seems to indicate that this phase of the cycle may be coming to an end. While they can’t say for sure, many experts believe the decline will continue as builders add more entry-level inventory and the custom market starts to cool.

Still Early

There are a variety of reasons why builders have focused their attention on larger, higher-priced homes. Since the financial crisis, mortgage lenders have been notoriously cautious, meaning people with even the slightest credit issues may not qualify for mortgages. At the same time, modern construction costs have jumped considerably, as have the prices of gypsum, lumber, labor and land. These concerns have combined with other factors to force builders to focus on the real estate market’s higher end.

A few of these dynamics appear to be cooling, however, as the economy has recovered, and some material prices have dropped. Although unemployment rates are astonishingly low, wages haven’t kept up with the pace of home prices. This all points to the very real potential of entry-level construction becoming more attractive to builders, especially in markets where home prices have begun to crest.

A decline in high-end, custom home building and increase in townhouse construction also points toward renewed interest in entry-level properties among builders. Still, significant drops in home size only tend to come before and during economic recessions. Dire predictions about a potential economic decline and the recent stock market selloff may be causing forward-thinking builders to plan accordingly.

 

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