Real Estate News & Area Happenings April 2024
April 30, 2024
The scarcity of small homes in the U.S. has long been attributed to factors such as local zoning laws, consumer preferences for larger homes, and the lingering effects of the 2008 housing crash. However, there’s a less obvious yet significant reason: economies of scale. This concept, well-known in the business world, explains why builders are inclined to construct larger homes, as doing so reduces the overall cost per square foot, providing cost advantages to both builders and buyers.
According to a recent report from the National Association of Home Builders (NAHB), as home size increases, the cost per square foot decreases significantly. Paul Emrath, NAHB’s vice president for survey and housing policy research, highlights this in his article titled Economies of Scale in Single-family Home Construction. Emrath’s analysis shows that homes under 1,200 square feet cost $200 per square foot, while homes over 5,000 square feet cost just $132 per square foot. This dramatic difference demonstrates the power of economies of scale in home construction.
At the core of this phenomenon is the ability of builders to spread fixed costs, such as design and administrative expenses, across a larger footprint. As builders increase the size of the home or subdivision, the per-unit cost of labor, materials, and other construction expenses becomes proportionally lower. This allows builders to improve their profit margins while offering a lower price per square foot to buyers. However, it’s important to note that builders aren’t sharing all the benefits of economies of scale with buyers, as their profits also increase with larger homes.
Emrath explains that these economies of scale are not just limited to building large subdivisions or developments, but they also apply at the individual home level. A larger home requires more materials and labor, but the increase in cost doesn’t scale proportionally with the size. This results in the lower cost per square foot for larger homes, making them more cost-efficient from a production standpoint. Builders also prefer larger homes because they generate more profit, even though their fixed costs per home remain relatively stable.
This trend is one of the reasons why small homes are less common in the American housing market, even though they may appeal to first-time homebuyers, retirees, or those seeking a more affordable housing option. The financial benefits for builders are simply more attractive when constructing larger homes, leaving smaller homes with higher relative costs. Furthermore, the 2008 housing bust, which drove many entry-level homebuilders out of business, has made it harder for smaller homes to make a comeback.
For homebuyers, this means that although large homes might seem more expensive at first glance, they can actually provide more value per square foot. Buyers get more “bang for their buck” as the price per square foot decreases with home size. On the flip side, the higher price per square foot of smaller homes makes them less financially appealing, creating a market imbalance that favors larger homes.
Ultimately, the phenomenon of economies of scale is shaping the landscape of the American housing market. While there is demand for smaller, more affordable homes, the economics behind building larger homes make them a more viable option for both builders and buyers. This economic reality explains why small homes remain relatively scarce, despite the interest from certain segments of the population. As long as economies of scale continue to favor large homes, the trend of “bigger is better” in home construction is likely to persist.
