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Homebuilders churn out smaller homes to attract first-time buyers

July 25, 2023

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Homebuilders are downsizing the American Dream to lure in entry-level buyers frustrated by the resale housing market.

Builders have been increasing housing starts and offering incentives like mortgage-rate buy-downs to boost demand. Now they're shrinking footprints and choosing more affordable finishes, according to experts and some executives in the latest homebuilder earnings calls.

The strategy largely reflects how more first-time buyers are considering new builds because there are still too few previously owned properties for sale as homeowners with low mortgage rates remain reluctant to sell.

“As data suggests, some first-time buyers are opting to go with less square footage or fewer options and upgrades as buyers need to purchase a home in today's dynamic market environment,” PulteGroup (PHM) president and CEO Ryan Marshall said on the call with analysts Tuesday after the builder's second quarter results blew past Wall Street’s expectations.

D.R. Horton (DHI), which reported in its third quarter ending June 30 last week, showed that the average square footage of homes closed was about 2,020 square feet, down 2% from the same quarter in the prior year.

“To adjust to changing market conditions and higher mortgage rates over the past year, we increased our use of incentives and reduced the sizes of our homes to provide better affordability to homebuyers,” Paul Romanowski, D.R. Horton's co-COO, said on the earnings call with analysts Thursday.

The average square footage of a new home stood at 2,469 square feet in the first quarter of 2023, almost in line with the fourth quarter of 2022, but down 2.2% from the previous six quarters when the square footage averaged 2,525 square feet, according to data from the Census Quarterly Starts and Completions by Purpose and Design and NAHB analysis. That's a difference of 56 square feet or about the size of a generously proportioned full bathroom.

“It’s all about solving for affordability,” Eric Finnigan, vice president, research and demographics at John Burns Research & Consulting told Yahoo Finance. “Builders are reducing the square footage of their homes as one way to keep costs down and their homes affordable.”

They're also employing other strategies in the name of affordability.

“Builders are also changing up design specs and features to simplify designs and reduce costs. That includes switching out higher-priced materials for lower-cost, easier-to-install options, removing built-ins, and fewer windows,” Finnigan said.

To that end, the average prices per square foot for homes in public homebuilder communities were down 2% to 15% versus the last year, depending on the home's status, according to data from John Burns Research & Consulting.

And, so far, it's bringing in those entry-level buyers.

They are responding “to modest rate incentives, smaller product offerings, lower, more stable interest rates in our targeted marketing,” Eric Thomas Lipar, chairman & CEO of LGI Homes (LGIH), said in the company's first quarter earnings call in May.

As for PulteGroup, it said 7,518 homes closed for the quarter, a 4.8% gain over the last year, and beating the estimates of 7,266 homes. First-time buyers made up 41% of homes closed, up from 36% a year ago.

“The year-over-year increase in first-time buyer orders shows that our homes continue to offer a compelling value and meet the affordability requirements of this buyer group,” Robert O’Shaughnessy, PulteGroup’s CFO, told analysts on Tuesday.

That helped to drive the builder's adjusted earnings per share to $3.21, beating the $2.51 estimate from analysts, according to Bloomberg. Revenue in the quarter totaled $4.19 billion, up 6.7% over the last year, and higher than the $4 billion expected by analysts.

Net new orders from first-time buyers climbed 28% over the last year to 3,150 homes, while orders for move-up buyers increased 33% to 2,897 homes and orders from active adult buyers increased 7% to 1,900 homes.

“Our first-time buyers remain financially resilient as personal savings remain the primary source of down payment,” Marshall said. “At the same time, we continue to see millennials are getting self-support from parents if they need help making the move into homeownership.”

Following a series of interest rate hikes from the Federal Reserve, which has made mortgages more expensive, buyer appetite hasn’t cooled off, at least not in the newly built homes market.

Data from the US Census Bureau shows sales of new homes jumped 12.2% to a seasonally adjusted rate of 763,000 units in May from the downwardly revised April rate of 680,000. That’s a 20% gain from a year ago. The latest new homes data comes out Wednesday.

“Our first-time buyers indicate that an overwhelming majority bought a new construction Pulte home rather than an existing home because they felt it offered the best overall value,” Marshall said.

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