- ResiClub
- Posts
- The hidden reason small homes aren’t more common: economies of scale
The hidden reason small homes aren’t more common: economies of scale
The National Association of Home Builders published an article on Tuesday finding that big homes have an economic advantage over small homes.
Lance Lambert
September 03, 2024
There are a number of reasons that explain why there aren’t more small homes in America. Many local zoning laws and building codes favor larger homes by imposing minimum size requirements. Americans like big homes and associate larger homes with greater status and wealth. The 2008 housing bust and tightened lending standards drove many entry-level homebuilders out of business.
But there's also another, less talked about reason: economies of scale. Economists use this term to describe when firms gain a cost advantage by increasing their level or size of output.
On Tuesday, the National Association of Home Builders (NAHB) published an article titled Economies of Scale in Single-family Home Construction, finding that homebuilders, and home buyers, see an advantage by going bigger.
“In home building, economies of scale may exist in several forms. It is conceivable, for instance, that homes cost less if they are built in larger subdivisions, or by larger companies, where design costs may be spread over a large number of production units. This post, however, focuses on economies of scale at the level of an individual home. In other words, does cost per square foot decline, all else equal, as a home increases in size?” wrote Paul Emrath, NAHB’s vice president for survey and housing policy research, in the article.
Emrath found that: “The answer is yes… The chart below shows how it varies with the size of the home (measured in square footage of finished floor space). It is easy to see that the median price declines systematically, from a high of $200 per square foot for homes under 1,200 square feet to a low of only $132 per square foot for homes with 5,000 square feet or more.”
“The cost per square foot of a [new] single-family home declines systematically as the home becomes larger… In microeconomics, unit costs that decline as a business operation increases in size are called economies of scale,” wrote Emrath at NAHB.
NAHB calculated the median new home price per square foot by home size after subtracting “the improved lot” price.
Big picture: Building larger homes spreads the fixed costs over a bigger area, benefiting both homebuyers, who get more bang for their dollar (i.e., a lower price per square foot), and builders, who can achieve a better margin (keep in mind they aren’t sharing all the benefits from economies of scale with buyers) and total profit.
According to John Burns Research and Consulting, homebuyers in California and Florida are the most concerned regarding the availability and cost of homeowners insurance.
A quick glance at recent headlines explains their angst.
Look no further than the fact that Allstate plans to increase home insurance rates for California customers by an average of 34.1% this year. The rate hike will take effect in November, and will impact 350,000 policyholders across California.
The rise in home insurance premiums isn’t just because of climate risk.
A driving force: Recent housing and construction inflation.
Replacement and repair costs have soared (+40% since 2019), and insurers are trying to keep up, although some state insurance commissions are slowing down the process. ResiClub calls this lagged inflation the ‘Echo Pandemic Housing Boom’.
ResiClub PRO members (paid tier) got these 14 additional research articles last month: