Real Estate as an asset class is a bit of an odd duck, because it typically involves a depreciating asset stuck on top of an appreciating asset.
Obviously, this is not always true. Land values can decline – ask someone from Saint Louis or Detroit. Likewise, structures can appreciate if they possess some characteristic which experiences a surge in demand, such as “Craftsman” architecture. But usually the land goes up and the structure goes down.
Most homeowners don’t think in this way, preferring to think of “their house” as a single appreciating asset. This is why spec builders rarely put small homes on large lots.
Consider the following math. At any given point in time there is a minimum price per square foot for residential construction that will net the homebuilder an acceptable profit. Local builders advertise homes for “as little as sixty dollars a square foot,” so for the sake of argument, let’s call this $70*, exclusive of land and sitework.
Meanwhile, the homebuyer is also thinking in terms of price per square foot. But since homebuyers conceptualize the house as a single asset, they divide the total value including land into the square footage. Realtors eagerly assist in this regard (some even publish the $/SF in the listing) as it frames larger homes as a better “value” and thus encourages higher commissions. What’s a buyer willing to pay? Let’s call it $100.
So now we have an equation. Subtract the builder cost/SF from the homebuyer cost/SF, then divide the cost of the lot by this number. You now have the minimum square footage.
Suppose a lot costs $50,000. Sitework is another $10k. The homebuyer will pay $100 a square foot, the builder needs $70 a square foot, so each square foot nets $30 for the builder. He needs at least $60,000 to break even on the lot. So the minimum house he’ll build will be $60k/($30/sf) = 2000 square feet.
Now suppose he’s allowed to cut that lot in two. Sitework is still $10k per lot, but the raw land that the house sits on was only $25,000. Now the minimum house size to break even is $35k/($30/sf) = 1167 square feet.
But now suppose the builder thinks that you shouldn’t have to buy a big house to get a big lot. He builds the 1167 sf house on the full lot. The house costs $81,667. With the lot and sitework he needs $141,557. That’s $121.40 a square foot. Still not a bad deal. But everything else in that neighborhood is going for $100/SF or less. He’s out there saying “sure, it costs more, but look at how big your yard is!” Meanwhile, prospective buyers who express interest are asked whether they might not want “room to expand” once they’re safely back inside the agent’s Infiniti.
In practice, of course, builders do not sit down and stroke their chin pondering “what is the absolute smallest house I could build that would make me the absolute minimum profit?” No, they build the biggest house they can sell until the demand is exhausted, then the second biggest, etc. Builders will happily throw up a five story stickbuilt home on a 1400 square foot lot, slap on some prefab stucco paneling, grab a stock photo of a woman in a sundress, and pronounce that “your new life inside the loop has arrived.”
These economics are a substantial factor in the replacement of the midcentury suburban paradigm (1400 sf house on a 7000 sf lot) with the current one (4000 sf house on a 4000 sf lot). But they seemed to have missed the attention of the urban planning set, at least on the coasts. Many a Pacific Northwest AICP has explained to me that “minimum lot sizes don’t force builders to build larger homes, they’re just choosing to build big houses.”
But in fact, as land value goes up, so too does breakeven square footage go up. To preserve affordable small houses, then, we need to continually shrink square footage requirements in the face of increasing property values.
Most cities could go far by adopting the Houston minimums of 1400 square foot in urban areas and 2500 in suburban ones. Houston could go further by reducing/eliminating the compensating open space requirements. “Open space” in an urban context ought to be a public good, the province of public agencies and nonprofits. That which isn’t public ought to be the homeowner’s alone.
*This is an oversimplification, of course. Larger houses have a lot of cheap square footage – great rooms and bonus rooms are just joists, floor and drywall. Smaller houses have proportionately more square footage tied up in bathrooms, kitchens and the like. So the assumption of a continuous price per square foot will tend to underestimate the extent to which economics push builders toward larger floor plans.