Buying a new house may now be easier for millennials as more starter homes get built

Staton McGowin went house hunting seven years ago but couldn’t afford the monthly mortgage payments on his $18-an-hour construction worker salary. 

Now 29 and an electrical engineer, McGowin’s pay has more than doubled, allowing the Greenville, Texas, resident to easily purchase a $223,000 newly built starter home, which he and his girlfriend, Caitlin Nance, moved into late last month.

Altura Homes sold McGowin the three-bedroom, one-story home after ramping up construction of entry-level houses last year. Units costing less than $300,000 made up about 50% of the company's production in 2019, up from 20% to 30% the previous six years.

“In the last 12 months, we have made an effort to try to build more affordable homes,” Altura CEO Justin Webb says. “We just know there are buyers out there.”

The starter home, an endangered species since the housing recovery began eight years ago, is making a comeback. Builders are putting up more small, low-priced homes as demand from millennials picks up and contractors figure out how to turn a profit from the units, even with persistently high construction costs.

“Builders are finally pushing to capture first-time buyers,” says economist Yelena Maleyev of Grant Thornton.

The pickup is also helping address a nationwide shortage of affordable housing for low- to middle-income Americans of all age groups, says Stephen Kim, a senior housing analyst at Evercore ISI.

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In November, single-family homes and townhouses priced at $200,000 to $299,000 comprised about 34% of all new home sales through the first 11 months of last year, up from 30% in 2017 and 2018, U.S. Census Bureau figures show. The median price of a new home in the third quarter was $311,000, according to the National Association of Home Builders (NAHB).

But since prices keep climbing and vary widely depending on the market, house size trends are even more telling. From 2015 to 2018, the share of new houses under 2,400 square feet rose to 51% from 47%, according to an NAHB analysis of Census Bureau data. 

“There’s some movement in the right direction,” says NAHB Chief Economist Robert Dietz. “We think it’s a fairly clear signal.”

Small new homes nearly vanished 

When the housing recovery began in 2012 following the late 2000s crash, the trend was decidedly in the other direction. The share of new homes with less than 2,400 square feet was tumbling after reaching 60% in 2009. Many of the first-time buyers who drove sales during the housing bubble left the market after their risky subprime mortgages imploded and they lost their homes to foreclosure.

Meanwhile, the Great Recession of 2007-09 set back the early careers of the millennials who were supposed to comprise a new crop of first-time buyers, leading many to delay marriage and children. That, combined with massive student loan debt, prompted many young adults to live with relatives, or to rent, and put off home purchases.

Banks, meanwhile, tightened lending standards after the housing meltdown, making it harder to qualify for a mortgage even for millennials who wanted to buy.

At the same time, construction costs soared as housing emerged from the depths. Land prices leaped because of a shortage of developed lots. Labor expenses shot up amid construction worker shortages after laid-off employees left the industry. And material costs surged, most recently because of Trump Administration tariffs on imports such as Canadian lumber.

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Homebuilders also faced stringent local regulations that limited construction of smaller homes and townhouses.

Builders, in turn, overwhelmingly put up larger homes priced above $400,000 that could earn a healthy profit despite the higher costs and sold them to higher-income buyers who were trading up or moving into the luxury market.  

“It became increasingly difficult to build entry-level homes,” says Jerry Konter, president of Konter Quality Homes in Savannah, Georgia.

The tide is turning

But many older millennials in their early to mid-30s have better-paying jobs and savings for down payments. They’re finally getting married and having kids. And they’re moving to the suburbs from the urban cores they favored in their 20s, says Brad Hunter, managing director of RCLCO, a real estate consulting firm.

In the third quarter of 2019, 37.5% of millennials owned homes, up from 36.8% a year earlier and the largest share since 2011. Millennials also made up the biggest portion of all homebuyers in 2018, at 37%, according to the National Association of Realtors.

“It’s just the peace of mind knowing I’m investing in something that can benefit me in the future instead of burning money on rent,” says McGowin, the freshly minted Greenville, Texas, homeowner. While his higher salary allowed him to qualify for a bigger mortgage, he also whittled down his student loan debt to about $3,500 from $24,000 when he first shopped for a home.

Builders, meanwhile, have figured out ways to squeeze out an industry average 20% profit margin on starter homes despite the higher costs. Their chief strategy: provide just a handful of choices for floor plans and features such as cabinets, countertops, and carpeting. That allows them to order materials in bulk so they can get discounts and minimize changes that delay construction and add costs, Kim says. 

“Builders have been able to crack the code,” he says.

National homebuilder D.R. Horton led the effort, launching its Express Homes division in 2014 to target first-time homebuyers, Hunter says. The brand “offers fewer floor plans” and “little to no options,” company vice president Jessica Hansen said in an email. It also has lower material costs because it's such a large buyer. And it snapped up lots of land before prices skyrocketed.

Noting that its flagship D.R. Horton brand also has been putting up more entry-level homes, Hansen says 68% of the houses it closed in fiscal 2019 were priced at less than $300,000.

The other national builders have followed that path the past couple of years. Besides offering fewer floor plans, Pulte Group typically builds starter homes “a little further from the city center where land is less expensive,” says company Vice President Jim Zeumer.

In its fourth-quarter earnings report Wednesday, Lennar said it produced 16% more homes compared to a year ago but its average sales price fell 7%. Entry-level homes make up about 40% of its business, the company recently said.

While starter homes are cheaper, builders can put them up more quickly and in greater numbers, helping offset lower per-unit profits, Kim says. It takes as little as three months to complete a starter house, he says, compared with six months or longer for pricier units.

Prices have risen

One caveat: With entry-level homes still in short supply, their average price has climbed from about $200,000 to nearly $300,000 the past several years, Hunter says. Even existing starter homes are appreciating at nearly twice the rate of expensive houses, according to real estate research firm Trulia. That could shut out some first-time buyers but it bolsters the business case for affordable homes.

For example, luxury home builder Toll Brothers, with an average sale price close to $900,000, has waded into starter homes but with a higher price range of $300,000 to $500,000, says company Senior Vice President Fred Cooper.  

Noting that many millennials waited until their mid-30s to buy, he says, “The choices of first-time homebuyers may not be traditional…Instead, they’re looking for more features and a more upscale design.”

Regulations are also slowly easing in some areas, Dietz says. Places like Minneapolis and Oregon are allowing higher housing densities.

Konter, the Savannah builder, notes the Trump administration is relaxing a 2015 rule that restricted development even on small wetlands areas. That – along with strategies such as smaller bedroom doors that don’t swing out as much to save space -- should help Konter build about 10 starter homes this year and 35 in 2021, he says.

Webb, the Texas builder, developed the community where McGowin lives after obtaining a zoning change that let him construct more houses on smaller lots.

“The market is fixing itself,” he says.