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Homebuilders Think Small

Homebuilders, facing stiff competition from a glut of cheaper foreclosures, are reversing their decades-old philosophy that bigger is better. They're now offering smaller, more basic homes designed specifically for the market's hottest segment: the first-time buyer.

The median home size has risen steadily for decades, from about 1,500 square feet in 1970 to about 2,302 sq. ft. in the first quarter of 2007, when the trend began to reverse as the housing downturn worsened, according to the National Association of Home Builders. By the first quarter of 2009, the median home size had dropped to 2,239 sq. ft.

"A lot of the features important to buyers during the boom are less important now, including square footage and granite countertops," says Barclays Capital analyst Megan McGrath in New York. "They still want the most space for their buck, but they're willing to buy a smaller home if they can meet their monthly payment."

ABurst of New OrdersLos Angeles-based KB Home (KBH), which has been most aggressive about this strategy, attributed its 59% jump in new orders nationwide since the start of the year to its new energy-efficient Open Series of homes, which it launched late last year. (Orders were down 31% year over year, but the company says orders will be up for 2009 as a whole.) KB Home didn't provide an average price or square footage for the houses, but homes in its Sonoran Ranch project in Tuscon are as small as 961 sq. ft., with a starting price of $89,999.

In more expensive markets, prices are higher, and home sizes typically start at about 1,200 sq. ft. Single-story homes with three bedrooms, two baths, and a two-car garage in the builder's Alpine at Willow Ranch community in Corona, Calif., start at $290,990.

KB Home says it was able to cut costs by shrinking the size of the homes, streamlining construction costs, cutting the size of bathrooms and hallways, and making other design adjustments, such as putting bathrooms back-to-back so they share plumbing systems. Buyers can also pay for upgrades and make changes to floor plans by adding or subtracting bedrooms, storage areas, and other rooms and adding up to 40% more living space to the base model.

KB Home Chief Executive Jeffrey Mezger said in a conference call with analysts last month that the new designs allowed the company to cut prices by $60,000 on a typical home while cutting construction costs by $80,000. "In communities across the country where we have introduced the Open Series, our sales rates are typically running at historic levels," Metzger said. "The sales consistency of the Open Series in this challenging housing market is validating our strategy on the ground."

KB Home isn't alone. Fort Worth's DR Horton (DHI) has a number of models in Denver; Seattle; Houston; Albuquerque; Orlando; and Bakersfield, Calif., ranging from 900 sq. ft. to 1,500 sq. ft. and from $99,000 to $179,000.

Temporary, or a paradigm shift?Even luxury builder Toll Brothers (TOLL), based in Horsham, Pa., is adding slightly less expensive homes to its mix of offerings in communities in North Carolina, Florida, and suburban New York. In one Jacksonville (Fla.) project, the developer this year introduced a 2,215-sq.-ft. home at $429,995. It is 52 sq. ft. smaller and $29,000 less than the collection's previously lowest-priced plan.

Toll Brothers isn't wading into the starter-home market. These are "smaller moves of the dial," says Kira McCarron, a Toll Brothers senior vice-president and the builder's chief marketing manager. Fred Cooper, senior vice-president for finance and investor relations, says he's unconvinced that the market is entering a new era that favors smaller houses. "When the immediate [economic] pressure is removed, there will be a normal realignment," he says.

Alex Barron, an analyst at Agency Trading Group in Wayzata, Minn., says builders such as KB Home that are trying to compete with foreclosures have other problems. For one thing, buyers could see foreclosured homes as a better value because they are often larger and more luxurious, having been built during the boom. And the prices of those homes are falling quickly.

"Right now there's no bottom to how low [foreclosure prices] can go," Barron says. "And KB Home does have cheaper homes than most builders, but they're still not cheap enough to compete against foreclosures." Steve Ruffner, president of KB Home's Southern California division, says its new homes have an edge over foreclosures because they're more energy efficient, can be customized, and don't require renovations.

John Caulfield, senior editor of Builder Magazine, says customers, who have seen energy costs rise recently, are more willing to consider smaller homes because they're cheaper to heat and cool. "Smallness is the way back in for a lot of builders that have been struggling in this recession," Caulfield says. "It's a big change relative to what has gone on for a generation."

But if larger homes come back into fashion when the housing market recovers, McGrath says, small homes might not appreciate as much. "It might affect long-term appreciation," she says. "I don't think they'll lose value, but I think they might not be as in demand 10 years from now."
Gopal is a reporter for Bloomberg News in Boston.

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