Monday, April 15, 2024

Shrinkflation In the Real Estate Market

Inflation has been a reality for the past couple of years. As a result, many companies have decided to respond to the rise in prices and the weakening of the dollar by shrinking the size of their products without reducing their price. This practice has been given the name “Shrinkflation,” which is  defined as “the practice of reducing a product's amount or volume per unit while continuing to offer it at the same price.” Shrinkflation started to become apparent during the pandemic, but was so craftily employed that many doubted that it was even happening. Now, however, it is well acknowledged that just about everything is smaller, but more expensive. Shrinkflation has so integrated itself in today's reality that it has made its way into the real estate market.

In the past few months, a lot has been written about Shrinkflation in the residential real estate market. Everyone from the Wall Street Journal to Yahoo Finance has chimed in on shrinking new construction sizes. One of the earliest articles on the topic was a September 2023 article posted on the Green Builder, in which author Michele Lerner reported that the tastes of home purchasers had begun to shift toward smaller houses. She presented these changing sensibilities as an adjustment made by buyers as a result of affordability concerns and the increasing amount of new homebuyers entering the market at the time. This second point is very relevant in that first-time homebuyers form their expectations based on the market in which they purchase and "affordability" was a buzz word in 2023, as it continues to be today.

Affordability, in truth, seems to be the driver of Shrinkflation in today’s real estate market for all participants, including builders and suppliers. Inflation and resource shortages have driven up the cost of building and builders continue to mitigate this change by building smaller houses. This size reduction may be commonplace today, but major builder D.R. Horton began to discuss the practice as early as 2022. In one of its earnings calls in 2022, D.R. Horton proposed shrinking the size of houses it builds as a way to mitigate the rising costs of building. They began shrinking houses and it paid off big. By 2023, building smaller houses became their modus operandi. D.R. Horton reduced the square footage of its homes by 3%. Other builders took notice of their success and followed suit. So much so that by the end of 2023, the National Association of Homebuilders reported that 38% of homebuilders reduced the square footage of the houses built in 2023 and 26% plan to do the same in 2024.

Although new homes don’t make up all available residential inventory, they have historically made up a significant portion of luxury inventory. Accordingly, the market in the years to come will be shaped by the current popularity of smaller houses and buyers in today’s market may look to upsize in a few decades. Real estate preferences change over time. The McMansion for example, which had its heyday nearly twenty years ago, is no longer seen as realistic undertaking by builders today. The fact that the pendulum has swung so far away from oversized houses is strong proof that the preference for smaller houses will not last forever. Momentum will cause the pendulum of preference to swing back.

One point that should not be lost in all the talk about Shrinkflation is that it is definitively an attempt by companies to pass the rising costs of building on to the purchaser. Since most real estate investors at some point are purchasers, the measurements of new construction houses from our current time period should be taken into consideration when buying, selling and structuring deals. The unique combination of factors that have led to Shrinkflation in the current market will not be taken into consideration or even remembered in the future markets in which the sale of these properties will likely take place. If the trend toward smaller houses does not continue indefinitely, these houses risk being deemed to be inferior.

In light of current residential building practices, house size has become an important variable to consider when attempting to price a deal. Once resold, these smaller properties will have to compete with older inventory that is larger. Purchasers, both investors and homebuyers, are now faced with weighing newer features, better amenities and a newer structure against more area and thus greater value. It’s a decision that must be evaluated on a case-by-case basis, but there’s no denying that Shrinkflation has further complicated a complex residential landscape.

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