Is the McMansion Era Gone for Good?

It's not just home values that are falling in the wake of the real estate bubble bursting. The size of newly built homes has also dropped. According to U.S. Census data, the median size of new homes dropped more than 6 percent from the 2007 peak of 2,277 square feet to 2,137 square feet in 2009. That's more than the decline seen during previous economic downturns. During the recession in the early 1980s, for example, median home size shrunk about 4.5 percent. In the early '90s economic downturn, median home size slid less than 1 percent, while during the 2000-2003 recession, median home size actually grew slightly.

And it's likely that once the 2010 data is in, we will see a further decline in new home size, as the National Association of Home Builders seems to have adopted a smaller-is-better mantra. "A new housing market is emerging, and even with the recession in the rear view mirror we expect the popularity of smaller homes to persist," says Bob Jones, chairman of the NAHB. "Builders are responding to a new mindset among home buyers that has been shaped not just by a weak economy."

Jones wasn't kidding about builders downsizing the footprint of the American dream. Each year the NAHB comes out with a "concept" home that is a pretty good barometer of our national housing zeitgeist. This year, the NAHB's concept home is a 1,676-square-foot "Home for the New Economy." Talk about a comedown: the 2010 concept home is about 70 percent smaller than the NAHB's 2006 concept home that clocked in at an astounding 5,394 square feet.

The End of the McMansion Era?
Less than 1,700 square feet is probably a tad smaller than most Americans are angling for. According to a recent survey by real estate search firm Trulia, just 37 percent of Americans pegged their ideal American dream at less than 2,000 feet.

Source: Trulia

Still, it's clear our appetite for smaller homes is real, and here are some reasons I think this won't just be a temporary trend:

• A home is a place to live, not a retirement account. One era we know for sure is over is the age of double-digit annual gains in consumer housing. As economist Robert Shiller has pointed out repeatedly, the long-term rate of appreciation is maybe 1 percent point above inflation. Not the 10 percent and 20 percent craziness we saw during the bubble. If you accept recent history was in fact an anomaly not soon to recur, it makes no sense to buy as big a house as possible.

• Interest rates and lending standards will be a headwind. While mortgage rates remain at historic lows today, the longer view is that we are now at the tail end of a generation-long cyclical decline in interest rates. That helped lower the cost of buying bigger homes throughout the '80s, '90s, and the first half of the '00s. As we eventually move to higher rates, mortgages will become more expensive. And I am going to assume we won't soon see a return of no-down payment mortgages. The ability to buy with 100 percent leverage during the height of the boom -- along with an insane loosening (disappearance is more like it) of income and credit standards -- helped fuel our appetite for bigger homes. Now that down payments and more prudent income-to-debt standards are back in play, buying a home has become more expensive. One way to counteract that is to set your sights on a smaller (less expensive) home.

• Lower carrying costs. Smaller homes cost less. Lower property tax. Lower utility bills. Lower maintenance; it's easier to handle the upkeep of a small yard than a McMansion-sized lot. In this era of national belt-tightening, spending less on a home leaves more money for more pressing needs. Exhibit A: The retirement fund we now realize we must build up given that we likely won't have a huge cushion of home equity to cash in and live off of in retirement.

• The mortgage interest deduction wildcard. One of the proposals in the Bowles-Simpson deficit reduction plan that was floated last week was to eliminate the mortgage interest deduction (MID) for loans above $500,000. Yes, it's just a proposal, and yes, it is indeed a long-shot proposal. But if you think any change to the MID would be a hit to your fianances (just a note: the current proposal to scale back the MID would also be at least partially offset by lower tax rates and a tax credit), then it follows you would favor a smaller, less expensive home.

• Sellers and owners. The pie chart above is a pretty decent guide for how this might impact the housing market. If you're looking to sell a McMansion north of 3,000 square feet, you likely have a small universe of eager buyers to sell to. That's an argument for pricing a home aggressively if you are serious about making a deal. I'm also thinking that McMansion owners who are sitting tight through the down market in anticipation they will eventually see a rebound could be in for a very, very long wait. Sure, housing demand will eventually pick up, but you have to wonder if demand in the larger-end of the market will be as strong as for more modest-size homes.

• Buyers: While bigger homes may in fact offer a better deal on a per-square-footage basis, keep in mind the carrying costs, and the fact that one day, you, too, will want to sell that home. If current trends are indeed a harbinger of a smaller-is-better shift in home ownership, any deal you get today on a McMansion could end up costing you in the long run.