Home Builders may finally be targeting the under-served middle market

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Last summer, a middle school teacher and her husband spent several months trying to buy a home in Denver, only to be repeatedly outbid by fellow house hunters. The Colorado natives were trying to move back to the neighborhood where they grew up, after living in San Jose, California for three years. Turned out the housing market in Denver wasn’t much more affordable than San Jose.

“We started in December,” Bettina Garcia explained. “We probably looked at 50 homes. We’ve put in multiple offers. We’ve been outbid each time.” One of the homes Garcia missed out on was a modest brick home in the Denver suburb of Wheat Ridge, priced at $399,000, with two bedrooms, one bath, 850 square feet, a two-car garage and a fenced backyard. But it was gone in a flash-likely because it was one of the only choices at the lower-end pricing of the Denver metro market.

For most Denver middle-income home buyers, Garcia’s experience is the norm. There simply isn’t enough housing available in the “middle market.” Whatever inventory becomes available is snapped up in a bidding war. Denver desperately needs lower and middle-income housing. After a brief uptick in housing inventory at year-end, things are as tight as ever in Denver. According to Redfin, the average home listing in Denver stays on the market for only 11 days (below). 

According to the Denver Metro Association of Realtors, 39,861 single-family homes were sold in Denver metro last year. Of these, only 14,605 – about 37% — sold for under $400,000. If you’re a Denverite with a middle-class income, the American Dream of homeownership is increasingly out of reach.

A big part of the problem is that builders have targeted the more profitable high-end market over the last decade. As we’ve written about previously, a combination of zoning restrictions, the rising cost of land and construction, along with tighter mortgage standards have driven home builders toward more expensive properties. That has left considerable unmet demand in the middle market.

But after years of focusing on upscale developments, home builders appear to be increasingly addressing the need for smaller, less expensive, homes. NAHB data shows the average size of new houses continued to decline in 2018. Median square footage of single-family houses decreased to 2,320 last year after peaking at more than 2,500 square feet in 2015.

According to Robert Dietz, NAHB’s chief economist, the data probably indicates that home builders are turning toward middle-class housing after spending much of the current economic growth period focused on high-end development. “We’ve reached the point where the smaller part of the market needs additional inventory,” he said. “That’s where price growth has been the fastest due to of the lack of inventory. Younger buyers are trying to find entry-level housing.”


Increasingly, builders are targeting “Missing Middle Housing.” 

The term “Missing Middle Housing” was coined by California Architects Opticos Design in 2010. Here’s how they define the concept:

“The Missing Middle Housing types provide diverse housing options, such as duplexes, fourplexes, and bungalow courts, that fit seamlessly into low-rise walkable neighborhoods and support walkability, locally-serving retail, and public transportation options. They provide solutions along a spectrum of affordability to address the mismatch between the available U.S. housing stock and shifting demographics combined with the growing demand for walkability.”

While duplexes and fourplexes have been a rarity among new housing construction, these types of buildings were common in the 1920s and 30s.  Ask around; your aunt may have fond memories of living in a fourplex as a child, or you might remember visiting your grandmother in a duplex, with the blessing of having neighbors nearby to help out in a pinch. And today, young couples, single professionals and baby boomers are among those looking for ways to live in a walkable neighborhood, but without the cost and maintenance burden of a detached single-family home. Missing Middle Housing helps solve the mismatch between the available U.S. housing stock and shifting demographics combined with the growing demand for walkability.

Interestingly:  “The biggest challenge to building smaller housing is municipalities,” said Scott Thorson, chief operating officer of Oakwood Homes, a home builder whose “American Dream” development in Denver addresses the Missing Middle Market. “We hear all the time from city and town management that they want affordable housing, but then they turn around and require large-lot programs.”

Given that smaller houses sell for less, building them at a profit is a challenge that developers have struggled to overcome. Thorston said a key is to build on smaller lots. Oakwood’s American Dream development features houses with shared driveways on lots averaging just 2,000 square feet.  Oakwood’s American Dream homes are priced around $230,000. While smaller than the average Denver home – roughly 1,200 to 1,400 square feet – buyers can choose a one- or two-car garage, the number of bathrooms, and from two to four bedrooms.

Though Aloha Capital is somewhat price agnostic in terms of the real estate deals we lend on here locally in Denver, we are keen on understanding market trends, along with their current and anticipated effects on our business.  Day to day, we are most concerned with the underwriting and track record of our borrowers, and the finer points of each underlying deal. But if the housing market contracts meaningfully in Denver metro, we may augment our sensitivity to market segment, potentially focusing less on higher-end properties, and more on the upper middle and middle markets, where demand is not currently satisfied, and thus arguably less risk lies.  We view it as positive news that the ‘missing middle’ is finally getting the additional attention it deserves; it should provide for a more balanced housing market, which ultimately helps everyone.  Plus, as citizens who live and work in this fine city, we are hopeful that these new building trends provide meaningful support to local home seekers–in the form of greater affordability and access to ownership.  

Aloha Fund’s fifty-one month run of positive performance since inception continues.  We work diligently to get the best returns possible for our investors, and at the right risk trade-off. As many Aloha investors know, few investments have a return stream with such solid absolute returns, consistency and non-correlation.

As always, please reach out with your questions and interest in working with Aloha Capital in this excellent investment–Aloha LTD Income Fund.

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