A couple of recent industry studies prove a correlation between home size and cost per square footage as well as the importance of considering economies of scale when it comes to residential construction.
A recent analysis from the National Association of Homebuilders (NAHB) suggests the cost per square foot decreases as home sizes increase — a finding that is important for both homebuilders, consumers, and industry experts to be aware of when measuring new construction costs.
Cost per square foot is a primary way to measure the expense of new home construction; however, there are economies of scale that must be considered in order to avoid large errors when estimating construction costs. Economies of scale occur when unit costs decrease as a result of business operations.
There are several different types of economies of scale to consider. For example, homes built by large firms or constructed as part of a subdivision generally cost less because construction and design costs are spread out over many units. Many industry experts are aware that cost per square foot varies across time and geography; however, many overlook the influence size can have on home costs, but the recent NAHB study proves such a trend exists.
The NAHB’s study used data pulled from a Survey of Construction which was performed by the United States Census Bureau and the Department of Housing and Urban Development. According to data, the median price per square foot declines as the square feet of finished floor area rises. For example, homes under 1,200 square feet cost as much as $200 per square foot, while homes between 1,200 and 1,599 square feet cost $177 per square foot. The cost per square foot dropped to $132 for homes exceeding 5,000 square feet.
While there could be many factors behind this trend, one is likely related to the fixed costs that exist regardless of home size. For example, processes like designing the home, securing permits, and waste disposal don’t fluctuate with the size of the home.
While the NAHB study does subtract the value of the improved lot, one potential flaw with the analysis is that it doesn’t control for variations in the home quality or amenities included in the home. However, other studies controlling for these factors show a similar trend.
Another study from RSMeans controls for both quality and amenities by separating homes into four well-defined categories: Economy, Average, Custom, and Luxury. Within each category, home characteristics other than size are constant. For example, a simple two-story home with a standard design, single bathroom, wood siding, wood framing, and an asphalt roof would qualify as an “Average” home.
The RSMeans study shows the relationship between cost per square foot and overall size across all four home categories and in every instance, the cost per square foot decreased as the size of the home increased. In most cases, the declining costs decrease at the low end of the size scale, but the study proves that doubling the size of the home could reduce the cost per square foot by nearly 30%.
Given this significant variance, homebuilders would be wise to keep economies of scale in mind when requesting construction cost information from the NAHB. Suppose you take the cost of a 3,000-square-foot home and apply it to a 1,500-square-foot home. In that case, you’re likely going to significantly underestimate construction costs, which could lead to costly errors and inaccurate estimates.
