American residential real estate is dominated by the single-family detached home and the apartment; however, there are a broad range of housing options largely missing from US real estate. Daniel Parolek, founder of Opticos Design, coined the term “missing middle housing” to explain this phenomenon. Missing middle housing refers to residential real estate like duplexes, townhomes, and multiplexes that fall between a single-family home and an apartment in terms of density.
Middle housing is considered “missing” as it has largely been illegal to build since the mid 1940s. Zoning codes have separated single-family neighborhoods from mid- to high-rise neighborhoods, excluding middle housing densities. Despite these historical challenges, it may finally be the time for developers to pursue middle housing.
Middle Housing as an Opportunity for Developers
1. Changing Consumer Preferences
Changing consumer preferences have created an opportunity for middle housing. According to the National Association of Realtors, 56% of millennials and 46% of baby boomers want to live in more walkable neighborhoods with mixed uses. When combined, these generations make up around 42% of the US population and are especially important to the housing market.
Millennials are incredibly important because they are beginning to look for their first homes. Millennials show a clear preference for efficient space near restaurants, shops, and recreational space, while displaying a distaste for large, ornate homes in the suburbs.
Before Covid-19, millennials preferred apartments in dense urban spaces, but as they approach their mid 30s and begin to start families, owning a home becomes more important. Middle housing is an excellent option as the scale allows for dense, urban-like communities, while still providing enough space for young families.
Baby boomers are equally important as many are starting to look for downsizing options. In 2019, the National Association of Realtors reported that 26% of homebuyers were downsizing, and according to Merrill Lynch, over 40% of retirees believe they will downsize in their next move.
Downsizing is attractive to baby boomers because it promotes a simplified lifestyle for those who find their large homes unnecessary. It also comes with considerable financial benefits like reduced mortgage payments, property taxes, and utility costs.
Additionally, baby boomers express a preference for active and tighter knit communities. Middle housing plays perfectly to downsizers due to its affordability and density that promotes the lifestyle preferences of this demographic.
2. Increased Home Prices
According to the Federal Reserve Bank of St. Louis, home prices have increased by over 30% since 2020. These increased home prices allow developers to generate a greater return on development projects.
Home prices fluctuate greatly throughout a real estate market cycle, so developers need to be confident price trends are based on fundamentals and not market cycles. Developers should be cautiously optimistic that home prices will remain high due to three underlying factors.
First, Freddie Mac 30-year fixed rate mortgages are sitting around 6.8%. Most current homeowners are on 30-year fixed rate mortgages that are locked at rates around 3%. Anyone locked at a lower mortgage will be extremely hesitant to look for a new home as they will have to forgo their 3% interest rate for a much more expensive mortgage. This has led most homeowners to stay in their current homes causing decreased supply and elevated home prices.
Second, remote work has driven up demand in suburban locations. Remote work has decreased the number of days employees need to commute to work which has allowed workers to live further away from metropolitan centers. This increase in demand has driven up housing prices in outlying areas as supply has not matched increased demand.
Third, zoning codes have prevented homebuilders from increasing supply in many municipalities. Suburbs with high demand due to strong schools, nice homes, etc. have seen the largest price hikes as their zoning codes and town boards prevent most new development. Without new supply, home prices will likely remain high in these desirable locations.
With home prices unlikely to change, housing developers can be cautiously confident their product will sell at high prices. Middle housing offers even greater upside as greater density coupled with similar construction costs will lead to greater profit.
3. Zoning Changes
Luckily for middle housing developers, middle housing has recently become popular with state and local governments as a solution to the housing affordability crisis.
Burlington, Vermont passed its “Neighborhood Code'' on March 25th to encourage denser housing development throughout the city. As stated by Mayor Miro Weinberger, it is “the first time in about 70 years that Burlinton’s residential code has made it easier to build, not harder, in our existing neighborhoods''. The law increases floor area ratios, a measure of the density of a property, and allows for duplexes and multiplexes in areas formerly zoned for single-family development.
State level legislation has also gained traction with the passage of middle housing legislation in Washington State in July 2023. The new legislation requires local governments to change their regulations to allow for middle housing in areas traditionally dedicated to single-family detached housing. There are currently proposals in the Nebraska and Kentucky state governments to introduce similar bills.
Constraints on Middle Housing Development
1. Credit Crunch
While consumer preferences, housing prices, and legal reform are promising for middle housing developers, there are still some concerns. Increased interest rates and nonperforming commercial real estate loans have left banks unable or hesitant to issue real estate loans. As a result, developers are struggling to obtain construction financing which can delay or even dismantle projects.
If a developer can secure financing, it comes with an expensive price tag, as elevated interest rates make construction incredibly costly. Interest rates may come down by the end of 2024, but they are unlikely to reach pre-pandemic levels in the near future.
2. Construction Costs
Construction costs are another cause for concern. The Associated Builders and Contractors reports that as of April 3rd, building material costs have increased by 37.7% since 2020. This number exceeds the 20% national inflation and the 30% housing price increase since 2020.
High prices are largely the result of supply chain constraints stemming from the Covid pandemic. When supply chain issues have been fixed, construction cost increases will slow.
According to Gordian, prices will likely level off throughout 2024; however, this means developers will need to find new ways to accommodate these higher, stabilized prices. The bright light for middle housing is that it is less expensive to build than other residential assets, but overall, construction costs are a serious concern for developers.
3. Zoning Codes
Local zoning regulation may pose the greatest threat. Zoning codes still make middle housing illegal in most neighborhoods, and legal changes have been limited to this point. The policy decisions in Burlington and Washington are encouraging, but housing developers will need to make considerable legal headway to make middle housing realistic in many cities.
A Look to the Future
As developers look to stay afloat in today’s difficult market, middle housing may be an innovative opportunity that not only generates developer profits, but also has a clear, positive impact on local communities.
As seen by the Burlington and Washington State decision, local and state governments are beginning to see real estate development as a favorable, market based solution to the nation’s severe housing affordability crisis.
The real estate community should watch carefully as the debate surrounding middle housing unfolds, as it could be a gateway to unprecedented cooperation between developers and the government.