Very true, but the problem is often that the neighborhood isn't one I'd care to live in. For that matter, unless we went into a condo we will likely always have more area than we need because of the surroundings we'd want.
Around these parts (Maryland suburbs of DC) you're not going to find much at all in the 500-700 square foot range, unless it's an efficiency apartment in someone's basement. There is one community, Greenbelt Homes Incorporated, or GHI, that is the country's oldest successful co-op. You can get a flat over there of around 550-600 square feet, for around $55-70K. There's one on the market right now, for $59,900, billed as a 1br/1ba, upper level unit. 575 square feet. Built in 1941. Actually looks pretty nice. Co-op fee is $200 per month, but that includes property taxes. So you'd have to just foot the bill for heat, cooling, telephone, cable, and water.
Not a bad deal, actually, if you want to go a bit minimalist. I think the lower-level flats have a small yard. And you can get a small townhome for as little as $130-140K. GHI is populated mainly by older residents. One thing they do to keep out the riff-raff is make you put 10% down, and it must be your principal residence. You can't buy it and rent it out.
Other than that though, most smaller places are going to be condos in bad neighborhoods, or house trailers. The condos in the bad neighborhoods will have ridiculous condo fees, and will be hard to refinance and re-sell because of a high percentage of rentals, and vacant units. And the trailer parks are going to come with a lot rent of around $700+/mo.
Most new construction around these parts is condos and luxury townhomes for the smaller square footage set, and 3000+ sq foot wanna-be McMansions on the single family front. Long gone are the days of sprawling ranchers and more modest homes. If it's a single family lot, the builder is going to try to get the most bang for his buck out of it. Suddenly I feel grateful for my 98 year old, 1500 square foot house on 4+ acres, that the county only has listed at 1106 square feet. And I'm not about to correct them on that!