It's fallacious to equate "there is no demand at that price point" with "there is no demand".

If the starter housing bonus was less profitable than building monster/luxury houses, developers (rightly) ignored it as irrelevant. It's obviously fallacious to equate "there is no demand at that price point" with "there is no demand". A single look at a basic economic chart* makes it pretty clear:

The price we 'see' and can observe is an equilibrium between supply and demand.  If I want 1100 SF of house, I can get that for $2000 a month. But If I could get 1200 SF, I'd take it. Likewise, if I could get 1100 SF for less than $2000 a month, I'd take that too. If push comes to shove, I might take 800 SF of house, but I'm not going to be willing to pay $2000 a month for it. 

Further, the discount in price has to reflect the discount in the quantity of what is being purchased. Being asked to pay $1800 for 800 SF is a bad deal when I can get 1200 SF for $2000. Of course, both supply and demand are non-linear (hence, curves), so I might be willing to pay $1500 for 800 SF, rather than the $1333 you'd intuitively expect. 

Regardless, there is no demand for starter houses at large-house prices. A subsidy offering me an extra $50 if I'll take an 800 SF house is totally irrelevant if aforesaid house costs $1600 a month. The subsidy just shifts the price curve down, but it's the equilibrium point that matters. Saying "there is no demand for starter houses" is nonsense. Look at that curve--there is a huge amount of demand below the equilibrium point! But none of it is matters, because the price is too high! 

* Undergrad economic textbooks are bad to the point of being gibberish. Do yourself a favor and buy Economix. I specifically mention this as mine left me baffled when it talked about things 'moving along the curve'. To be clear, in the chart, when one of the curves move, the equilibrium point shifts to a new point along the other curve.