I think your understanding of the "average" living room is also way off. Sure some areas will be restricted like dorms and small apartments that college kids/single people will have (though my own apartment is plenty big enough for Kinect).
Most people with families will have a large enough living room space to support the 8ft necessary for 2 players.
Also, I think the lag comments are exaggerated and you only notice them because you specifically are looking for them. The only game I have played so far that saw noticeable lag which took away from the gameplay was Rallyball and to a lesser extent reflex ridge. Most of the time when simply playing the games it worked so well that you didn't notice lag at all.
Dance Central isn't masking/hiding the lag, either. It works because it is taking the raw data and matching it up to the dance move you have to do. The only place where lag is present in Dance Central is when it returns the data in your body outline on the right side or during free style and even then it is very minor.
Hell, even Kinect Joy Ride worked surprisingly well for me. It takes you a little practice to get the right turn gesture down and to figure out how much gesture is needed for certain turns, but after that was settled it was pretty fun!
The voice control and hand guided menus worked flawlessly for me and I loved them.