Advantages and opportunities of developing and investing in micro-units

(1)

Advantages and Opportunities of Developing and Investing in Micro-Units by

Marine Potikyan

Doctor of Dental Medicine 2002 Verevan State Medical University

Submitted to the Program in Real Estate Development in Conjunction with the Center for Real Estate in Partial Fulfillment of the Requirements for the Degree of Master of Science in Real Estate Development

at the

Massachusetts Institute of Technology

February, 2017 2017 Marine Potikyan

The author hereby grants to MIT permission to reproduce and to distribute publicly paper and electronic copies of this thesis document in whole or in part in any medium now known or hereafter created.

Signature of Author

Certifi

Signature redacted

Center for Real Estate

January 13, _29?0

ire

redacted

Professor Albert Saiz Daniel Rose Associate Professor of Urban Economics and Real Estate, Department of Urban Studies and Center for Real Estate Thesis Supervisor

Accepted by_

Signature redacted__

Professor Albert Saiz

Daniel Rose Associate Professor of Urban Economics and Real Estate, Department of Urban Studies and Center for Real Estate

MASSACH SETTS INSTITUTE

OF TECHNOLOGY

FEB 01 Z017

LIBRARIES

CHAPTER 1: INTRODUCTION

Housing is by far the largest expense in a household's typical budget and is considered a basic need for the health and well-being of people. American homes have changed significantly throughout history. Initially, North American homes resembled their European analogues: one-story small structures, no larger than 450 square feet ("sq ft") in area. Later, with technological development and increased living standards, the size of housing grew. These changes in turn shaped families and social relationships. More personal privacy and space became available. However, since the last economic crises, the trend in United States housing size diverged for apartments and single-family houses. While newly built house sizes increased to all-time highs of up to 2,687 sq ft, average sizes of apartments built in each year decreased to 934 sq ft in

2016.'

APARTMENT AVERAGE SIZE, sq ft 1,015 _1,008 999 ₉₉₈ ₉₉₅ 991 963 961 943 944 934 2004 2006 2008 2010 2012 2014 2016 2018 Year Built

Source: Rent Caf6

At the same time, the U.S. also saw a shift in average 3.01

household size with its decline to a new record low of

2.54 people per household, a reduction of about 0.5 2.54

people per household since 1973, which is explained by

1973 2015

N US Household Size

'"As US Apartments Get Smaller, Atlanta, Charlotte, Boston Rank among Top Cities with Largest Rental Units,"

Rent Cafg Blog, June 23, 2016,

(5)

various demographic trends such as delayed marriages, childbirth and higher divorce rate.2

During the last decade, the U.S. homeownership rate has gone down to its lowest level in nearly a half-century. The decline was noticeably higher for the younger generation, which constitutes the first time home-buyer generation.

Home Ownership Rate for Different Age Groups

90.0 80.0U 70.0

1 li

10.0

I

50.019

30.0 iI

h 1111 1 1 II 2095.190.05 21

Source: Joint Center for Harvard Housing Studies(JCHHS), US Census

High foreclosure rates, a tight credit market, real income decline and high student loans all had their share in the homeownership rate plunge since its peak in 2004. In the meantime, the number of renter households has climbed steadily for a decade, increasing by 9 million according to the Housing Vacancy Survey. While both renters and owners represent a diverse group, renters tend to be younger, with lower-income, and single. A number of major demographic trends will shape rental housing demand over the next ten years, such as the doubling of millennial renters,

growing minority share of households, and the baby boomer generation ageing. Even though homeownership rate is at its historic low, population growth by itself will drive the rental housing market.

(6)

CHAPTER 2: MULTIFAMILY MARKET REVIEW

While the last economic contraction very negatively affected all other types of real estate, multifamily housing has been the number one asset class in real estate that consistently attracted more investors and provided higher returns compared to other commercial real estate classes. Even though multifamily property fundamentals remained healthy in 2016, they started to show signs of sluggish growth going forward. The national vacancy rate increased to 4.5% from 4.2% according to Reis Inc. The majority of AptmuntvaMcr9te Efctin ratgowth

the 900,000 units that were developed

5.0 _5.0

since 2013 were targeted for middle to 48

4.0

higher income segments, and as new 4.6

similar projects are coming online they 440

4.2 z

have to offer higher concessions to

attract a limited pool of those tenants to 3.8 0

2012113 [14 115 116 2012113 114 11s 116

fill the vacant units. Sources: Reis (vacancy rate); Axiometrics (rent growth) THE WALL STREET JOURNAL.

According to Freddie Mac's 2016 multifamily outlook, 2016 rents grew more slowly than in 2015 in the majority of metropolitan areas, but still at a pace above historical averages and the expected inflationary target of 2 percent.

The multifamily sector remains in demand in terms of investment volume, and pricing has held firm overall. However, investors have been shifting their focus to older garden-style apartments that can offer a more affordable housing alternative. The multifamily average annual expected return rate ("cap rate") decreased to a historical low of 5.5% according to Reis data in 2016. Increasing long-term interest rates will negatively impact the real estate market in general, and the multifamily market in particular, where the return margins against 10-year T-bills are the lowest compared to other classes of commercial real estate.

(7)

Trensodiotn Volume (S Billions) 60 50 40 30 20 10 A

Individual Asset Sales (1) h nrived () LJ kw CaR e_(%)

7.5 7.0 6.5 6.0 5.5 5.0

Sance- (BRE Research, Real Capital Analytcs, 03 2016.

For the first time since the recession, multifamily completions outpaced demand in 2016, and the outlook for 2017 is the same. Approximately 233,000 units were completed during the year ending

Q3, marking a 24.1% increase year-over-year and the highest four-quarter completions rate since

2001. Permits growth moderated in the past year and a half, which suggests that completions will peak by the end of 2017.

The recent development cycle was skewed more towards building upscale communities with convenient access to public transportation and entertainment venues. This shifted the development more towards urban infill rather than suburban. Even though this trend shaped more dynamic urban cores, it also created housing oversupply in urban areas, causing developers to offer more concessions than they had initially projected. In contrast, suburban markets and older vintage communities generally were much less affected by the newer supply.

Historical U.S. Multifamily Completions

(Ofts) E 01 S 02 0 03 E 04

UFAl (MO)

Source: CBRE Research, CBRE Econometic Advisors, 032016. *In 2016,

04 is a forecast. Note that deliveries are counted in the quarter in which property

is stabilized.

(wrvdrwrstU A..

10OW

200N106o 109 12 8 12 16

-lotem e.h m .. isa l.

Souwt. (BtE lRaw*i (BRE fawee Mmmri, 03 2016.

Units 300 250 200 150 100 50 (I tt Mill[ Uap Rale 3

(8)

MULTIFAMILY MARKET IN CALIFORNIA

Since the case studies and hypothetical example in this thesis are focused on micro-unit developments in California, I have focused my real estate market research especially on general real estate market conditions in California, with an emphasis on Los Angeles and San Francisco. Even though the U.S. economy has gained momentum since 2010, multifamily development in California lagged the pace of new household formation and was lower than its historical average.

The combination of lagging supply and increased demand allowed investors to increase rents while keeping the occupancy high. The multifamily vacancy rate in 2016 fell to 5.1% in California, which is the lowest since 2008. At the same time, the average rent increased to $2.37 per square

foot in 2016.

Vacancy and Rent perSF Multifamily Inventory

$2.50 S2.34 $2.37 12.00% 250,000 $2.13210,460 $2.00 $ $.3 1.8 $.6 $1.9 3 10.00% 200,000 192,858 169,532 $.08.D 15,0 1061 3,3 150,607 6.00% 121,865 127,582 130,671 S1.00 104 367 4.00% 100,000 S0.50 _2.00% so so 200% 50,000 l $0.00 0.00% 2008 2009 2010 2011 2012 2013 2014 2015 2016 ₁ S Asking Rent Per 5F -Vacancy % 2008 2009 2010 2011 2012 2013 2014 2015 2016

Source: Costar (Multifamily units built from 2002 to 2016 with 100+units)

Even though supply and demand conditions in the real estate market might cause midterm misbalance in the housing market, the situation in California is slightly different. The California Environmental Quality Act ("CEQA") and Proposition 13 regulations make it harder to develop housing than in other states. California is home to 13% of the nation's population and traditionally sees a faster than average rate of population growth. Yet, over the last 20 years, the state has only been responsible for 8% of new residential building permits, and this trend is continuing. Over the last two years, California has added more than four new people for each new residential building. Similarly, the credit market tightness that currently constrains demand for owner-occupied housing is magnified in a state with home prices that are twice as high as the national average.

While the overall market will remain tight, one can see potential issues in the high-end rental markets. The distortions that exist in California's housing supply pipeline also tend to skew

(9)

construction towards high-end units. The average permit value for a multifamily unit in California is up 35% in real (cost adjusted) terms from 2004. The average permit value is 40% higher in California than the U.S. average. Families that start to move to owner-occupied units are likely to come out of the demand base for this type of product, but this implies weaker rental growth for class A property. Since there is enough excess demand in lower quality products, developers can fill the space if priced accordingly.

MULTIFAMILY MARKET IN LOS ANGELES

Los Angeles County has been growing at a steady pace over the last several years. It is now starting to become not only an entertainment hub but also a new high-tech center. Many Silicon Valley companies have established a significant presence in Los Angeles. The recent economic growth in Los Angeles has started to attract more educated and higher income professionals. Builders have responded to these demographic and economic changes by pushing new multifamily construction to pre-recession levels. The total number of newly built units, which was only 28,451 from 2002 to 2012, jumped to 48,664 from 2013 to 2016.

There are currently 20,452 units under construction in the Los Angeles Metro area, which is well above the 5-year average of 8,105. Downtown Los Angeles by itself has 9,957 units under construction. Access to convenient public transportation in Los Angeles together with a cluster of entertainment venues have been the catalyst for downtown's revival in the last five years as a residential center for millennials and an epicenter for multifamily development.

Construction Projects in Downtown Los Angeles

There were a total of 3,283 studio units in the Los Angeles Metro as of 2015. Studio units' share of all unit types increased from 5.5% in 2008 to 7.5% in 2015. Even though the general public perception is that developers started to develop smaller units, the Costar data shows that there has been no significant shift in the average size of units since

2008 in Los Angeles. Image Source: Costar

9

(10)

It appears that developers have kept the average size of units the same, while increasing the most the share of studios in the overall mix.

Inventory by unit type built from 2002 to 2015 40,000 35.000 30000 25,000 20000 15,0009Ju 10,000) 5.0008 .402 66 )53 %OS 1o.~4& 2003 2009 2010 2011 2012 2013 2014 201s

*Studio U1Bed 2WBed 03Bed

Source: Costar (Multifamily units built from 2002 to 2016 with 100+unit

2008 622 775 1161 1484 2010 616 782 1150 1464 2012 637 780 1151 1471 2014 627 777 1142 1454 2s15 634 1140 1471 s)

The average rent at institutional grade properties grew by a moderate 2.2% in 2016 compared to

8.8% growth in 2015, which is a result of increased supply of new units in the market. Studio

apartments had a higher vacancy rate of 7.2% compared to the average vacancy rate of 6.2%. Even though developers were able to charge higher rent per square foot for singles, the premium in Los Angeles was not as high as in San Francisco.

Rent per SF S3.18 S2.98 $2.56 $2.37 2008 2009 2010 2011 2012 2013 2014 2015 . 2008 2009 2010 2011 2012 2013 2014 2015 -Studio -1 Bed -2 Bed -- 3 Bed -Studio -- 1ed -2 Bed -3 Bed

Source: Costar (Multifamily units built from 2002 to 2016 with 100+units)

As in the most of the other cities in the U.S., the developers in Los Angeles were focused on premium housing. Due to significant expected and existing supply of newly built projects, the consensus is that Los Angeles will experience rent level correction in 2017 to cope with increasing vacancies in the premium multifamily segment.

Rent per Unit

$4000 $3,500 $3,000 $2.500 S2,000 $1,500 $1,000 .$3,443: $2,336 $2,032 $3.30 $3. 10 $2.90 $2.70 $2.50 $2.30 $2.10 $L.90 $1.70 $1.50 4., s .. ".e u IA 9

(11)

MULTIFAvILY MARKET IN SAN FRANCISCO

The San Francisco economy has been a standout throughout the current business cycle, sponsoring above-trend advancement in employment and wages. The information technology sector was the major growth engine for the region. While this created substantial demand for housing, particularly for apartments due to the high cost of single-family homes, the regulations and the infill nature of the metro area constrained deliveries in earlier years of the cycle and delayed the start of new projects. However, as the projects received approvals, the developers built 7,329 units from 2014 to 2016 compared to 1,121 units built from 2011 to 2013. The rapid supply growth of new units caused the metro-wide vacancy rate to increase by 30 basis points to 3.7% in 2016, while the average rent per square foot decreased from $4.39 to $4.31. There are currently an additional 3,483 units under construction.

Construction Projects in San Francisco

' N

The average size of units has not changed much since

2008, except for studios and three bedrooms. The

average size of studios decreased from 801 sq ft to 520 sq ft in 2009, and since then has remained more or less the same.

Image Source: Costar

2008 801 781 1181 1330 2009 520 762 1151 1252 2010 520 771 1155 1358 2011 520 771 1155 1358 2012 521 773 1155 1358 2013 528 791 1143 1369 2014 531 777 1122 1427 2015 526 777 1147 1510

Source: Costar (Multifamily units built from 2002 to 2016 with 100+unit

Inventory by unit type built from 2002 to 2015

12,000 10,000 8,000 24 6,000 5 59 2,000 L977 2,253 2,25 2,68 3 is 2028 2009 2010 2011 2012 2013 2014 2015

(12)

At the same time, developers consistently built more studios since 2009. Studios' share of all unit types jumped from just 3.8% in 2008 to 10.7% in 2015.

Rents in San Francisco are among the highest in the nation. Even though developers tried to address affordability by offering smaller studio units, they still charged an 18% rent premium per square foot on studios compared to one-bedroom apartments.

Rent per SF $5.3 $4.5 $4.1 $6.000 $5,000 $3,000 $1,000 Rent by Unit --- $5,809 $4,506 $2,924 2008 2009 2010 2011 2012 2013 2014 2015

- Studio - 1ed - 2ed --- 3 Bed

Even though multifamily rents will correct slightly due to robust construction through 2017, housing affordability will remain a major issue for young professionals working in the area. The average vacancy will still remain below the 5% market average going forward. San Francisco has one of the strongest economies in the world and will always attract young and highly educated professionals. 12 $5.5 $5.0 $4.5 $4.0 $3.5 $3.0 $2.5 S2.0 2008 2009 2010 2011 2012 2013 2014 2015

- Studio - 1 Bed - 2 Bed -- 3 Bed

Source: Costar (Multifamily units built from 2002 to 2016 with 100+units)

(13)

CHAPTER 3: MICRO-UNIT APARTMENT TREND

The micro-unit development trend became one of the market responses towards more affordable living. While as a new trend it started in densely populated cities such as Boston, New York and

San Francisco, micro-units were also built in small university towns and do comprise a higher percentage of existing stock in these smaller cities than in bigger and more crowded cities.

"Micro-unit" has various definitions associated with it. Lately, "micro" is used less since according to developers it diminishes the positive traits of this product type. Another term used for a micro-unit is "innovation unit". Boston has promoted the development of "innovation units" to cater to changing demographics and house middle class, as a result of the informal collaboration between the Boston Mayor's Office, Boston Redevelopment Authority, real estate developers, local firms and non-profits. They saw the "innovation" being in the size. In contrast, San Francisco's newer small apartments became infamous as "Twitter apartments", since the community resisted the idea of small units that would host technology employees moving to the area.

DEFINITION

[A] micro unit is a purpose-built, typically urban, small studio or one-bedroom using efficient

design to appear larger than it is and ranging in size

from

as little as 280 square feet up to as

much as 450 square feet (which roughly equates to 20 percent to 30 percent smaller than conventional studios in a given market).'

At the end of the day, the rationale of the size and composition of micro-units depends on the market and existing inventory. Wherever the average size of the housing is bigger, micro-units tend to have bigger sizes, and vice versa.

A very small apartment development was ruled out in the twentieth century, but revived in the

last decade as a creative and flexible housing option. Based on Axiometrics' database of 7.5

3 Urban Land Institute, "The Macro View on Micro Units," 2015, 6 http://uli.org/wp-content/uploads/ULI-Documents/MicroUnitfullrev_2015.pdf.

(14)

million institutional-quality apartment units nationwide, RCLCO Advisory Group identified

21,500 units in 148 metropolitan statistical areas nationwide, and 65% of those

micro-units were built between 1960 and 1990.4

While there is a general perception that the micro-unit development is becoming standalone product type on its own, only 3% of 21,500 identified units were built in dedicated building structures. As for those small units built in multifamily developments, micro-units amount to

18% of the total number of units.

eA R*?en7vv --.

Image Sourct:teCLCO

* ~w

SOA ase dee RlCiomet aa of gstle 2016 a entoue feri ae ro itr n h wnit

Avg AFl

century, society became worried about its consequences. Most of the time, opponents of the micro-unit movement argue that micro-unit development only benefits developers since they can charge premium rents. Some of them agree with the possible benefits that micro-units can provide to young adults in their 20s, but they are against it for older generations by pointing to

4 Derek Wyatt and Daniel Warwick, "Is Smaller Getting Bigger? Visualizing Micro Units Across the United States," RCLCO Advisory Group, October 13, 2016, http://www.rclco.com/advisory-micro-units.

(15)

the negative psychological effects that compact living might cause.5 However, their justification is related more to overcrowding, housing instability and other factors associated with low-income unit living, which is different from compact living. According to Jeni Cross, Associate Professor in the Department of Sociology at Colorado State University, the aesthetics of design of a space matter a lot not with regards to the amount of square footage dedicated per person, but the view the space provides.6 In addition, the feeling of crowding is closely related to cultural preferences and perceptions. The same space might feel sufficient to a Tokyo resident, while causing discomfort for a Montana native.

How big is a house?

Average new home size around the globe in ft2

Sources: CommSec, RBA, UN. US Census Note: data for 2009 buids, Chin figures urban only shrinkthatfootprint.com

How much space is enough?

Average residential floor space per capita in ft2

Note: data for ?009 builds Chinai hqures urban only. assumes average nafional household size

Sources: CommSec, RBA, UN, US Census

shrinkthatfootprint.com

The community response, in general, is also negative. They perceive compact living residents as a transient population that is not going to have a positive impact on the neighborhood. In San Francisco, new small apartments are derisively called Twitter apartments designed for tech workers - a population whose willingness to pay higher rates will displace families and lower income individuals. Sara Shortt, executive director of the Housing Rights Committee of San Francisco, told the San Francisco Chronicle that the apartments are designed as "crash pads for

s Jacoba Urist, "The Health Risks of Small Apartments," The Atlantic, December 19, 2013, http://www.theatlantic.com/health/archive/2013/12/the-health-risks-of-small-apartments/282150/. 6 Alexis Sobel Fitts, "The Psychology of Living in Small Spaces," Undark, May 31, 2016,

http://undark.org/2016/05/3 1/psychology-living-small-spaces/.

(16)

people who work 24/7 in Silicon Valley and need a place in the city to sleep and party... [they don't] build a sense of community or neighborhood."7As for proponents, they believe in

fulfilling market demand by offering more affordable housing with reduced energy consumption. They also claim that micro-units are a way of attracting and keeping young talent.

7 John Wildermuth, "'Micro-apartment' plan may face limits," SFGate, November 14, 2012,

(17)

CHAPTER 4: POLICIES RESTRICTING DEVELOPMENT

"You can't build what people want. "8

City officials are designing policies to accommodate growing populations. They must provide housing to residents with different income levels and at the same time not compromise on environmental and traffic matters. While to varying degrees, most municipalities regulate urban development with zoning, density restrictions, and parking requirements, such policies also restrict housing supply and urban density compared to what could be built in an unrestricted environment.

From the twentieth century, policymakers have implemented regulations limiting the height and mass of buildings, as well as regulations separating building uses in a space. Many studies find that both traditional land use policies such as exclusionary zoning, and newer policies such as inclusionary zoning, increase the cost of housing. Meanwhile, researchers have debated how land-use regulations restrict housing supply and drive up housing prices in general. It appears that even though regulatory barriers are different across the states, their impact is more vivid in regions with housing affordability gaps. A restrictive zoning example is seen in the case of Los Angeles, which was previously zoned for 10 million people but downzoned for only 4.3 million notwithstanding its growing population.

SMon - Z... ~nCW.r .n.. Nowadays the city is undertaking action to

update city plans to facilitate development and fight housing crises.

7-Souce: Mcwcw(2016)

8 Alex Sanders, "You Can't Build What People Want: Building Codes vs. Affordability," Community Solutions

Blog, February 26, 2013,

https://cmtysolutions.org/blog/you-cant-build-what-people-want-building-codes-vs-affordability.

(18)

In 2007, Joseph Gyourko, Albert Saiz, and Anita Summers created Wharton Residential Land Use Regulatory Index which measures the regulatory burden across communities nationwide.9 Cities with high housing costs correlate closely with those that rank high on the Wharton Index.

Zoning restrictions are supply constraints, and as economic theory suggests, housing markets see price increase where supply cannot keep up with demand. Glaeser, Gyourko, and Saks's

statistical analysis quantified the effect of components and found that New York, Boston, Los Angeles, Newport News, Oakland, Salt Lake City, San Francisco, San Jose, and Washington,

DC, have "regulatory taxes" that account for more than ten percent of housing costs.'0

In general, housing prices depend on the physical costs of construction, land prices and regulatory barriers. Although one would think that rising housing prices could be attributed to rising costs of construction, the graph below shows average construction cost in the U.S. including labor and material remained relatively unchanged over time while house prices increased." In expensive markets, such as California, construction costs rose as well but at a slower rate.

Real Construction Costs and House Prices Over Time

1im0ee 1 1 80 0 0 200 8 2010 2015

- Reel ouNn Pita-- R*6 COnStaucnCo0 _{Image Source: The Urban Institute}

City zoning codes, in general, require a certain number of off-street parking spaces to be built along with residential construction. The impact of

9 Joseph Gyourko, Albert Saiz and Anita Summers, "A New Measure of the Local Regulatory Environment for Housing Markets: The Wharton Residential Land Use Regulatory Index," Urban Studies, 45 (2008): 693 - 729.

10 Edward L. Glaeser, Joseph Gyourko, Raven Saks, "Why is Manhattan So Expensive? Regulation and the Rise in Housing Prices ", Penn IUR Publications (2005)

1 Jason Furman, "Barriers to Shared Growth: The Case of Land Use Regulation and Economic Rents," remarks to the Urban Institute, November 20, 2015,

https://www.whitehouse.gov/sites/default/files/page/files/20151120_barrierssharedgrowthlanduseregulation-a ndeconomicrents.pdf.

(19)

parking requirements on housing affordability has also been questioned. Studies show how parking requirements make housing less affordable, contribute to sprawl, and amounts to inequitable treatment of people who do not own cars.

In a study of San Francisco neighborhoods, Wenyu Jia and Martin Wachs find that housing that is built to comply with parking requirements costs ten percent more than housing with no off-street parking.'2

As of January 2015 data, building an off-street underground parking unit in San Francisco costs up to USD 100,000 per unit, one of the most expensive compared to other U.S. cities.'3

The high cost of parking is passed on to the consumer through an increased sale or rent price. Also, the parking requirement reduces the amount of housing that can be built on the site. Typically, developers choose to build less housing when there is a parking requirement, which decreases density and creates fewer units that can absorb the cost of parking. Finally, parking requirements are inequitable for people who do not own cars, and a greater percentage of lower income people do not own a vehicle.

An Oakland-based nonprofit, TransForm, which aims to decrease minimum parking

requirements through a new database, pointed out that despite their central place in both zoning codes and development plans, parking structures in Northern California's urban core are

underutilized as residents drive less.

12 _{Wenyu Jia and Martin Wachs, "Parking Requirements and Housing Affordability: Case Study of San Francisco,"}

Transportation Research Record Journal of the Transportation Research Board, 1685 (1998): 156-160, doi:

10.3141/1685-20.

" Rider Levett Bucknall Ltd, "Riders Digest," 2016, http://assets.rlb.com/production/2016/04/20002334/RLB-Riders-Digest-USA-2016.pdf..

(20)

CHAPTER

5:

FACTORS FOSTERING MICRO-LIVING AND

DEVELOPMENT

Various factors have fostered the micro-living trend. Changing demographics and lifestyle, as well as rising unaffordability, have all played a role. One of the earlier definitions of lifestyle introduced by Salomon and Ben-Akiva (1983) is "the pattern of behavior which conforms to the individual's orientation toward the three major roles of: household member, a worker, and a consumer of leisure, and which conforms to the constrained resources available".14 Lifestyle is a broad concept and considered to be the key driver in making the decision of where to live.

Why would people opt to live in micro-units? According to Kingsley Associates' consumer

research of potential renters, people are ready to sacrifice the space mainly for

location/neighborhood and affordability. Only after these preferences do they pay attention to the option of living alone, community amenities and proximity to transportation.

Micro-Unit Renters

Importance in initial lease decision

Location

Price - - 1

Proximity to work//school 78%

Proximity to neighborhood amenities - -Ability to live

Proximity to public transit Internet/wi-fi Quality of finishes Floor plan/layout Assigned parking Common areas/amenities Sustainability practicies Sense of community Pets allowed 26% In-unit storage Visitor parking

Neighbors with similar lifestyles

Source: Kingsley Associates Research, ULI 2014

14 ._{Salomon and M. Ben-Akiva, "The Use of the Life-style Concept in Travel Demand Models," Environment and}

(21)

Such results are somewhat supported by several other researchers of location choice and lifestyle change. In an attempt to group households with similar lifestyles in relation to residential location choice, Walker and Li observed that people's preferences seem to be more complex than were typically hypothesized and to some extent these preferences may be unrealistic, suggesting that each in their own way wants to "'have it all." 15

Millennials are demanding an "on-demand lifestyle," that values location over square

footage

and amenities. They want to be close to the city center, close enough to walk, bike, or rely on public transportation.'6

Duobinis summarized the housing preferences of multifamily housing renters."1 7 He outlined cost and location as the major aspect for multifamily choice.

As for location choice, studies show that in general, bigger households are prone to decentralized locations while younger one-person households prefer central locations. 18

From observation of individual and combined demographic and lifestyle characteristics, Lee et

al. found that single-person households and males tended to prefer downtown or urban locations.

Households that preferred downtown or urban locations placed greater value on social prestige and community.19

While housing choice is sensitive to price, sensitivity decreases with rising income.2 0

" Joan L. Walker and Jieping Li "Latent lifestyle preferences and household location decisions," Journal of Geographical Systems, April 2007, Volume 9, Issue 1 (2007): 97

16 Alexei Barrionuevo, "High-Tech Millennial Lifestyle Inspires Micro Apartment Boom," Curbed, March 15, 2016, http://www.curbed.com/2016/3/15/11 235986/micro-apartments-tech-industry-millennials.

17 Hyun-Jeong Lee, Julia Beamish, Rosemary Carucci Goss,"Location preferences of multifamily housing

residents",Housing and Society:43

18 _{B. Heldt, K. Gade, and D. Heinrichs, "Determination of Attributes Reflecting Household Preferences in Location}

Choice Models," Transportation Research Procedia 19 ( 2016 ): 119-34.

19 Hyun-Jeong Lee, Julia 0. Beamish and Rosemary Carucci Goss, "Location Preferences of Multifamily Housing Residents," Housing and Society 35 (2008): 41-58.

20 Joan L. Walker and Jieping Li "Latent lifestyle preferences and household location decisions," Journal of Geographical Systems, April 2007, Volume 9, Issue 1 (2007)

(22)

AFFORDABILITY CHOICE

Affordability choice suggests less rent, less utility bills and less relocation costs. The idea behind micro-unit affordability is that per unit rent, in general, is less although per square foot rent is higher compared to market size apartments. A smaller space requires less heating, cooling and electricity expenses. Very often, micro-units come furnished and include utility expenses such as electricity, water, internet and cable. Due to these factors, we might observe micro-unit rents

similar to market size apartment rents.

This phenomenon is observed in New York City's first micro-unit building at Carmel Place, where micro-apartments

Micro Units vs Studios

range from 265 to 355 sq ft

East Harlem $42

Central Harlem $56 in size and rents range rom

Lower East Side $62

Murray Hill $67 $2,500-2,900 per month.

Greenwhich Village 11$81

Cramercy Park O $81 Comparable market size

Tribeca I $82

SoHo , $99 studios, which range on

West Village ~$100 _average_500-600_{sq ft, rent}

Kips Bay $58

Carmel Micro Unit at Kips Bay $107 for $2,300- $3,100. $0 $20 $40 $60 $80 $100 $120

ANUAL RENT PER SQUARE FEET PER YEAR

Source: NeighborhoodX

LOCATION CHOICE

Housing location choice has a twofold implication. First, it results in less commute. According to

U.S. Census data, average commute time in the U.S. is 25.4 minutes each way. While some

people commute less than average, the percentage of longer commuters is comparably higher and growing.2 1 _{Second, location is a lifestyle choice preference, with walkable urban neighborhoods}

with nearby groceries, trendy restaurants and cultural venues.

"[A] vibrant neighborhood is the key to a successful micro-unit project. "22

21 The Guardian, "Millions of people spend two or more hours commuting a day"

https://www.theguardian.com/money/201 5/nov/09/million-people-two-hours-commuting-tuc-study

(23)

Buying, renting or building bigger units has its pros and cons. Small means no room for future expansion, storage constraints, lack of living space for entertainment, or in some cases, privacy. However, at the same time, one has less environmental effect, greater affordability, and lower utility/insurance/tax bills/maintenance expenses.

A question remains open: How much space do people really need?

A study of 32 middle-class Los Angeles families revealed that out of 1000 sq ft of space on the first floor, only 400 sq ft was mostly used: the dining, family and kitchen facilities.

mtcw. Faftly RoOM

Source: Life at Home in the 21st Century, Wallstreet Journal

DRIVING FORCES FOR MICRO-UNIT DEVELOPMENT

Developers as a proactive group usually respond to rising demand. During the last decade, lifestyle and demographic changes have triggered micro-unit development. Due to existing regulatory obstacles, one of the micro-unit development waves emerged through collaboration with city governments. Boston, New York and San Francisco were the cities that decreased minimum unit size requirements and encouraged developers to build small units in specific locations or to participate in pilot projects. Another wave constituted developers from Seattle and Santa Monica who found loopholes in the existing code that enabled them to avoid lengthy design review processes. However, the sustainability of the micro-unit development trend is questionable. Some

23 Jeanne E. Arnold, "Life at Home in the 21st Century" (2012)

(24)

developers are designing a certain percentage of micro-units in new developments to test the market for its broader use in the future. Others think that if policymakers do not facilitate with policy changes, it will not be economically feasible.

Essentially, developers will consider micro-unit development if it provides better risk-adjusted returns. Since per square foot construction costs both for finishes and higher ceilings2 4 are 5-10% higher than the market size apartments, developers, in general, make up the difference by

charging premiums of about 20-30%.25 Meanwhile, the rent premiums differ from city to city. One of the highest premiums is charged in San Francisco. According to RCLCO Advisory Group, on average micro-units rent for 36% less than the average unit of all types in the same market. In some cities, the rent premium is negligible which will most likely discourage the rise of the small product type.

Metropolitan Statistical Area (MSA) San Francisco Los Angeles

Oakland Long Beach

Hayward Anaheim

Number of Micro-Units: 458 1,898

Micro-Unit Average Effective Rent: $2,358 $1,284

Market Rank: 6/148 68/148

Micro-Unit Percent $/sq ft Premium:

Market Rank: 72/148 61/148

Micro-Units Percent of MSA Units:

Source: RCLCO

Micro-units thrived in the era of unaffordability. When people cannot afford bigger spaces, they turn to smaller ones. On the other hand, it is also about the choice of location: small, affordable units provide an opportunity to experience the location at the expense of a smaller sized home.

2 Lawrence, "Developers Big".

(25)

CHAPTER 6: OBSTACLES FOR MICRO-UNIT DEVELOPMENT

Various barriers exist for micro-unit development including regulatory (specific to location), as well as non-regulatory (nonspecific to location but more related to the product type and market perception). Some of the regulations impact housing density and others increase development cost.

Minimum unit size is one of the main requirements that can hinder micro-unit developments. Different cities have their own set minimums. In 2012, San Francisco amended its building code

by reducing market rate micro-units' allowable size to 220 sq ft down from 290 sq ft. However,

the planning department capped the approval of such units to 375 to be able to observe and control its impact. The change and cap did not count student housing, group housing and affordable housing. The new rule also suggested the provision of common usable open space rather than private open space. The changes were intended to benefit that part of the population with moderate medium income.

Another important aspect of micro-unit development depends on the off-street parking

requirement. Essentially, micro-units are economically viable to build in areas where there is no minimum put on developers. While San Francisco is a progressive city and in many high density mixed use zones changes have been made relaxing parking obligations, there are still locations such as RC4 (high density residential-commercial mix), which requires 0.25 parking space per unit. As for Los Angeles, in most districts, there must still be at least one parking lot for each residential unit built (calculated based on room number in the units). That is the reason why existing micro-unit projects in Los Angeles were built through city's Adaptive Reuse Program, which relaxes many zoning requirements such as parking and density and provides flexibility in the permit process.

The unit mix requirement, in general, is a challenge for developing micro-units since cities and communities are keen to adopt plans for family size housing. Several zones in San Francisco require a certain percentage of family size apartments opposing even market size studios and one-bedrooms. In a few other zones, however, there is no restriction on building structures

(26)

composed entirely of small units. In contrast to San Francisco, the City of Santa Monica adopted a unit mix requirement for market rate developments to design at least 15% of the units with three-bedrooms, at least 20% of the units as two-bedroom, and no more than 15% of the units as studio units.

The open space requirement along with off-street parking indirectly diminishes the building area which could be used for micro-unit development. The San Francisco Planning Code requires developers to provide outdoor open space and indoor common areas. At the same time, common space is counted at 1.33 times the private one. In high-density zones, a developer generally must provide 36 sq ft of private open space or 48 sq ft of shared open space per unit and in medium-density zones, a developer is required to provide 60 sq ft of private open space or 80 sq ft of shared open space per unit. It also states that the requirement for efficiency units is one-third that of regular units.

The City Code also defined Common Area Requirements for Efficiency Dwelling Units with Reduced Square Footage (Section 140.1) to include at least one common room for use by residents such as a library, media rooms, game rooms or other uses suited to residents' needs. Common areas should not be less than 10 sq ft per each efficiency unit.

Los Angeles code requires open common space not less than 400 sq ft. As for private open space, in general, it should not be less than 100 sq ft per unit but at the same time not more than

100 sq ft can be attributed towards open common area requirements.

The maximum number of units permitted on the lot regulates direct density possibility on developable land. In Los Angeles, medium and high-density zones require at least 400 sq ft lot area per dwelling unit. Very often higher densities are reached through inclusionary zoning bonuses.

In high-density zones, San Francisco code limits building to one dwelling unit per 200 sq ft of land. In addition, it allows the counting of an efficiency unit as 3/4 of a unit to enable more building.

(27)

FAR ("Floor to Area Ratio") zoning restrictions are another difficulty faced by small unit development. It is the high ceiling that gives the space more volume. When designing big units, height is not a primary necessity but in small units it is critical since that is one of the only ways to give the room volume and a feeling of space.

Other barriers to micro-unit development are associated with financial capital availability and community resistance. According to developers, capital availability is one of the major obstacles for micro-unit development. Since the micro-unit product trend is somewhat new and not well observed in terms of its performance, financial institutions are reluctant to provide easy access to capital.

(28)

CHAPTER 7: DESIGN CHARACTERISTICS

MiCR O- UNIT BUILDING AND UNIT DESIGN

There are many old stereotypes labelling dense neighborhoods with tiny units as poor,

overcrowded and located in dirty areas. However, cities and developers look at them as a way to address the needs of modem society, mostly millennials, with minimalistic preferences.

While micro-units have been around for a long time, developers and designers have put a great amount of effort into them to make them as livable as possible in a modem urban setting.

"A well-designed 400 sqft apartment can have a greater amenity than a poorly designed 600 sq ft apartment. -26

Micro-units vary in size, configuration and layout but one thing is common in most of them: they incorporate several rooms in only one compared to typical units, i.e., the average new 934 sq ft size of the rental apartment in the U.S. may be squeezed in up to 350 sq ft of micro-unit.

FUNCTIONALITYAND DURABILITY

As an emerging trend, micro-unit design strives to give multi-functionality to various use elements to save space as well as incorporate various living areas. The smart design is crucial since it must integrate several use elements in one spot. In the process of decreasing the total floor area, micro-units still need to follow ADA requirements. Design details create the feeling of space by building high ceilings even if these are not required by building code. For example, the adAPT NY Concept ceiling height is 9'8" with large windows for massive exposure to daylight and neighborhood views. Developers are also keen to use durable fixtures for further ease of maintenance as well as acoustic isolation for tenants' comfort. In a smaller space like micro-units, lack of soundproofing can be detrimental.

26 "Life in small rooms: 5 micro apartments and how they fit it all in" 04.03.2015

(29)

SPACE USE AND FURNISHING

Very often micro-units come furnished, as traditional furniture is not as functional in a smaller unit. This also facilitates residents with an easy relocation. Built-in furniture creates a smooth transition between various spaces and provides ample storage space in comparison to free-standing furniture since it can use the "dead space". Transforming furniture engineered for multiple purposes solves the goal of space saving and broadens the space for entertainment.

~fr Nj

Source: Resource Furniture Swing, queen size wall bed with a 9foot sofa and sliding chaise with additional

storage under the sofa and integratable with modular Closet and Shelving Systems.

Source: Resource Furniture Cristallo table,adjusts to various heights to perform various Junctions, from coifee table to dining table.

Space-saving furniture for a small apartment broadens the living space, organizes belongings efficiently and provides a modern edge. Developers are constantly seeking innovative solutions

(30)

In the end, it's not the size of the space that's important; it's how you use it." says Monadnock

project developer Frank Dubinsky2 7

A different design was used for a 350 sq ft apartment in Moscow. The wooden sleep box with a

storage space separates the sleeping area from the rest of the apartment and at the same time allows light access to the box.

Source: Archdaily

TECH INTEGRITY

"The idea is to bring technology to space to make it much more functional and much more

intelligent, " saysfounder Hasier Larrea.2 8

Robotics furniture is the next generation innovation for efficient space use that aims to disrupt the urban built environment. Ori - an MIT Media Lab based startup - has developed a robotic furniture system that transforms the space into a multifunctional living area. In order to assess the minimum functional living space, the

company developed a furniture unit designed specifically for micro-units. It includes a bed, a sofa, a walk-in closet, a working desk and shelves. The furniture unit acts as a separator

27 Adam Bonislawski, "Let's Get Small: The Micro-apartment Trend is Taking Off," Blueprint, May 9, 2016,

https://blueprint.cbre.com/lets-get-small-the-micro-apartment-trend-is-taking-off/. 2 8

Madeline Bilis, "This Robotic Furniture Will Optimize Micro-Living," Boston Magazine, July 13, 2016, http://www.bostonmagazine.com/property/blog/2016/07/13/ori-micro-robotic-fumiture/.

(31)

between the living room and bedroom, moves, and interchanges between functions. Ori

partnered with several Boston developers to test the unit and make the necessary adjustments to commercialize it soon. The innovative design effectively increased the micro-unit's usable area

by 71 sq ft, an increase of 17% in a 400 sq ft studio.

Image Source: Business Insider

COMMUNITY PROGRAMMING

Residential Community Space Design plays an integral part in small unit buildings. In fact, generous community space integration into micro-unit structure design became a differentiating factor between new and old versions. Although there is a stereotype that common areas are diminishing due to increasing living spaces, the developers focus on community planning by providing more public amenities within the building to make up for the smaller size of units. They thoroughly program and properly distribute common spaces, the way one might often find in luxury buildings. Such spaces may include meeting and lounge spaces, music practice rooms and art studios, dining rooms and laundry rooms, roof gardens and sky decks, yoga and fitness studios, bicycle parking and car charging stations. While developers design and build common spaces based on potential tenant desires, it is worth understanding why some of the spaces are not used to the extent that they were designed.

One of the post-occupancy studies of Julia Nugent outlined characteristics of successful vibrant common spaces in student housing design as:

* Proximity, visibility and openness.

* Integration of multiple activities in one space.

(32)

* Optimal size.

* Distribution and variety.

* Importance of space ownership. * Quality of space.

* Furniture. 29

Even though one can argue that students' preferences might differ, they are still part of the target cohort

for micro-housing both in terms of

demographics and lifestyle. Interestingly, different generations

look for the same design and DOMICILE I

planning solutions to foster similar social interactions.30

MODULAR CONSTRUCTION

Modular construction is changing the way the world builds. Prefabrication technology can save time and money. It is not a secret that high wages and construction delays increase total project costs. Bridge Housing estimated that by using modular construction, builders could save 10% to

15% and reduce construction time by up to 25%. There are a whole variety of advantages to modular construction including speed, lower environmental impact, and improved sustainability. In some cases, depending on the building type, the direct cost advantage may not be the most important one. Due to a micro-unit's small size, each unit can be prefabricated as a separate module and delivered to the site for installation. Many developers are willing to switch to modular construction, especially for micro-units. However, developers can encounter various obstacles such as debtors' unwillingness to fund such projects, labor unions' opposition as well as policies that impose on using certain labor types.

29 Julia Nugent, "Residential Common Spaces That Really Work," Planningfor Higher Education, 41 (2012): 234. 31 Jami S. Mohlenkamp, "Blurring the Lines Between Generations," Ozarch,

(33)

NEW STANDARD OF MICRO-LIVING

An important step forward in establishing micro-housing development standards was the NY adAPT competition. It was initiated by New York City and aimed at responding to changing household composition and setting a new standard for micro-living. New York City was ready to experiment with unit size by overruling the current minimum size of dwelling units. However, participants had to follow accessibility and building code regulations. To win the competition, the project had to demonstrate sustainability certification, unique design, management

guidelines, a mix of units offered with minimum 75% micro-units and 20% affordable units, innovative exterior and interior design, exterior lighting, attractive common spaces, substantial access to light and air for openness both for primary sleeping and living spaces as well as for

common areas.

* Winning Project Carmel Place

Developer _{Monadnock Development}

Architect nARCHITECTS

s Manager Ollie

Site dimensions 45 ft x 105 ft Building area 35,000 sq ft Construction Method Modular

Project Program 9 story, mixed use development with 55 units including 40% affordable and ground floor retail space

Image Source: cityrealty.com Unit average size 260-360 sq ft

Shared Places 3,525 sq ft exterior amenities 5,470 sq ft interior amenities Unit Amenities 9'8" feet ceiling, custom built-in

furniture, washer/dryer in the unit Building Amenities Sustainable design, a gym, lounges and

roof deck, secure bike storage

Walking Score/ 98/100

Transit Score

Average Rent USD 8-1 131

(34)

CHAPTER 8: CASE STUDIES

SAN FRANCISCO

Although San Francisco made a progressive move towards reducing the minimum unit size of efficiency apartments in 2012, the market has seen only a few completed micro-unit structure projects from which two were eventually designed for student housing.

CUBIX was one of the Ist micro-unit condo *E I

u b

xprojects that did not enjoy resounding success

due to its delivery period during economic pg crises in 2008. It was designed as a Single Room Occupancy building that would have higher density and relaxed parking

requirements. Located in Yerba Buena Arts District of SoMa, San Francisco, the developer offered unique exterior design coupled with trendy interior finishes for lower than the average unit price in San Francisco at that time. Steps away

from transportation and neighborhood amenities, apartments featured almost 9 feet ceilings, large windows, balcony, contemporary design with exposed concrete floors, and great common areas to

compensate for small living areas in the separate units.

Address 766 Harrison Street Developer HausBau/Hauser Architects

Building type Eight story mixed use with 4,500 sq ft ground floor commercial areas micro-units Number of Units 91 market price and 7 affordable units Unit average size 250-350 sq ft

Unit Amenities Private balcony, edgy design with exposed concrete heated floors and large bathroom Building Amenities Landscaped roof deck with BBQ place,

glass-enclosed outdoor picnic area, Cafd

Walking Score/ 94/100

Transit Score

Rent The only 270 sq ft unit currently available asking price is USD 10 per sq ft per month12

Image Source: Vangard Properties, sq ftGATE

(35)

38 HARRIET was built in 2013 by assembling prefabricated 295 sq ft modules within four days. Located in the heart of the trendy SoMa district it offers residents all amenities of urban living with nearby cultural venues, grocery shops, trendy cafes and restaurants. The building features 23 micro-unit apartments with high ceilings that give a feeling of ample natural light and ventilation. Units come with transformable built in furniture and provide about 300 cubic feet of storage space. As a common space, residents have the opportunity to use the landscaped garden. Being a LEED Platinum Certified building, 38

Harriet has solar-heated water, low-flow fixtures and a rainwater harvesting system in addition to having little construction waste due to prefabrication.

Address 38 Harriet Street Developer Panoramic Interests

Lot Size 3,750 sq ft

Building area 11,775 sq ft Construction Method Modular Number of Units 23

Average size of the units 295 sq ft

Unit Amenities 9 feet ceiling, custom built-in

Building Amenities

Walking Score/Transit Score

Average Rent per sq ft per month

Rent Type

furniture, washer/dryer in the unit

LEED Platinum certified, sustainable design, landscaped 1,000 sq ft backyard, secure bike storage, onsite city car share 98/100

USD 5.433

JIG?~~.

Utilities included student

housing

Image Source: lifeedited.com, microbuilding.com

33 https://www.cca.edu/students/housing/halls/harriet

(36)

Address 1321 Mission Street Developer Panoramic Interests Building area 108,000sq ft Number of Units 160

120 micro studios 40 micro suites Average size of the 274-295 sq ft studios

units 605-630 sq ft. suites

Unit Amenities 9 feet ceiling, custom built-in furniture

Laundry facilities and common areas on the floor, Building Amenities lounge area with working

stations and fireplace on the ground floor, rooms for meditation and study, spacious roof deck, secure bike storage, onsite city car share

Walking 97/100

Score/Transit Score

Average Rent per Studio - USD 11 sq ft per month Micro Suite - USD 6.6 34 Rent Type Utilities included and shared

option

PANORAMIC RESIDENCES, situated

within walking distance

from Chinatown, Union Square, and the Ferry Building, offer unparalleled housing

alternatives for students in the neighborhood. Initially designed as market rate apartments, later on the project was half master leased to the College of Art. It stands out with a broad variety of common spaces, activated ground floor, environmentally friendly building and unit design that one experiences in luxury buildings. Design features include 24/7 fresh-air ventilation, unit soundproofing, dual glazed and UV protected bay windows and low flow plumbing features. Units are

designed for double and quadruple occupancy with built-in furniture, ample storage space and durable fixtures. Developer Patrick Kennedy has vast experience developing micro-units in Berkley.

Image Source: Panoramic Interests

(37)

STEVENSON LOFTS are a conversion of an existing industrial building to a mixed use with

efficiency and one-bedroom units, 210 sq ft ground floor commercial space and 8 off-street parking spaces. Unit sizes range from 250 to 677 sq ft. The developer applied for approval with

4

i

A

E~I

r;j~iIJI

I 12'-6' *W I LrTCA 1r TYPICAL PLAN ( (APROX. 250SF&,OOSF LDFT

Image Source: reallisto.com

3 http://stevensonlofts.com/#apartments-and-pricing

OPEWTO BMDW)

variances and finalized the project with 27 studios and 33 one-bedroom units.

Apartment features include high ceiling loft design with signature ladder, wood grain flooring and large windows. Select apartments come with in-unit laundry and private balconies. The project is located in

SoMa district, where most of latest micro-unit projects were developed, minutes away from Bart and Muni, many tech companies, restaurants and cafes.

Address 527 Stevenson Street

Developer Stevenson Lofts LLC

Lot Size 10,646 sq ft Building area 42,600 sq ft

Year Built 1924

Year Remodeled 2015 Number of Units 60

Average size of the Studios 250-380 sq ft

units One-bedrooms 450-550

sq ft

Unit Amenities High ceiling, loft

sleeping area

Building Amenities Lounge areas, furnished

roof deck, bike parking,

onsite city car share

Walking 96/100

Score/Transit Score

Average Rent USD 735 U

I_-SU=P ~ AK

(38)

LOS ANGELES

ROSSLYN LOFTS rehabilitation project

located in Downtown Los Angeles was originally built in 1913 as a hotel and later purchased and redeveloped by Alexandria Housing Partners in 2009. The company has since renovated the once decaying building with a 15 million dollar budget, which for years

served as a residential hotel for low-income

4

tenants. There are 259 affordable housing units

and 38 market rate units in the building along

with 8,070 sq ft of retail space on the ground floor. The common areas include laundry facilities and a community room with increased security.

Address 501 S. Spring St

Developer Alexandria Housing Partners

Building area 188,000 sq ft

Year Built 1913

Year Remodeled 2009

Number of Units 259 affordable units

38 market rate units Average size of the Studios 300 sq ft units One-bedrooms 1300 sq

ft

Unit Amenities Loft type units with exposed break walls Building Amenities Common kitchen and

ground floor lobby

Walking 98/100