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Although the term “micro apartment” is not clearly defined, the general guidelines seem to be as follows:  a bed/living/dining room with a kitchenette, and a bathroom…all in under 300 square feet of total space.  If this description conjures up visions of your first dorm room, you aren’t too far off.  Floor plans and amenities differ from city to city due to varying building codes and definitions of a dwelling unit.  As highlighted in this USA Today article, Seattle only requires dwelling units to have access to a shared kitchen and separate living quarters for each unrelated person.  Therefore, units in some buildings consist of nothing more than a room with a bed, an open closet, a sink, microwave, and a mini-fridge.  Bathrooms, showers, and full kitchens are considered shared amenities.

Other developers are taking the concept to a higher level by providing a full “micro” kitchen, unique built-in storage options, and space conscious multi-purpose furniture.  Although the thought of cooking, eating, working, and sleeping in the same room may seem foreign to Midwestern sensibilities, the concept is not new.  Living units of this size are fairly common in London and Paris, and residents in Tokyo might consider 300 square feet spacious.  The idea is that residents have access to all that the city has to offer and therefore will not spend much time inside their unit.  Further, technology has eliminated the need for a desk, and big screen TVs can now be mounted on the wall.  Why pay for unnecessary space?

In Seattle, young professionals employed in the tech sector are taking advantage of micro apartments in order to reduce their commute and live near the city’s hot spots.  In San Francisco, the average rent of a micro apartment is roughly one-fourth of the rent of average apartments.  In New York City, plans for that city’s first micro apartment community have just recently been announced.  It’s easy to imagine the need for micro-units in a massive metro with a dense urban core; but what about in tertiary markets like Champaign-Urbana?

              Rents near campus average roughly $500/month per bedroom; studios and one bedroom apartments demand higher rents.  Land is expensive and space is limited.  For many students, rent and location are the top two considerations when searching for housing.  How much demand would there be for micro apartments located one block from class with rent as low as $300/month?  In downtown Champaign, apartments are scarce and rents are high.  Is there enough employment downtown and/or are there enough amenities to entice people to rent a micro apartment?

Time will tell.  If there is demand and money to be made, developers will supply the product.

As an example, I'm going to use a 4-unit multifamily property that I recently looked at with a friend of mine - we'll call him Neal.  Neal is a sophisticated investor who has built a small multifamily investment empire over time.

The property brochure gave us a few important pieces of information:

Price: $144,000

Monthly Rent: $2,140 ($535/unit)

Taxes: $4,403

The property was in a decent location, but was a bit rough.  When quickly running the numbers, I suggest you figure out four things:

Price-to-Rent Ratio

Monthly Cash Flow

Capitalization (Cap) Rate

Cash-on-Cash Return

Price-to-Rent Ratio

When purchasing a property, a lower price-to-rent (P2R) ratio is better than a higher one, but you also want to compare it to your area's average (Champaign's is 17.67).  Find out your subject properties P2R ratio by dividing the purchase price by yearly income.

Monthly Cash Flow

This is your income minus expenses.  Your income is simply gross rent plus any additional income (ie. laundry).  To figure out your expenses, you'll want to know these six things:

Property Taxes

Insurance

Property Management Fee

Mortgage

Vacancy

Maintenance/Repair

Now just subtract your monthly expenses from your monthly income.

Capitalization Rate

The cap rate is the expected return on a property based on its projected income.  Simply divide Net Operating Income (NOI) by your purchase price.  For NOI, I exclude the mortgage payment as an expense.

Cash-on-Cash Return

This will tell you the return on your cash invested.  Divide your yearly cash flow by the amount you have invested in the property (down payment).

All of this is easier to understand on a napkin (or in a notebook), so here  are the numbers for the 4-unit multifamily property that we looked at.

This looks pretty good on paper:

5.61 Price-to-Rent Ratio

$530 in monthly cash flow

8.72% cap rate

22.08% cash-on-cash return

What this didn't take into account is the amount of money that would need to be spent to update this place, ie. new restrooms, new wiring, repair windows, etc.  Remember, it was in rough shape.

If you estimate spending $40,000 in repairs/updates right off the bat (cash, not a loan) - your cap rate just went to 6.68% with a cash-on-cash return of 9.24%.  All of a sudden this deal isn't as attractive as it once was.

Obviously a napkin calculation isn't going to tell you everything that you need to know (neither is fancy software), but it's a tool that can help you make a decision when evaluating investment real estate.

Josh Markiewicz is a commercial real estate broker at Coldwell Banker Commercial Devonshire Realty (CBCDR), and can be reached at 217.352.7712 or [email protected].

There are three basic factors that are driving demand for apartments:

Increase in young adult renters

Downsizing by baby boomers

Decrease of homeownership due to poor economy

Developers have found that demand is high and supply is low for quality multifamily apartments across the country.  In addition to the three factors above, new construction has also been driven by the fact that many older properties need replacement due to obsolescence.

Certain major markets (and some tertiary) are seeing a “reverse migration” effect, where people are moving back to downtown and urban neighborhoods.  This has created demand for both new development and redevelopment.

In my market; Champaign, and across the country, on-campus student housing has become the Taj Mahal of multifamily.  Locally, I’ve seen cap rates dip below 6%, and have even seen some in the 4.5% range!  Even with rates at historic lows, it becomes difficult to receive the type of return that investors require when cap rates are in the 4%-6% range.

The National Multi Housing Council (NMHC) Quarterly Survey of Apartment Market Conditions has shown improvement across all four indexes that it measures for the seventh quarter in a row.  The quarterly survey looks at market tightness, sales volume, equity financing, and debt financing.  Even with continued new construction, demand has outpaced supply.

Looking forward, I would focus new investments in off-campus properties, value-add plays, and quality properties in good areas.  Depending on your market, I think urban/downtown assets could be a good play in 2013 as well.

How is multifamily performing in your market?

Where do you see the good bets in 2013?

Josh Markiewicz is a commercial real estate broker with Coldwell Banker Commercial Devonshire Realty (CBCDR), and can be reached at 217.352.7712 or [email protected].