04 September 2015

The Economics of Micro-Housing

Between Sports Authority Stadium at Mile High and the booming Highlands neighborhood in Denver, just across I-25 from the Elitch Gardens amusement park, is a building that used to be the somewhat worse for wear Hotel VQ, a cylinder which once had a rotating restaurant on its top floor in "mod" style built in 1969.

A pair of real estate development companies converted the hotel to 179 apartments, mostly spartan 335 square foot studio apartments, together with a few penthouses where the restaurant used to be on the 13th floor.  Units have hot plates instead of gas or electric ranges, because the building's utilities can't handle any more demand.  The amenities are at the low end, but with the range of what modestly prices apartment buildings near downtown offer.  The signature piece of this development is a bicycle repair work space available to all tenants.

Realistically, this is about as small as a studio apartment can get without dropping down into the currently almost non-existent in Denver realm of youth hostels, dormitories, and flophouses aka "single occupancy hotels".

The developers paid $9 million for the Hotel, as is, and put $11-12 million into thrifty renovations, for a total price of about $20,000,000.  This is about $90,000 per unit and about $270 per square foot. It helps that mortgage interest rates for commercial and residential borrowers with good credit and adequate down payments are at record lows.  The rent for one of the studio units about $990 a month - 1.1% of the cost of the unit per month, about 45% of the rent for a two bedroom apartment in the neighborhood - which may include some utilities.  The city also requires 350 square feet of parking space per unit, which is workable for this project because the hotel already had plenty of parking.

Tenants start moving in this week and about half the units are currently leased.  I'm sure that the rest will fill up soon.  Vacancies in apartments in Denver are at record lows, rents are surging, and more affordable units are particularly scarce.

There is a pent up demand for studio apartments in downtown Denver which this project seeks to fill. For whatever reason, the tens of thousands of new apartments that are being built in Denver each year for the next several years, are overwhelmingly one and two bedroom units at the luxury end of the rental market.  Studios and apartments with three bedroom are scarce in general, and even more scarce in new apartment construction.  Existing units that used to be considerable desirable are being forced to renovate or move down the rental housing hierarchy.

Some of the unprecedented surge in apartment building is due to pent up demand from the years after the Financial Crisis when nobody was building and nobody was investing in housing or lending the money to make it happen.  Part of the demand comes from the ranks of people who lost homes or gave them up during the Financial Crisis and are now looking for apartments to live in, instead.  Part of the demand comes from a strong Denver economy (5th fastest growing in the nation in 2014) that is expected to attract about 50,000 new residents to the Denver metropolitan area over the next few years, although it is hard to know if that surge will be muted if low oil prices take some of the steam out of the Mountain West's economy that is managed mostly from Denver. New zoning regulations across the metro area to encourage high density development near light rail lines, and other strategic zoning changes in Denver to encourage new development have also played a part.

Of course, $990 a month for a studio apartment that struggles to house an intimate couple and mostly houses young single people who want to live near downtown is hardly a steal.  Just a couple of years ago, you could get a decent sized one bedroom place for that.

Of course, for genuinely affordable housing, the city really needs more studio apartments with rents in the $450-$600 a month range to be affordable for working class and lower middle class renters who don't need prime locations and glitz, or even single parents with one or two children (often on a part-time basis).

This means that for these studio apartments to be built on a for profit basis, the units need to cost developers something on the order of $45,000-$60,000 to buy or build, which works out to about $135-$180 per square foot.  A number of developers (profit and non-profit) are trying to convert motels build on arterial streets in the metro areas that lost their clients when the interstate highway system was developed, into this kind of housing which is close to possible price point for the old motel units with modest renovations to make them suitable for housing.

Some of that budget needs to go towards land acquisition, which can be reduced by zoning more land for higher densities and reducing parking requirements at locations where transit is good enough to allow a significant share of residents to go carless or rely on car sharing programs (really short term, low paperwork car rentals).  Some of that budget needs to go towards construction - which is expensive when the metro area is in a building boom and is also somewhat a function of distinguishing between what is necessary for health and safety, and what is merely aesthetic or designed to discourage low income housing, in building codes.

Alternately, one can build units with even fewer square feet per unit, amending zoning and building codes to allow it, by creating affordable housing in which, for example. residents share some or all bathroom facilities and/or have minimal or non-existent kitchens, perhaps trading out an affordable cafeteria serving mostly residents instead.  This takes you into the realm of youth hostels, dormitory and barracks style housing, and single occupancy hotels.  It's modest living, but beats being a vagrant sleeping on the streets, living in your car parked anywhere you can overnight, trying to cram several people into a small apartment as roommates in violation of the lease (a popular option with immigrant blue collar workers in Denver), or having to drive or take buses for hours from more affordable areas (or with relatives) for low wage workers.

Another affordable option if zoning codes would allow it, would be to allow single family houses in residential neighborhoods to be used as boarding houses with one or two renters per bedroom, or renovated into multiple unit apartments with similar densities but more separated living spaces. This kind of development is a staple of college towns and some high density, high cost cities, but is prohibited by zoning codes in most places.

Similarly, accessory dwelling units, such as "granny flats" or garages or basements converted to residences are prohibited by zoning codes in most residential areas in Denver, but could provide a huge inventory of affordable housing that doesn't overwhelm residential neighborhoods with high densities of low income tenants (because primary houses would still be occupied by middle class families that own homes).

Ultimately, the big problem has less to do with economics and building costs, and more to do with urban planning initiatives like restrictive zoning and building codes, that rule out a variety of workable solutions to the affordable housing problem without big investments of government funds or mandates imposed on developers of new housing.  But, to open up those possibilities, city leaders need to find a way to defeat NIMBY driven neighborhood activists who don't want more lower income people (or for that matter, more people, in general) in their neighborhoods.  Denver has a better track record on that score than many cities, but is missing out on low hanging fruit solutions like allowing accessory dwellings and multiple households in single family homes.

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