Azure has been churning out features faster than anything I can ever remember coming out of Microsoft. I finally moved to Azure with my production apps this weekend. It was a pretty painless move, as far as data center moves go. One of the biggest road blocks that I hit was trying to create virtual applications for each of my apps inside one Azure Web Site. I wanted to go this way to get the benefits of having one DNS entry, coupled with an SSL certificate, and eventually wildcard subdomains. It seemed the smart way to go, given that each app is isolated and I've been running that way on my own IIS server for a couple years (or more) now.
The key to getting things right is to select your Azure Web Site in the portal, and go to Configure. Then, at the bottom of the page you can add your virtual applications. The placeholder text says "PHYSICAL PATH RELATIVE TO SITE ROOT". Don't listen to that. Instead, make your virtual applications live underneath site\wwwroot.
If you do that, you can then download the Publish Profile Settings from your dashboard and update the <DeployIisAppPath> element to look like this:
Now when you deploy, the files will land on the server in the right directory.
I couldn't find a way to get the deploy to put the files in the site\app1 directory on the server. DeployIisAppPath and RemoteSitePhysicalPath could not get me up to that level in this setup. If you know of a better way, I'd love to hear about it!