July – September 2009 Quarterly Newsletter

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Mary Lou and I were off-island in August and September. It seemed as though every state we visited had problems similar to what Hawaii is experiencing. Reading the various local newspapers, you could put almost put any state in many of the articles and the stories still made sense. Every state seems to be experiencing reduced tax revenues and as a result is being forced to cut non-essential services including laying-off and/or providing forced furloughs to city and state workers. In Hawaii, public school teachers are state employees and being forced to take 17 unpaid furloughs per year so there is lots of hue and cry about the public school children being impacted which would make far more sense if Hawaii public school students didn’t continually test near the bottom of all 50 states.

Granted, there may be a periodic bright spot here and there, but the housing market in many areas is soft with property foreclosures on the rise. The five worse areas on Oahu comparing the first six months of last year to this year: Waikiki 29/203 (+600%); Kapolei 21/148 (+590%); Waianae 26/179 (+588%); Ewa Beach 49/257; (+424%); and Waipahu 26/124 (+377%). Our hotel occupancies are down with the global economic decline and swine flu scare. And every time you turn around, someone seems to be increasing taxes. We are the only state with a General Excise Tax (GET) on all goods and services, have the highest state taxes in the nation, unemployment taxes are expected to increase some 12-fold next year, etc.

However, there are many wonderful things that remain marvelous with our 50th state . . . even the housing market has started to pick up for both sellers and buyers. So, rather than pound away with negativity, this issue is designed to provide some useful information about credit reports and how to obtain them at no cost, the state’s involvement in rental GET, a mixture of Talk Story and a very interesting, completely different type of editorial on the last page. Enjoy!

Odds & Ends

Hawaii General Excise Tax (GET): I own a tenant-in-common position with eight other investors in an apartment complex in Gulfport, MS. Recently, I received two rather thick, dunning letters from the Hawaii Department of Taxation claiming that I had not paid Hawaii General Excise Tax (GET) on my gross rental income for the past two years. A quick call to my CPA verified that the tax laws hadn’t changed. GET is not required since the rental property is not located in Hawaii. Copies of my 1040 Schedule E’s resolved this matter with the state.

My Federal Tax Return (1040) for last year was fairly complex while my Hawaii N-11 Resident Tax Return consisted of only four pages Most of the information for the state return was copied from my 1040 without any detail. The detail was subsequently provided the state by the feds from my Federal Tax Return. It is not clear whether this included the address of the Gulfport property. In either case, the local auditor made an erroneous assumption that my Gulfport rental property was located in Hawaii and that I had failed to pay GET. Without bothering to verify her assumption, the auditor had their computer generate pages of detail as to taxes I owed the state for each year with both letters arriving on the same date.

Hawaii is desperately in need of additional tax dollars. My experience makes me believe that they may be examining new auditing areas. If you are not paying GET on the gross rental income from your Hawaii rental properties, I would be concerned. For both years that they claimed I owed GET, I was billed GET on the gross income plus a 50% penalty plus interest.

NOTE: If you sell investment property where there has been no gain or insufficient proceeds to pay the withholding under HARPTA, state form N-288B applies. It requires the owner to provide their GET license number.

Rail System: The Sunday, August 16th issue of The Honolulu Advertiser discussed rail funding at some length in its front-page headline article titled: Rail to cost us $4,000 each. According to the article, the $5.3 billion Honolulu rail transit system will be the most expensive rail line currently on the drawing board with a per-person cost of $4,309. The total cost of the Honolulu system is $5.3 billion with $1.4 billion expected to be federally funded and $3.9 billion coming from taxpayers in the form of a 0.5% increase in General Excise Tax (GET). The population of Honolulu is 905,034 per the Census Bureau. Dividing $3.9 billion by 905,034 equals a per-person cost of $4,309.

The Honolulu Advertiser researched nineteen different rail systems in preparing their article. The second most expensive was the Northern VA Metro Dulles Corridor at $1,307 per person; the third most expensive was the Seattle Central Link at $579 per person. The Honolulu system was the only system with a metro population less than one million people and was the second most expensive in total cost.

The problem with the Honolulu rail system is that it is way too expensive for a population density of less than one million people. Voters approved moving ahead with the rail project last November, but that hasn’t quieted the debate over the cost of the project. The cost could be reduced by building sections of the train at street level instead of having a completely elevated rail system. The American Institute of Architects and Kamehameha Schools have both expressed concern over the high cost and visual impact of an entirely elevated train system. The city argues that an elevated train will be faster, more reliable and cheaper to operate. Like many other critics, I don’t understand the logic supporting that position.

The city is already experiencing funding problems, as GET collected in the 12 months ending June 30th was $27.1 million below what had been projected. Since economists don’t expect any marginal rebound in the economy until 2011, the city is already talking about using funds allocated in the budget to revenue shortfalls and cost overruns and we haven’t even started building the rail yet. Then to top it all off, a May report released via the freedom of information act in August over the city’s objections projected a $500 million shortage in tax collections for the rail, creating great hue and cry. Many are asking why the city deliberately hid this information from the public. How many of you want to bet against GET increasing once again?

Rental Market: The slump in the housing market coupled with low interest rates make the current rental market very attractive for investors that are interested in upgrading their portfolios. The investors need to be thinking long-term when analyzing the existing market. In most areas, there is a healthy supply of rental units on the market resulting in a “renter’s market” with lower rents in view of the higher inventory. Some owners have put their homes on the rental market vice selling thereby increasing the number of rental units. Add to that, job losses and credit issues which prompt some renters to go back home to live with parents or relatives or to share homes with other tenants in order to reduce living expenses.

Stott Property Management manages some 400 rental properties island-wide on Oahu. The current downturn in the economy has created longer vacancies, higher delinquencies, lower rental rates and fewer qualified renters. Evictions have increased as many tenants living paycheck-to-paycheck have lost their jobs or had their salaries reduced similar to the forced furloughs state workers are now experiencing. Some tenants find themselves living on credit cards that eventually end up creating poor credit ratings coupled with lack of income. Many of today’s tenants could not qualify to rent their current homes as both their financial situation and credit have deteriorated since they were originally qualified.

So, with all these problems, why on earth do I say that this is an attractive market for owners interested in upgrading their portfolios? That’s because you should always try to make an upward move in a down or depressed market if you have the funds to do so. Experienced investors try to take advantage of downturns to strengthen their competitive position for the next upturn by investing capital where it can achieve the most benefit to them. Their investments are often made with cash vice additional mortgage leverage. This may be the time for some owners to reallocate some of their investment resources.

Granted the home you sell will net you less; however, the replacement property will cost you less and with all our problems, there are still some good buys available, particularly if you project into the future when rents once again will rise. Assume you own a one-bedroom unit or studio unit in Salt Lake and want to upgrade to something larger or closer to town that will provide you more rental income and/or higher quality tenants. If your unit was worth $250,000 and prices declined by 30%, it would only be worth $175,000. Assume the replacement property had been worth $400,000 and also declined by 30% to $280,000, the difference between the two would be $105,000 ($280,000 less $175,000) compared to $150,000 ($400,000 less $250,000) with no market decline.

The vehicle that enables you to conduct such upgrades and avoid capital gains taxes is a 1031 exchange. We have seen a significant increase over the past year in owners using 1031 exchanges; it is an area where we specialize in providing assistance to owners. The first step is to ask yourself some simple questions: Are you happy with your investment; is it working for you or is there a way to trade it for something better? If a change might be in order, then it is time to talk to my son-in-law and Property Manager, Tim Kelley, about rental properties on Oahu and rental rates versus property costs. I’m available at the same time to talk to you about 1031 exchanges. Demand at the lower end is currently much stronger than at the upper end with prices at the lower end seeming to level out which is another reason for a move-up now, positioning yourself for the future.

Improving Your Credit Score

Background: Gone are the days when lenders leaned over backwards to qualify borrowers for mortgages. After all the subprime lending problems, it has become increasingly more difficult for many potential homebuyers to qualify for desired financing. This section of the newsletter will discuss things a borrower can do to improve their credit score. The article is based upon a paper used by Keri Shepherd (808-223-4118) a local loan officer with Prospect Mortgage who is often used by clients of The Stott Team. At the end of the article is information concerning how to obtain free credit reports. I recently did this and obtained a free copy of one of my reports.

Check Your Credit Limit(s): Credit scoring software obviously prefers to see that you pay off the balance on all your credit cards each month. If it is impractical for you to do this, the guidance herein should assist you in being able to improve your score. Make sure your creditors report your credit limits to the credit bureaus. When no limit is reported, credit score software scores the amount as though your current balance is “maxed out.“ For example, if you know you have a $10,000 limit on your credit card, make sure that the $10,000 limit appears on the credit report. Otherwise, your score will be damaged as severely as if you were actually carrying a balance of the entire available credit.

Evenly Distribute the Balances You are Carrying: A balance of over 70% of your total credit limit on any card damages your credit score the most. The next level is over 50% of your balance, then over 30%. In order to maximize your score without having to pay down your balances, evenly distribute your credit card balances among all your credit cards, rather than carrying a large balance on one credit card. For example, if you are carrying a $9,000 balance on a credit card with a $10,000 limit and have two other credit cards with a $3,000 and $5,000 limit, transfer your balances so that you have a $1,500 balance on the $3,000 limit card, a $2,500 balance on the $5,000 limit card and a $5,000 balance on the $10,000 limit card. Evenly distributing your balances will enable you to improve your score.

Do Not Close Your Credit Cards: Closing a credit card can hurt your credit score, since doing so effects your debt to available credit ratio. For example, if you owe a total credit card debt of $10,000 and your total available credit is $20,000, you are using 50% of your total credit. If you close a credit card with a $5,000 credit limit, you will reduce your available credit to $15,000 and change your ratio to 67%. There are two caveats to this rule . . . If an account was opened within the past two years or if you have over six credit cards, an account can usually be safely cancelled. The preferred number of credit cards accounts to maximize your score is three to five, although having more should not significantly damage your score. If a card was opened within the past two years and you have over six cards, you should be able to safely close that account.

Keep Older Credit Cards Active: 15% of your credit score is determined by the age of the credit file. The credit scoring software assumes people who have had credit for a longer time are less at risk of defaulting on payments. Therefore, even if your old credit cards have high interest rates, closing those cards will decrease the average length of time you have had credit. Continue to use the old card at least once every six months to avoid the account being changed to “inactive status.”

Get Rid of Your Past Due Accounts: Within the delinquent accounts on your credit report, is a column called “Past Due.” Credit scoring software penalizes you for keeping accounts past due, so any “Past Dues” destroy a credit score. If you see an amount in this column, pay the creditor the past due amount reported.

Get Rid of Your Collection Accounts: Paying a collection account can actually reduce your score? Here’s why: Credit scoring software reviews credit reports for each account’s “date of last activity” to determine the impact it will have on the overall credit score. When a payment is made on a collection account, collection agencies update credit bureaus to reflect the account status as “Paid Collection.” When this occurs, the date of the last activity becomes more recent. Since the guideline for credit scoring software is the date of last activity, recent payment on a collection account damages your credit score. If you are purchasing a property or refinance an existing one and you have a collection account, wait to pay off the collection until you are closing on the loan and pay it through escrow.

Obviously, the best way to resolve this dilemma is to completely pay-off the collection account. If that is not practical, then see if the collection agency will remove all reporting to the credit bureaus. Request a letter from the collector that explicitly states their agreement to delete the account on receipt/clearance of your payment. Not all collection agencies will delete such reporting; however, it is worth the effort to try, as if there is no reference to a collection account in your report, your score will improve.

Get Rid of Your Charge-Offs and Liens: Charge-offs and liens do not affect your credit score when older than 24 months. Therefore, paying an older charge-off or a lien will neither help nor damage your credit score. Charge-offs and liens within the past 24 months severely damage your credit score. Paying the past due balances, in this case, is very important. If you have both charged-off accounts and collection accounts, but limited funds available, pay the past due balances first, then pay the collection agencies that agree to remove all references to credit bureaus second.

Get Rid of Your Late Payments: Contact all creditors that report late payments on your credit report and request a good faith adjustment that removes the late payments reported on your account. Be persistent if they refuse to remove the late penalties and remind them that you have been a good customer that would deeply appreciate their help. Since most creditors receive incoming calls in a call center, if the representative refuses to make a courtesy adjustment on your account, call back and try again with someone else. Persistence and politeness pays off in this scenario. If you are frustrated, rude and unclear with your request, you will make it very difficult for them to help you.

Obtaining Free Credit Reports

There are advertisements that advertise a “FREE” credit report and then charge you for various services. If you have to provide your credit card number to obtain your credit report, it is probably not going to end up being free. My understanding is that the only place where you can actually get a free credit report is through AnnualCreditReport.com. The site is supported by the three credit reporting bureaus: Experian, Equifax and TransUnion. You are entitled to get one free credit report from each of the three credit reporting bureaus each year.

You can request a report by phone by calling 1-877-322-8228 and going through a simple verification process over the phone. Or, you can request that it be mailed to you by completing a request form that you can download from the website and then mailing it to:

Annual Credit Report Request Service
P.O. Box 105281
Atlanta, GA 30348-5281

Or, you can do what I recently did and download your report online. Without providing a credit card number, I got my 19-page Experian report within a few minutes.

A Mixed Plate of Talk Story

On Friday 8/21/09 Hawaii celebrated 50 years of statehood to far less hullabaloo than I would have expected. Rather than a grand parade, bonfires or block parties, the state had a group of speakers talk to an all-day crowd of some 2,100 attendees at the Convention Center about the future of tourism, education, the economy, energy, the native Hawaiian community and preservation of Hawaii’s natural resources. The conference ended with a 1950s-style concert by the Platters, the Coasters and the Drifters. Various protesters, mostly native Hawaiian splinter groups, did their usual thing at various city locations including cutting out a 50th star on the flag and burning it. The Native Hawaiians have been unable to present a united front, as there are too many small, splinter groups that cannot agree on major issues.

Hawaii made national news in August as Hurricane Felicia, a category 4 hurricane and the strongest storm seen in the Eastern Pacific for several years was directly headed our way. The Air Force Reserve’s “hurricane hunter” flew into the state along with a 10-person team from the Federal Emergency Management Agency. With several days of advance notice, civil defense officials mobilized to clear streams and drainage areas and to activate an emergency operations center. Hurricane Felicia fizzled out as it got close to Hawaii, which was fortunate as it passed directly overhead several islands as a tropical depression bringing some heavy showers but no major damage. It provided a good drill in what is expected to be a busier than average year for tropical storms, as this is an El Nino year. Local stores did a brisk pre-hurricane business as residents stocked up on bottled water, flashlights, toilet paper, etc.

KGMB9 (CBS), KHNL (NBC) and K5 (UH Sporting Events) will merge their newsrooms, eliminating about one-third of their staffs while simulcasting news programs and continuing as separate channels for non  news programming. This move was announced in mid-August and is being taken to cut costs and ensure the stations survive the current economic decline. TV ad revenue is down $20 million or 30% in the last three years. Prior to the consolidation, there were 198 employees at the three stations; it is estimated that 68 jobs will be lost.

The SAT scores of college-bound Hawaii students this year were relatively unchanged from last year and still lag the national averages according to College Board information released in late August. The College Board, which administers the test, cautions against making comparisons between schools, as students don’t have to take the test and demographics and other non-school factors such as access to expensive test preparation courses can have a strong affect on scores. Having provided that caveat, the following 2009 test scores reflect: Hawaii private school students/Hawaii public school students/nationwide averages: Math (574/474/515); Reading (537/454/501); Writing (535/441/493) . . . About 51% of Hawaii’s 2008 public high school students continued on to college according to a study that appeared in the August 28th issue of The Honolulu Advertiser. Kalani High School sent the most students at 79% while Waianae High School sent the fewest at 30%.

Father Damien DeVeuster will be declared a saint in Rome on October 11th. As we near that date, there have been various parades, festivities and activities throughout Hawaii. Perhaps, the best feel-good story occurred in July. A small group of organizers planned a relatively low-key dinner at the Sheraton Waikiki Hotel to help raise funds to send 11 of the 19 residents of Kalaupapa to Rome for the canonization. They expected about 200-300 people to attend the fundraiser and were completely overwhelmed when over 1,000 people requested tickets. Father Damien dedicated his life to victims of leprosy ostracized on Molokai. His life inspired paintings, poetry, plays, songs and sculpture including the famous bronze one fronting the state Capitol as well as one in the U.S. Capitol in Washington, D.C. At least five English-language movie/TV productions as well as a one-man stage show starring Terrence Knapp honor the years he spent at Kalaupapa.

In late August, U.S. Media Group released its first annual listing of “America’s Best Places to Find a Job,” an expansion of its “Best Places” series. The editors assessed factors such as unemployment rates, job growth and career opportunities in a broad spectrum of industries in 2,000 cities. The 10 best cities, listed alphabetically were: Anchorage; Arlington, VA; Columbus, OH; Honolulu; Houston; Oklahoma City; Salt Lake City; Shreveport, LA; Tallahassee, FL; and Wichita, KS. The report noted that the most in-demand jobs in Honolulu over the next ten years are expected to be in retail, higher education and nursing.

One of the top tourist attractions on Oahu is the USS Missouri or “Mighty Mo.” 12% of all visitors to Oahu visit the “Mighty Mo.” In October, for the first time in 11 years, the ship will be released from its moorings at Ford Island and placed in drydock for three months at the Pearl Harbor Naval Shipyard for $18 million of repairs and upgrades. The bulk of the funds will be spent grinding off the Missouri’s old paint from top to bottom and putting on fresh coats.  The Department of Defense is providing a $10 million grant with the balance paid by the non-profit USS Missouri Memorial Association via funds raised through admission fees and fundraisers. In the summer of 1952, I spent a couple of months on the “Mighty Mo” during my “Youngster” or “third-class” midshipman cruise along with other midshipmen from the Naval Academy and NROTC programs. We rotated through various ship divisions; for about two weeks, I was assigned to the first deck division where one of our jobs was to polish the WWII surrender plaque.

Mauna Kea has been chosen over a site in Chile as the location for the world’s most powerful telescope. Mauna Kea is blessed with superb atmospheric conditions for astronomy . . . good access to a high mountain, low average temperature and very low humidity. The Thirty Meter Telescope or TMT Project will be the largest optical telescope ever built, reaching further in space and seeing more clearly than any existing telescope. The telescope will be more powerful than the Hubble Space Telescope, capable of producing images 12 times sharper by using sophisticated adaptive optics systems. The TMT is expected to be able to see 13 billion light years away, a distance so great and so far back in time that researchers predict they’ll be able to watch stars and galaxies in the universe forming. Housed inside a 180-foot-tall dome, the primary mirror will have nine times the collecting area of the 10-meter Keck telescopes, now the world’s largest optical/infrared telescope. The telescope will be the 14th to be built on Mauna Kea, further enhancing its reputation as the premier spot on the planet for astronomy.

Three major steps in life are getting married, having a child and buying a home. In Hawaii, the getting married step often lags the other two. However, having said that, it is noteworthy that the divorce rate in Hawaii is lower than all but three states according to recently released Census data. 9.1 percent of isle residents are divorced placing HI in a tie with MA and behind ND (8.1), NJ (8.2) and NY (8.4). At the other end of the spectrum are NV (14.2), ME (13.6) and OK (12.9) . . . Hawaii motorists are buckling up at a record breaking level. During the “Click It Or Ticket” statewide campaign held earlier this year, seat belt use increased to 97.9%, the highest level any state has ever achieved according to state transportation officials . . . A Navy Captain will be the first commander of the joint base formed by the merger of Naval Station Pearl Harbor and Hickam Air Force Base to be known as Joint Base Pearl Harbor-Hickam.

University of Hawaii enrollment is up almost 9% from last year to an all-time high of over 58,000 students. Our economic problems have resulted in many students staying home vice going to Mainland schools. Plus, the lack of jobs has encouraged many students to continue their education . . . The last of the discount movie theatres on Oahu has closed as Hollywood Theatres at Restaurant Row has shut down to be replaced by an outpatient surgical center . . . One in eleven people in Hawaii are getting food stamps.

Happy you live Hawaii, despite shortcomings

An editorial in the 8/16/09 Honolulu Star Bulletin (slightly edited):

Regarded in some circles as “tax hell,” bad for business, housing priced out of affordability and jarred by a hurricane every decade or so, people who live in Hawaii know better. Part of the unflattering reputation may be deserved, but Hawaii residents are the happiest in the country according to an index based on interviews conducted in the first six month of this year by Gallup-Healthways Well-Being.

The index measures what the World Health Organization defines as health – “not only the absence of infirmity and disease but also a state of physical, mental and social well-being,” according to the pollsters. It tries to “measure what it is that people believe constitutes a good life such as who is feeling good about life and who is in need of a helping hand.” People living in the Plains and the West generally reported feeling better about life. This year, Hawaii replaced Utah as the happiest place to live.

Among the six categories of wellness, Hawaii was judged No. 1 in emotional health, a factoring of smiling or laughter, learning or doing something interesting, being treated with respect, enjoyment, happiness, anger, stress and depression. The islands, though, slipped from last year’s top spot in the category of life evaluation – self-evaluation of one’s present life situation and anticipated life situation five years from now.

In other categories, Hawaii was in the top 10 in physical health, based on sick leave and other health-related experiences; healthy behavior such as eating healthy, consuming fruits and vegetables, exercising and not smoking; and “basic access” to such things as clean water, affordable and healthy food, a comfortable place to live, health insurance and dental care.

That is not to say that everything is perfect or even close to it in Hawaii, which scored high not because of Joe’s and Jane’s work climate but in spite of it. When it comes to overall feelings about job satisfaction, abilities to use one’s strengths at work, a supervisor’s treatment – like of boss or partner – and “an open and trusting work environment,” Hawaii is close to the bottom.

When chief executive officers from across the country responded to a poll taken earlier this year, they ranked Hawaii last in the quality of its work force. The Hawaii work force’s opinion of its bosses, placed 50th in last year’s Gallup-Healthways poll, was replaced at the very bottom this year by Delaware.

“What we have here is a failure to communicate,” as Cool Hand Luke’s captain observed. Or is that Rodney King begging, “Can we all get along?”

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