July – September 2010 Quarterly Newsletter

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Virtually all mortgages are held in the name of MERS, which stands for Mortgage Electronic Registration System. The MERS system was set up by banks to enable mortgages to be bundled into securities and sold without having to pay a recording fee on each sale. It’s not unusual for the original mortgage to be sold before the borrower makes their first monthly payment with some mortgages going through several sales. If the mortgage subsequently goes into default, MERS serves the foreclosure on behalf of the bank and that seems to be creating problems. Some foreclosures were apparently filed without a proper review by the lender. According to the 9/8/10 Wall Street Journal, nine branches of the government are involved in talks about these problems. As a result, lenders in some states, including Hawaii, have pulled their REO’s to review their foreclosure process. We don’t know when the REO’s will be able to be actively marketed again. We’ve heard everything from 30 days to several months.

Oahu Housing Prices appear pretty certain to rebound from a two-year slump this year. With three months to go, it seems likely that year 2010 will show an overall improvement and end the price declines of 3% in 2008 and 8% in 2009. The University of Hawaii Research Organization recently forecast that Oahu’s median home price would rise 4.4% this year and continue between 4% and 5% in each of the next two years. I do not agree with that optimism for two reasons: First, interest rates are at phenomenally low rates. When they increase, there will be a downward impact upon sales prices. And second, foreclosures on Oahu are increasing. After three months of subsiding levels of foreclosure filings, volume in August soared to a new high equating to one filing per 315 households. Compared to other states, Hawaii’s rate in August was the 10th highest, the worst position Hawaii has occupied since RealtyTrac began its reports in 2005. An increase in the number of foreclosures will also have a downward impact upon sales prices.

Odds and Ends

Leasehold Properties & 1031 Exchanges: As land leases on Oahu get progressively shorter, it impacts upon the value of the leasehold property for three reasons: First, most land leases on Oahu have a surrender clause. At the expiration of the lease, the improvements (buildings, etc.) revert back to the landowner. Second, the cost of buying the fee will continue to increase, as the lease gets progressively shorter. And third, financing becomes progressively more difficult to obtain, as well as more expensive, once a lease has less than 20 years remaining.

One of the most valuable tax-saving tools real estate investors have is the ability to conduct a 1031 exchange. The 1031 exchange allows the investor to defer both federal and state capital gains taxes, saving the investor thousands of dollars in taxes. However, if a property is owned in leasehold and the investor wants to exchange into a fee simple property, the leasehold property must have at least 30 years remaining on the lease to be eligible for a 1031 exchange.

If I owned a leasehold property and wanted to shift my equity into a fee simple property, I could either buy the fee (assuming the fee is available) or I could sell the leasehold property and conduct a 1031 exchange into a fee simple property. Assume I prefer to conduct an exchange and my lease expires January 1, 2041, my drop-dead date to close on a 1031 exchange and have at least 30 years remaining on the lease would be January 1, 2011. Any closing later than January 1, 2011 would be disallowed by the IRS for a 1031 exchange, as there would not be 30 years from closing to the expiration of the lease.

As the remaining period of the lease gets closer to 30 years, it will begin to impact negatively upon the sales price. Therefore, I would like to be able to market my leasehold property with a margin or cushion of 3-5 years for the buyer, sufficient time for them to be able to own the property for a few years and then be able to conduct their own exchange. Assuming I’m able to close January 1, 2011, I would need an expiration date of January 1, 2044 to January 1, 2046 to be able to provide the buyer a cushion of 3 to 5 years.

If you own leasehold property on Oahu that is approaching these thresholds and would like to discuss your options, contact us locally at 254-1515 or toll-free at 1-800-922-8911 or contact us via e-mail at team@stott.com.

Homebuyer Tax Credits: Nearly half of all Americans who claimed the first-time homebuyer tax credit on their 2009 tax returns will have to repay the government. According to a report from the Inspector General for Tax Administration, about 950,000 of the nearly 1.8 million Americans who claimed the tax credit on their 2009 tax returns will have to return the money. The confusion comes because the homebuyers were eligible for two different credits depending on when their home was purchased.

Those who bought properties during 2008 were able to deduct, dollar for dollar, up to 10% of the purchase price of their home or $7,500 whichever was less. The catch: The money was a no interest loan that had to be repaid within 15 years. Had they waited to buy until 2009, they could have gotten a much sweeter deal, as Congress extended the credit and made it a refund rather than a loan. Now, the IRS is developing a strategy for separating the taxpayers who are required to repay the credit from those who are not.

A review by the Inspector General earlier this year found that the IRS could not easily distinguish between home purchases made in 2008 and 2009. That heightened concerns that some claims could be erroneous or even fraudulent, that buyers could, for example, claim their purchase came later than it actually occurred. A recent report indicated that more than 4% of the 1.8 million homebuyers that received the credit had incorrect purchase dates recorded by the IRS.
Some of the inaccuracies actually counted against the taxpayers. Nearly 60,000 were listed as purchasing in 2008 (meaning they had to repay the credit) or had no purchase dates at all, rather than their corrected 2009 purchase dates, which would free them of the obligation to pay it back. However, the overwhelming majority were purchases in 2008 recorded as being in 2009.

The IRS is also taking a look at all those deceased taxpayers who received credits. The Inspector General reported that 1,326 single people listed as dead by the Social Security Administration claimed more than $10 million in credits. The IRS threw out 528 of those claims, saving $4 million.

And prison inmates have gotten involved as more than 1,200 prison inmates, including 241 of them serving life sentences, defrauded the government of over $9 million in tax credits reserved for first-time buyers. According to a Treasury Department report, 4,608 federal and state inmates filed for tax credits with fraudulent refunds doled out to 1,295 of them. The most egregious fraudsters were 715 lifetime prisoners, including 174 prison lifers who filed with the help of paid preparers. From this group, 241 lifers were awarded $1.7 million. The report also found that improper filers included 34 employees of the IRS.

Tripler Army Medical Center: The hospital (TAMC) came into being in 1907 on North King Street in Kalihi as the Fort Shafter Hospital. It replaced an earlier Army facility that had been built to handle casualties from the Spanish-American War in the Philippines. In 1920, the Fort Shafter Hospital was renamed in honor of Brigadier General Charles Stuart Tripler, who had been Medical Director of the Army of the Potomac during the Civil War.

Doctors and nurses rushed to Tripler on December 7th 1941 after that attack on Pearl Harbor. Their hard work saved all but 13 of the 344 battle casualties they treated. However, World War II casualties soon overwhelmed the 450-bed hospital at Fort Shafter. Temporary facilities were leased at Farrington High School, Kamehameha School for Girls, Kuakini Hospital, and the Kaneohe Territorial Hospital increasing the hospital’s beds to almost 2,000.

During World War II, 1,800 patients from all branches of the armed forces were cared for daily. The first casualties were victims from the attack on Pearl Harbor and other Oahu installations. Later, patients came by hospital ship and airplane from fighting in the battlegrounds of the Pacific. It became readily apparent that a new facility was needed and ground was broken in 1944 on Moanalua Ridge. In 1948, it was completed and ready to be occupied.

Rumors abound concerning Tripler: One is that it was built backwards. Story has it that while it was being built, the architect was called back to the Mainland because of a family illness. When he returned, he saw that they had reversed the plans and it was too late to fix it. In disgrace, the architect committed suicide. In actuality, Tripler was built as designed to take advantage of the winds that sweep down the mountain behind it to help keep the hospital cool.

Another persistent rumor is the pink color was a mistake and resulted from a large order of the wrong color paint. In actuality, the color “rose coral” vice pink was deliberately selected to mask Hawaii’s red dirt that was is blown on it by the trade winds. Another bizarre tale involves keeping the body of an Army Major who died in 1978 and was left in cold storage for over a year until a dispute was settled between two women who both claimed to be his wife.

During a typical day at Tripler, 157 hospital beds are occupied; 2,188 people visit clinics; 115 come for treatment in the emergency room; 30 surgeries are performed and 8 babies are born.

A Mixed Plate of Talk Story

Neil Abercrombie defeated Mufi Hannemann in the Democratic primary race for governor. The two men both gave up elected positions for a shot at Washington Place. Abercrombie resigned early from his urban Honolulu seat in Congress while Hannemann stepped away from his final two years as Honolulu Mayor. Hannemann had endorsements from a Who’s Who in Honolulu but still trailed throughout. Abercrombie crushed the former mayor in the primary taking all but 4 of the 51 districts. He will face GOP Lt. Gov. James “Duke” Aiona in the general election. Former Honolulu Prosecutor Peter Carlisle won a very close race against acting Mayor Kirk Caldwell, both Democrats, to finish the two years remaining on Mufi Hannemann’s mayoral role. In the Congressional race it will be GOP Charles Djou who won the winner-take-all special election for Abercrombie’s seat versus Democrat Colleen Hanabusa who essentially ran unopposed in the primary after Ed Case bowed out. In the special election, Djou finished with 39.4% of the votes while Hanabusa had 30.8% and Case 27.6%.

Four UH men’s sports (baseball, basketball, football, and volleyball) made money during the last fiscal year while only one women’s sport (volleyball) made money. Football was easily the top moneymaker in gross income; however, the Wahine volleyball team was the best per dollar moneymaker returning $2.02 in gross revenue for dollar spent. Football powerhouse Boise State is leaving the Western Athletic Conference (WAC) next year followed by Fresno State and Nevada a year later leaving only six schools: Hawaii, Idaho, Louisiana Tech, New Mexico State, San Jose State and Utah State in the WAC. Unfortunately, most of these schools create travel problems for UH while not providing any meaningful rivalries. Replacement schools being considered are Texas-San Antonio, Texas State, and Montana all of which would exacerbate the UH problems of travel expenses and establishing meaningful rivalries.

UH is seriously considering leaving the WAC and joining the Big West Conference for all sports except football. All the Big West Schools are located in California. None of them play football, however, they are very competitive in other sports such as volleyball. The lack of meaningful WAC competition does not prepare the Wahine for the level of competition they face in post-season play. As for football, UH is studying what would happen if they were to go independent. Possible opponents might be the service academies, perhaps a different one at home each year, BYU (meaningful rivalry) on a home and away basis, and Notre Dame also on a home and away basis. My guess is UH shifts to the Big West for all sports except football where they remain in the WAC for at least a few more years.

Following are the expenses underwritten by UH when Charleston Southern came to Hawaii. The South Carolina school used the trip as a recruiting tool, telling potential recruits in their area that they would spend several days in Hawaii taking in the sights. UH kept the proceeds from the game and covered the following Charleston expenses: Guarantee: $125,000; Airfare: $83,475; Hotel: $21,385; Buses: $8,870; Meals/Incidentals: $15,000; TOTAL: $253,730.

UH opened the football season with a home game against always-powerful USC. The final score was 49-36 but could have been much closer, as UH won the statistical battle 588 to 524 in total yardage and 31 to 25 in first downs. The second game was against Army at West Point. The score was tied at 28 apiece with Army positioning for a go-ahead score late in the fourth quarter when UH forced a fumble with 24 seconds remaining. They then drove 59 yards on two passes and a penalty and kicked a game-winning field goal. Next was a game at Colorado. UH was ahead 10-0 at halftime but lost 31-13 in a second half that is best forgotten. The fourth game against Division 1AA Charleston Southern was essentially a scrimmage. The score was 56-7 at halftime when UH cleared the benches with a final score of 66-7. UH then opened the WAC season with a 41-21 victory against Louisiana Tech at UH.

At the end of September with most colleges having played four games, the most prolific tacklers according to the NCAA are both linebackers from Hawaii: Notre Dame’s Manti Te’o who graduated from Punahou and Hawaii’s Corey Paredes who graduated from Castle. They average 13.50 and 13.25 tackles per game respectively. A study by the Tulsa World newspaper earlier this year rated Honolulu the most productive city in turning out major college football players @ 4.6 per 1,000 high school boys and Hawaii, the top state @ 3.8 per thousand.

The 11-, 12-, and 13-year olds in their sky-blue uniforms from Waipio almost pulled it all off by winning five straight elimination games in the Little League World Series at Williamsport, PA. They got off to a bad start losing the opener to Georgia 6 to 2. The following day, they won the first of five elimination games 3 to 1 over New Jersey. Next, they entered the fourth inning against Ohio hitless and down 4 to 0 when they scored 6 runs and won 6 to 4. Then they played Georgia again in the double elimination series and won 7 to 4. The following day they avenged their first game loss by winning the rubber game beating Georgia 12 to 5. After scoring four unlikely elimination wins, Waipio beat Texas 10 to 0 setting up a championship game pitting the U.S. Champion against the Foreign Champion (Japan). Waipio won the Little League Championship in 2008; however, this time they lost the Championship game 4 to 1 to Japan. Still plenty of good stuff for the kids . . . parades, team introduction at a UH football game, etc.

Hawaii ranks last in the nation in the percentage of core classes in high poverty secondary schools taught by highly qualified teachers. The “No Child Left” law requires that all teachers of core subjects be done by highly qualified teachers, a designation that means a teacher must have a bachelor’s degree, full state licensure, demonstrate subject matter competency and pass a teaching exam. More than half of Hawaii’s public school teachers leave within five years of being hired, when experienced teachers are needed by the state to meet federal requirements for “highly qualified” teachers and meet ambitious school reform goals. At the same time, the state is bracing for a wave of retiring baby boomer teachers and principals.

A project launched in January 2008 has resulted in the collection of more than $100 million in delinquent taxes owed to the state of Hawaii according to a report issued in late-Sept. Under a partnership with CGI Technologies and Solutions, Inc., the Hawaii Department of Taxation applied computerized tracking technology to identify companies and individuals that failed to file some or all of their required tax returns. One area being examined was the failure by some investors to pay General Excise Tax (GET) on gross rental income. Stott Property Management handles over 400-rental properties island-wide on Oahu. To our knowledge all of our clients conformed to the state GET requirements.

Hawaii consumers lead the nation in credit card debt carrying an average of $9,296 per person in the first half of 2010. That’s 17 percent higher than the national average of $7,917 according to Credit Karma, Inc, a California-based credit scoring website. With many Hawaii consumers losing their jobs or having their pay cut, the average Hawaii credit card holder took on an additional $2,263 in debt in the past year. The top five states for credit card debt were HI ($9,296), CO ($9,177), AR ($9,109), NJ ($8,916) and CT ($8,897). Not only did HI lead the nation in credit card debt, they were second in mortgage debt for the first half of 2010. The top five were CA ($334,120), HI ($314,721), MD ($241,136), NJ ($234,629) and WA ($228,925).

The decks of the battleship Missouri have long been losing a battle against the elements. About 52,000 square feet of teak decking from stem to stern needs to be replaced. Late last year and early this year, the “Mighty Mo” had a three-month dry-docking including a top-to-bottom $15.5 million paint job. During the summer of 1952, I spent about two months on the Missouri on my youngster cruise traveling from the Naval Academy to Europe where we visited England and Norway. One of the many things I did on that trip was to learn how to holystone the teak decking.

To Buy or Not to Buy; The Million $ Question

The American Dream has long been ownership of your own home. This dream continues even with all the foreclosures and bankruptcy problems that are taking place as this is being written in late-September. In fact, a marvelous window of opportunity now exists with attractive sales prices coupled with low interest rates. Eventually, though, home prices will stabilize and begin to rise again with mortgage rates likely to be considerably higher than they are today.

Nationwide, the average annual inflation rate over the past 30 years has been 4.35%; i.e., the cost of living has increased by about 4.35% a year over the past 30 years. Although the inflation rate has been less than 4.35% for the past several years, most economists believe that the inflation rate will have to increase over the next few years to assist the government in being able to pay its debts.

If you look at sales prices of homes on Oahu since statehood, prices have risen at about 3% to 4% a year or very close to the inflation rate. However, it has not been a gradual increase. The Oahu Market has experienced soaring appreciation for a couple of years once each decade of about 30% with the exception of the 1990’s when our local economy tanked. The 1960’s, 1970’s, 1980’s and most recently, the 2000’s all had periods of soaring appreciation. In between the periods of soaring appreciation, the Oahu housing market has usually been relatively flat.

The question for many families is: Should they continue renting with the prospects of ever-increasing monthly rental fees or jump into home ownership now while prices and mortgage rates are down? Whether you rent or buy, you can be sure that housing expenses will eat up a significant chunk of your paycheck each month. So, it’s wise to take a good look at your personal situation and decide if renting or buying is best for you. Many people make such a decision based upon a comparison of monthly payments. If their rent is less than the monthly payment on a home, they may decide that it is cheaper to rent than to buy. This approach fails to take into consideration a number of other factors that influence the cost of home ownership.

It is important for anyone considering buying a home to understand the tax savings involved in owning a home. The interest on a mortgage and property taxes are both deductible for both federal and state taxes. Typical savings in Hawaii are 25% to 35% of the mortgage payment (principal & interest) depending upon the type and amount of the mortgage, the interest rate and the buyer’s tax bracket. If the mortgage payment were $3,000 per month, the tax savings for most homebuyers would be in the range of $750 (25%) to $1,050 (35%). The savings can be obtained each month by adjusting your withholding allowances. This is accomplished by filing an amended W-4 form with your employer. This is perfectly legal; in fact, the second page of the W-4 form is a worksheet to assist the taxpayer in calculating the number of additional withholding allowances they should claim.

Three other compelling reasons to buy rather than to rent are: First, it enables you to lock-in a permanent monthly principal & interest payment at today’s rates. If you purchase using a 30-year fixed mortgage rate, your principal & interest payment 10 or 20 years from now will be the same as they are today. In contrast, rent payments are likely to be increased every year or two by the landlord so that they keep pace with inflation. Second, you don’t need to be concerned that a owner will decide to sell the home and as a result, force you to make an unwanted move. And third, it enables you to use a mortgage to increase the profit you will make on the home. Assume a $500,000 property is purchased with a $100,000 down payment and a $400,000 mortgage and the home increases in value by 10%, the owner makes $10,000 on their $100,000 down payment and $40,000 on their $400,000 mortgage.