April – June 2011 Quarterly Newsletter

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We have recently added over six hundred absentee owners to the distribution list for our quarterly newsletter. For those of you that are receiving your first newsletter . . . welcome aboard! We are a family real estate company that has been in business on Oahu for over 33 years. In addition to four family members . . . my wife, Mary Lou, and I, our daughter, Tracey Stott Kelley and our son-in-law, Tim Kelley, we have three assistants in sales and five assistants in property management.

In June, sales of both houses and condos declined with 602 total sales compared to 737 a year ago, a decline of over 18%. What is more meaningful though are year-to-date figures. The following data compares the first six months of 2011 to the first six months of 2010. Closed sales of houses 1,375 compared to 1,478, down 7.0%; Closed sales of condos 2,009 compared to 2,062, down 2.6%. Median (midway) sales price of houses $570,000 compared to $585,000, down 2.6%. Median sale price of condos $304,500 compared to $305.000, down 0.2%.

While the nation continues to struggle from the recession, Hawaii has reason to be optimistic about the recovery of tourism, the state’s economic engine. The Hawaii Tourism Authority forecasts the best year for visitors in four years. Arrivals reached highs in 2006 and 2007 when more than 7.6 million tourists visited Hawaii in each year. The visitor count plunged to 6.5 million in 2009 but rose to 7.1 million the following year and is now expected to rise to 7.3 million this year despite the earthquake and tsunami in Japan. Korea now has two airlines providing several flights a week between Seoul and Honolulu with a third airline to start flights in September. Of greater potential as a visitor source is China. The first direct flights will begin twice weekly between Honolulu and Shanghai in August. Top restaurants are having their menus printed in Chinese.

Property Management Guidance

Background: Stott Real Estate, Inc. conducts business as The Stott Team for listings & sales of real estate and as Stott Property Management for managing rentals. We have two adjacent but separate offices for these two divisions. Our marketing area is the island of Oahu; we refer business on the neighboring islands to agents who live and work on the island where the property is located. My son-in-law, Tim Kelley, supervises our Property Management (PM) Division. His primary assistant, Karen Texeira, has been with us for over 18 years. We manage over 400 rental units, making us one of the largest PM companies on Oahu. Most of our clients are absentee owners; however, we also handle rentals for several owners that live on Oahu. Tim has personal experience as an absentee owner, as he and my daughter, Tracey, use PM’s to manage several investment properties they own on the Mainland.

There are many superb PM’s on Oahu; any negative comments made by me towards PM’s in this article are not indicative of Oahu PM’s as a group. Having said that, many of our accounts were listed with another Oahu PM and then shifted to us. This article will discuss some common errors made by PM’s and/or owners. The article is designed to help owners increase their net rental income by learning from mistakes made by others that have cost them tens of thousands of dollars.

1. Absentee Owner Acting as a PM: Hawaii law requires that an absentee owner have a representative living on the island where their rental property is located. It does not need to be a licensed real estate agent; i.e., it can be a friend of the absentee owner provided the friend does not represent more than one owner. Some absentee owners, knowingly or unknowingly, violate this law and manage their rental property themselves. This can create problems if a dispute arises that ends up in small claims court and the absentee owner cannot document that they have an on-island representative; i.e., the absentee owner is found to be violating the law.

The purpose of the on-island representative is to have someone immediately available to the tenant in case problems arise. Therefore, the on-island representative should be more than a mere figurehead. The tenant should be advised to contact the representative for problems and emergencies. We recommend that the representative’s name and telephone number be written on the rental agreement with any future changes also being in writing and dated.

Oahu General Excise Tax (GET) @ 4.5% is owed on all gross rental income. An owner acting as a PM should obtain a GET license for payment of this tax. The owner’s GET number is required on some sales forms used when an absentee owner sells a rental property. Plus, Hawaii may be actively searching for owners that are currently violating the law. A few years ago, I was erroneously billed for several years of GET on a property I own in Gulfport, MS. The bill would have been sizable: several years of back GET plus a penalty of 50% of the non-paid GET plus interest at 8%.

The attorney we use for evictions states that the majority of his most difficult and expensive cases involve owners acting as a PM that are not familiar with the Landlord-Tenant Code and proper tenant check-in/check-out procedures.

2. The Economy & Evictions: Job layoffs, cutbacks, forced furloughs, etc. are having a major impact upon the rental market. Tenants with financial problems are often individuals who had good credit during tenant screening with a secure job like working for the city or state. However, with forced furloughs and job cutbacks, they find that they no longer can afford their rental payments. In most cases, they advise us that they are vacating and agree to forfeit their rental deposit. However, in some cases the tenants merely stop making payments.

Evictions are an unfortunate but necessary part of the business. With 400-plus rentals in our current economy, we would expect to average one to two evictions in process at any given time. Some PM’s and/or owners avoid evictions like the plague. When we take over a delinquent account, it is not unusual for the tenant to be at least three months delinquent without an eviction having been initiated. There are an endless number of excuses delinquent tenants can create for failing to pay their rent. They always seem to need just one more month to work everything out. Then one day, you discover that they have flown the coop with no forwarding address and left the property in poor condition. Barring unusual circumstances, tenants that get behind on their rent by more than a month are usually unable to catch up.

An eviction action is initiated in Hawaii by sending the tenant a five-day demand letter. This letter states that the tenant has five business days from receipt of the letter to pay all overdue funds or their lease will be terminated. The five-day demand letter usually forces the tenant to negotiate with us in a meaningful manner. However, the owner must be prepared at this stage to spend money on an eviction attorney if the tenant doesn’t pay their overdue rent or agree to negotiate. A voluntary vacancy is usually far less costly to the owner than an actual eviction, particularly if the property is left in good condition. The eviction process usually costs $1-2 thousand dollars. We have used the same eviction attorney for years; his cost for our clients runs about $750. If the rent has not been paid by the end of the month and the tenant has not responded and/or provided us a satisfactory repayment plan, we normally start the eviction process by mailing them a five-day demand letter.

3. Changing Market: As this is being written in June 2011, the rental market is improving. On a selective basis, we are now increasing rents. The last time I wrote this section, the rental market had gotten soft and this section discussed actions to prevent prime-rent tenants from vacating. If you would like a Rental Market Analysis or Property Management Information, check the applicable box on the postcard and return it. We encourage all owners to conduct their own independent research as to what constitutes a fair rental rate. Two good sources of information are Craigslist Oahu (http://honolulu.craigslist.org/oah/) and classified ads in the Sunday edition of the Star-Advertiser (http://staradvertiser.com).

4. Communication: The most common problem that arises between Owners and their PM’s is poor communication. In almost every case where we obtain an account from another PM, there has been a period of poor communication between the owner and their PM. Larger companies, like ours, have in-office staff personnel and toll-free telephone numbers to assist absentee owners in addressing issues. Smaller companies usually have to rely on telephone messages. You should discuss communication with your PM including how soon you can expect them to get back to you if you have left a message for them to call. The PM should also provide you a list of applicable personnel for you to contact if the PM is unavailable.

5. Long Leases: Tenant leases should normally be written for a maximum period of one year thereby enabling rents to be increased annually if warranted. A one-year lease also enables the owner/PM to have far more control over a problem tenant. Merely threatening that the lease will not be renewed often works wonders. Lengthy leases can create problems in a rising housing market, as some owners may want to try to sell at the height of the housing market. A lease has priority over a sale i.e., the tenant can stay in the property until the end of their lease even though the owner sells the property.

6. Internal Inspections: Periodic internal inspections of a property are essential to ensure there are no major problems and the tenant is taking care of the property. We’ve taken over properties that were in horrible condition requiring major work by the owner as neither the Owner nor the PM had inspected the inside of the property for a number of years. Our policy is to conduct an internal inspection of every property we manage at least once a year by a member of our staff with photos available to the owner.

7. Inventory & Condition Report: An Inventory & Condition Report establishes the move-in condition of the property. It is approved by the tenant and establishes the basis for damages should the property not be maintained properly. Without this form, Hawaii law states that the condition of the property when the tenant vacates is the same as what existed when the tenant checked into the property.

One of the most common problems we encounter with absentee owners that have been acting as their own PM is their failure to have proper tenant check-ins. Sometimes, their property has been re-rented several times with each new tenant taking the home without any paperwork establishing the actual move-in condition. If you are an owner/manager, you might want to consider having someone video your property to establish current condition. We routinely video properties on our tenant check-ins, and we have found tenants tend to take far better care of a property when they know video exists of the move-in condition.

8. Unsupervised Repairs: Absentee owners acting as a PM sometimes will authorize work to be done by their tenant who is then compensated by a reduced rent. Such agreements sound marvelous in the discussion stage. However, the discussion is usually verbal without a clear definition of the exact scope of the work to be done as well as without any direct supervision. It is not unusual for disputes to arise over the quality and/or amount of work done by the tenant. The tenant, believing they are not being compensated fairly, may then stop paying rent and/or initiate an action against the owner in small claims court creating a problem for an absentee owner that is violating the law. We suggest that you not authorize unsupervised repairs or improvements by your tenant unless they are very minor like fixing a leaking toilet.

9. Good Tenants: Sometimes, owners will deliberately provide their tenant an under-market rent because they are such “good” tenants. Tenants should not be provided a large discounted rent merely because they pay their rent on time and take reasonable care of the property. That is what an owner has a right to expect. Granted, a particularly good tenant that has a “green thumb” or makes minor repairs and/or improvements may warrant a small rent reduction but not hundreds of dollars per month. We’ve taken over properties where a tenant had been paying the same rent for over ten years merely because they were considered to be a “good” tenant that the owner didn’t want to risk losing.

10. Befriending Tenants: Some owners make it a point to become personal friends with their tenant. They then tend to stop treating the rental as a business and end up losing money.

11. Kid Gloves Syndrome: Some owners treat a tenant with kid gloves because they believe the tenant might be a future buyer for the property. Perhaps, the tenant has said something like, “if you ever consider selling, please let me know.” Less than 1% of the sales on Oahu involve tenants buying properties they are renting. However, some tenants are aware if they act like potential buyers for the property, they may be able to forestall any rent increases.

12. Pets: Allowing pets will increase the number of prospective tenants and often enables an owner to get a higher rent while retaining flooring that otherwise might need to be replaced. If your flooring is not in good condition, consider allowing pets. Tenants with pets will almost always agree to pay a higher rent and/or elect to retain older carpeting (in lieu of having it replaced) if the owner will allow pets.

13. “For Rent” & “For Sale” Simultaneously: We have had considerable success listing homes “for sale” and “for rent” at the same time. Usually the owner prefers one to the other but only if they can achieve a specific price; e.g., they’ll continue to rent the property if they can get $2,500/mo rent otherwise they want to sell it. Or, they want to sell it if they can get $750,000 otherwise they want to continue to rent it. So, we try both simultaneously and take the first that is acceptable. If the owner is realistic concerning both the rent and the sales price, our experience is that it tends to be a toss-up as to which comes first.

Taxing Retirement Income

Many readers of this newsletter plan on retiring in Hawaii. A subject near and dear to most current and future retirees is the plan by Governor Neil Abercrombie (D) to tax retirement income (pension plans) to help close a projected two-year $1.3 billion budget deficit. Despite a Democratic 43-8 majority in the state House and a 24-1 majority in the state Senate, the Governor was unable to get his way with this tax proposal. Following is an editorial by Richard Borreca (slightly edited) that appeared in the Sunday 6/12 Star-Advertiser.

Taxing pensions is proving to be too hot a topic for Democrats in the Legislature. Both House Speaker Calvin Say and Senate President Shan Tsutsui are saying Gov. Neil Abercrombie’s plan to sweep pension income into state income tax laws is a non-starter next year. Abercrombie this year first proposed a tax that included all pension money from retirees earning more than $37,500 a year in adjusted gross income, then he and the Legislature raised the threshold, but the bill was blocked in the Senate. After the session, Abercrombie said he planned to continue the fight next year, saying that it was only fair.

Abercrombie reasons that if all taxpayers have to pay income tax on money earned in other retirement vehicles, then why not also tax pension money? That reasoning struck a nerve with active and mobilized senior citizens who flooded the state AARP office, prompting its local state director, Barbara Kim Stanton, to lead a fight to kill the Abercrombie tax plan. If Abercrombie is still smarting from his legislative thrashing at the hands of AARP he now threatens to “roll over” the politically powerful organization. Abercrombie, the liberal firebrand who represented Hawaii for 20 years in Congress, said “AARP is essentially a front for insurance companies,” a description he did not include when he welcomed AARP support to help pass President Barack Obama’s health care reform package two years ago.

Legislative leaders, however, are bowing out of the Abercrombie passion play. “It is not going to fly. We came out with our best shot and the Senate wouldn’t vote for it,” said Say, who is shaping up as Abercrombie’s most powerful legislative ally. Even Say notes that Abercrombie will have to come back with a more thoughtful plan next year. “If the governor does come back with the pension tax, it has to be well planned and strategically communicated both properly and wisely. And, he will have to do a full-court press,” Say warned. The Senate, which rejected both Abercrombie’s pension tax plan and calls to raise the general excise tax, appears firmly against any pension raids. “There were concerns over the threshold for the pension tax, and, quite frankly, I don’t think we will even take it up unless the state review drops,” Tsutsui said. “The pension tax proposal wasn’t well received; philosophically, the Senate isn’t in line with taxing pensions.”

So if not from seniors, where is the state going to get more money next year? Say figures that APEC and other planned conventions will contribute to a rosy second quarter for the new fiscal year, but he still thinks Hawaii tax law is in need of a serious, thoughtful review. He hopes the Legislature will put up the money for an outside group with no ties to the state to study our taxes and suggest ways to make them more equitable. “We should look at property taxes and the counties and all the tax exemptions — what is the total impact,” Say advises. Tsutsui says there should be a concerted effort to study Hawaii tax law with a focus on ways to “export” more of the tax burden to visitors, but not hurt the tourist industry. “While such an exported and tourist-industry painless tax may not exist,” Tsutsui says, “it also may be time to explore giving the counties the power to levy a sales tax. Failing that, the Legislature can just have Abercrombie come back down to wave his arms and yell at everybody.”

A Mixed Plate of Talk Story

The June 20th Wall Street Journal had a lengthy article on analyzing a housing market. It was interesting but not too applicable to an island in the middle of the Pacific. According to the article, there is a new punch line to the three most important things to consider when buying a home. Location, location and location have been replaced by jobs, jobs and jobs. The article states that the most important factor in determining whether a community has passed through the worse of the housing debacle is its current state of employment. The second most important factor is the state of the rental market. And, the third is the foreclosure rate. So, ideally you want a very low unemployment rate, expensive rentals and a very low foreclosure rate before making a decision to buy a home. Others would argue that a window of opportunity now exists in many housing markets where sales prices are low coupled with the current very low interest rates.

Hawaii dodged a bullet with only an estimated $30 million in property damage and no loss of life from the devastating Japan earthquake and tsunami. While our thoughts and prayers obviously go out to the victims in Japan, it is important to also turn our attention to the economic impact the disaster will have on Hawaii. Nearly one in five visitors to Hawaii normally come from Japan. The University of Hawaii Economic Research Organization (UHERO) estimates that visitor arrivals from Japan will fall by 10.8% this year before rebounding by 10.3% in 2012. Recent passenger counts from Japan have been running about 25% below year-ago levels.

Thinking of renting your home for a short period of time this summer? The 14-day rule may apply. If you rent your home for 14 days or less, that rental income is not taxable. The 14-day rule is well known in places like Augusta, GA where the Masters golf tournament is held each year. Some homeoowners in the area rent their homes out to golf fanatics for large sums of money and don’t have to report any of that rental income on their federal tax returns.

Many Oahu residents are concerned not only about the ballooning cost of the multibillion dollar rail project, but also how the 20-mile steel on steel elevated rail system through downtown Honolulu will impact upon the environment, view planes, ancient Hawaiian burial sites, historic buildings, property rights, traffic and noise levels. A federal lawsuit has been filed to stop the rail; those filing the lawsuit include former Democratic Governor Benjamin Cayetano and current GOP State Senator Sam Slom.

As is so often the case, the final decision may be determined by cost. The rail project estimates jumped from $2.7 billion in 2004 to $4.6 billion in 2006 to $5.3 billion in 2011 and is still climbing. While Honolulu Mayor, Peter Carlisle, maintains the rail is on track and recently held a $30,000 ceremonial groundbreaking and press conference to announce contracts that have been awarded, the promised $1.865 billion in federal funds has not materialized. In fact, the city has apparently received just $34 million from Congress. Getting more federal funds may be difficult.

The NFL Pro Bowl has been held at Aloha Stadium every year but one since 1980. Other cities have attempted to have the game shifted to their stadiums, which has been resisted by the Pro Bowl players; various polls have shown the players overwhelmingly are in favor of keeping the game in Hawaii. A study by the Hawaii Tourism Authority of the last Pro Bowl played in Hawaii showed that there were over 17,000 Pro Bowl visitors that stayed almost eleven days, spent over $28M and generated over $3M in state taxes. Therefore, it came as a surprise when Governor Neil Abercrombie (D) decried the $4M the state gives to the NFL with the following comment: “That kind of egregious self-indulgence has to stop. Four million dollars is a lot of money. That’s the kind of thing you have to look at.” As might be expected, Abercrombie’s comments generated huge hoopla.

Hawaii passed a bill in May (Act 48) that advocates say is one of the strongest foreclosure mediation laws in the nation. The new law applies to owner-occupants of residential properties where the owner-occupants have resided in the home for a minimum of 200 consecutive days. The law prohibits lenders from holding non-judicial foreclosure auctions until the borrowers have had an opportunity to participate in a dispute resolution program that will be overseen by a trained mediator. The dispute resolution program is slated to begin operating by October 1, 2011, so in effect, both new and existing foreclosure cases are on hold for several months. Participation is optional and is not expected to be too practical for homeowners who can’t pay a reasonably restructured mortgage.

Most large Mainland banks use non-judicial foreclosures that are done outside of court as contrasted to judicial foreclosures where the foreclosure is overseen by a judge. Hawaii’s new law allows a borrower to convert a non-judicial foreclosure to a judicial foreclosure overseen by a Circuit Court judge; however, this option is not available if the borrower chooses dispute resolution. Also, a deficiency judgment may exist with a judicial foreclosure that is prohibited by the new law with a non-judicial foreclosure. So, even though a judicial foreclosure is much more expensive and takes a much longer period of time, some lenders may opt to use a judicial foreclosure, particularly if they believe they will be able collect funds from the borrower.

“Hawaii Five-O” the Hawaii based crime show has been renewed by CBS for a second season. CBS plans to continue the show on Monday nights. When CBS aired first-run episodes of “Hawaii Five-O,” CBS won it’s hour 13 times. ABC’s “Off the Map” the only other network show to be shot in Hawaii this past year was cancelled. However, a new ABC show, “The River” which shot it’s pilot in Puerto Rico is moving to Hawaii. “The River” follows the story of a wildlife expert who goes missing deep in the Amazon while on a journey with his wife and son. His family, friends and crew set out on a mysterious journey to find him.

Hawaii has frequently been the source of large linemen in the NFL draft, often of Samoan descent. This year it was different as three skill players were selected: Alexander Green (FB) in the 3rd round to the Super Bowl Champion Green Bay Packers; Gregory Salas (WR) in the 4th round to the St. Louis Rams; and Kealoha Pilares (WR) in the 5th round to the Carolina Panthers . . . UH is discussing a home and home football series with Notre Dame . . . Lowe’s opened in Iwilei in April. So, now there are three hardware giants almost within spitting distance of each other . . . Lowe’s, Home Depot and City Mill. Other large stores in Iwilei are Dole Cannery and Costco . . . Canadians have overtaken the Japanese as the top international buyers of residential real estate in Hawaii largely as a result of sales on Maui. On Oahu, sales to Japanese buyers continue to lead all other countries. As for the next big international market, most point to China; however, last year there were only 11 sales to Chinese buyers in Hawaii.

The U.S. Army is planning a major overhaul of Wheeler Army Airfield’s 25th Infantry Division Combat Aviation Brigade facilities. The project involves the replacement or renovation of nearly every aviation facility on the base and will be done over a five-year period. The Combat Aviation Brigade consists of 2,400 troops, 92 helicopters and 280 land vehicles that are housed at aging facilities at Wheeler as well as neighboring Schofield Barracks . . . The Polynesian Cultural Center on Oahu’s North Shore is embarking on a $38 million redevelopment that includes building a restaurant and dining hall, adding facilities for various activities and shows and redesigning its retail complex. The Cultural Center had 692,000 visitors in 2010 with $358 million in revenue.

The Navy plans to shut down its special warfare submarine operations in Florida and California and consolidate the command at Pearl Harbor. The U.S. military presence is shifting towards the Pacific, requiring the Navy to adjust its force posture and basing to provide at least six carriers and 60% of the submarine fleet in the Pacific.

The following information appeared in the Wall Street Journal April 9-10, 2011:

Don’t underestimate the harm that even one missed mortgage can do to your credit score. The severe consequences underscore that you shouldn’t shrug off even an accidentally missed payment. Instead, you should pay it and call the lender right away, begging forgiveness before it mars your credit record.

Being 30 days late on a house payment—even if it is an accident—can knock 100 points off a pristine 780 credit score, moving you from qualifying for the very best interest rates to the edge of subprime territory. The actual numerical drop is less severe if your starting credit score is 720 or 680, but the impact is greater, since your new score is likely to sink to a level where new credit is hard to get and very expensive.

FICO scores range from a low of 300 to 850, with scores of about 750 or higher generally qualifying for the best loan terms. FICO says a foreclosure or short sale where the size of the unpaid balance is reported are equally devastating to a good or excellent credit score, reducing it by as much as 150 points, to the high 500s or low 600s.

Recovering your original score takes about seven years. That also is how long the information stays on your credit report, where insurers and potential employers can see it. Returning to a mediocre 680 score may take only three years. Here are some other lessons from the FICO data:

Credit scores are intended to measure the risk that you won’t repay a current or future debt. So your careful payments over many years translate into a higher starting score. However, your score takes a major hit when you are 30 days late on a payment, falling 70 to 100 points.

The best way to rebuild a damaged credit score, ironically, is to use credit. “Avoiding borrowing altogether means you’ve frozen your credit history in a negative state,” says Maxine Sweet, Vice President of Public Education for credit bureau Experian. “You will be better off using a credit card judiciously and paying it off promptly, adding good-behavior points to your record.”

A person with a 620 score would pay almost 12% interest on a four-year $25,000 car loan, compared with less than 5% for someone with a 780 score—a difference of almost $4,000 over the life of the loan. On a 30-year fixed-rate $250,000 mortgage, a person with a 620 score might qualify for a 6% rate, but probably wouldn’t be able to get mortgage insurance, which is required if your down payment less than 20%. A person with excellent credit might land a rate less than 5% and pay about $3,000 a year less.