April to June 2017 Quarterly Newsletter

Oahu’s median sales price for single family homes set a new record in June. The median price for single family homes rose to $795,000 (4.6% higher than June 2016) and the median price for condos fell slightly $400,000 (1.4% than June 2016). Demand remained strong and the supply continued to be limited. The growth in pending sales (properties that are under contract but have not yet sold) indicates that home sales this summer will remain strong putting further upward pressure on prices. There are currently 2.7 months of inventory for single family homes and 2.8 months of inventory for condos.

The University of Hawaii’s Economic Research Organization (UHERO) put out a new report in May forecasting, continued but weaker economic job growth over the next few years. Over the past three years, personal income grew by 2.7% each year. UHERO expects personal income growth of 1.6% this year and 1.3% next year. Oahu’s job market is considered at full employment with many restaurants and retailers placing help wanted signs at their storefront. New restaurants opening in Waikiki and other Oahu locations have had to scramble to find both kitchen and wait staff to serve customers. While future growth is limited, there are few signs that the job market will weaken any time soon.

Tourism has started off the year strong with growth of 2.3% more visitor arrivals than the same period in 2016. UHERO expects total visitor counts to end about 2% higher than last year. Future growth in tourism will be limited by available hotel and time-share capacity both on Oahu and the neighbor islands.

Construction appears to have peaked in 2016. Commercial activity is running about 2% lower than last year and some visiting contractors have left the islands after their projects have ended.

A Mixed Plate of Talk Story

The City and County of Honolulu passed a bill in April 7, 2017 that modified a city ordinance affecting residential units in condos on land zoned mixed use, hotel, or commercial. The Department of Budget and Fiscal Services mailed a letter in June to approximately 8,000 condominium units that may qualify for the residential classification. An owner of a condo being used for residential purposes (owner occupied or a rental leased for more than 30 days at a time) must file a petition form to dedicate the property for residential use by September 1, 2017. 45 buildings fall into this category according to an addendum included with the letter. If approved, the unit will be taxed at the lower residential rate. The dedication lasts for five years and is automatically renewed for another five year period unless the property is sold. The new owner will have to fill a new petition form. An existing Home Exemption will no longer automatically qualify the property for the Residential Classification. Failure to file the petition by September 1, 2017 will result in the property being taxed at the higher rate.

Roughly 50,000 people welcomed the return of the Hokule’a, a Hawaiian double-hulled canoe, that just completed a three-year, 46,000 nautical mile journey around the world to nineteen countries. The adventure was estimated to have cost about $12 million paid for by local and national sponsors of the voyage. Polynesian Voyaging Society President, Nainoa Thompson, led the crew and was overwhelmed by the welcome he and his crew received. Hokule’a’s first ocean voyage occurred in 1976 from Hawaii to Tahiti. In 1980, Thompson navigated the double-hulled canoe from Tahiti to Hawaii for the first time in 600 years. The Polynesian Voyaging Society now hopes to raise an additional $1 million so that the Hokule’a can sail to 30 ports across the state.

Hilo hosted the state of Hawaii’s annual Merrie Monarch Festival in April. The festival is a week-long event culminating in three days of hula competition. The festival started in 1963 to perpetuate and preserve the art of hula and the Hawaiian culture through education. The hula competition features two types of dance, kahiko and ‘auana. Hula Kahiko was developed by Polynesians who originally settled the Hawaiian islands and participants dance to chants and traditional Hawaiian instruments. Hula ‘Auana was developed in the 19th and 20th centuries and participants dance to song and musical instruments like the guitar and ukulele. You can learn more about the festival by visiting www.merriemonarch.com.

While Hawaii’s outer islands showed some success in reducing homelessness, Oahu is still struggling to find an answer. Oahu was the only island to show an increase in the homeless population despite years of well publicized efforts by nonprofits to provide services to those that are homeless and local government’s struggle to build shelters. A recent front-page article in the Honolulu Star Advertiser highlights efforts to address a 74% increase in the homeless population located in Wahiawa. Many nonprofits are trying to gain the trust of people who suffer from substance abuse and mental illness while others in the community have lost patience with people that they feel refuse to follow rules, accept responsibility for their actions, and make changes to behaviors that have lead to homelessness. The City and County of Honolulu’s special city cleanup crew recently swept homeless encampments along grassy medians along Nimitz Highway between the airport and Waikiki. Mayor Kirk Caldwell told the Honolulu Advertiser that the sight of blue tarps and tenants along one of Honolulu’s busiest corridors is a “shameful” impression for the 95,000 to 100,000 tourists every day on Oahu.

The Honolulu Authority for Rapid Transportation’s (HART) signature rail project is on the ropes as the State Legislature session closed in May without any new sources of revenue to pay for the project. The rail project is expected to now cost about $10 billion to complete, nearly double the original $5.26 billion price tag that Kirk Caldwell and then mayor, Mufi Hanneman, advertised to convince city and county of Honolulu voters to approve the project. The rail budget dominated this years state legislative session and appeared to cost the House Speaker, Joseph Souki, and Ways and Means Chairwoman, Jill Tokuda, their positions. House members voted to remove both Joseph Souki and Jill Tokuda from their positions during the last day of the session. Many state legislatures took the opportunity to rebuke mayor Kirk Caldwell once again for the financial situation that could likely impact both the state’s and city’s services in the future. The city council deferred a May vote on raising property taxes to help pay for the financially troubled project earlier in the month in the hopes that a special session would be called. The city council also approved a bond measure to borrow money in early June to continue funding for the project. HART’s Chief Financial Officer recently informed the City Council that the project would run out of money in January 2018 if the bonds were not approved. The Legislature recently informed the Federal Transportation in a letter that they would hold a five-day special session to discuss raising an additional $3 billion to close the funding gap. The current options on the table are extending the half percent rail surcharge to the General Excise Tax another ten years or raising the hotel room tax. No dates have been announced for the special session.

Hawaii hopes to replicate the water-quality improvement impact of places like Chesapeake Bay, the state Division of Aquatic Resources announced an expansion in its efforts to grow oysters in Pearl Harbor. The department has successfully grown several thousand oysters in Pearl Harbor’s West Loch. Pearl Harbor used to be home to lots of oysters. Each oyster filters about 30 gallons of water per day and is one of natures’ solutions to maintaining water quality.

Government workers and volunteers have been collecting debris that washes up and drifts into the reefs of the Papahanaumokuakea Marine National Monument over the past six years. The charter vessel, Kahana, recently picked up 12 shipping containers filled with derelict fishing gear, old nets, faded plastics, and other junk from Midway Atoll and other nearby reefs in the monument. The Northwestern islands and reefs are vulnerable to floating debris because they are located near the convergence of a series of Pacific currents that move counter-clockwise and carry rubbish from across the Pacific Ocean. During El Nino years, the currents move south and debris gets caught up on the reefs or washes ashore on the islands.   Hawaiian green sea turtles and Hawaiian monk seals can become lethally entangled in nets or starve after ingesting debris. The state of Hawaii paid about $225,000 for the vessel to pick up the containers and deliver them to Honolulu where the rubbish will be processed and burned in Honolulu’s H-POWER plant and converted into electricity. Government staff members and volunteers have removed an estimated 1.9 million pounds of debris from the Papahanaumokuakea monument over a 20 year time span.

Garrett and Melanie Marrero, Maui Brewing Company’s husband and wife owners, received the 2017 National Small Business Person(s) of the Year award from Linda McMahon of the U.S. Small Business Administration (SBA). Maui Brewing Co. started in 2005 as a small seven-barrel brewpub with the help of a loan from SBA. By 2013, Maui Brewery Co. was producing 19,000 barrels of beer per year. The company has grown to be the largest craft beer producer in Hawaii and has recently expanded to Oahu with a Waikiki restaurant and will open a new restaurant in Kailua early next year. Maui Brewery Co. plans on employing a workforce of 700 people by 2018.

Tracey was recognized along with 11 other Hawaii agents as the only agents who have been among the top 100 real estate agents in sales in the state for 11 years in a row. Congratulations to Tracey who has consistently worked extremely hard to help her clients reach their real estate goals.

Odds & Ends

VA Home Loans: A series of television commercials by NewDay USA got us thinking about aggressive marketing campaigns pitching VA Home Loans to active duty military and veterans. Tim is well aware of the temptation to use the military’s generous cost of living allowance to buy a home as a prior officer in the U.S. Navy stationed at Pearl Harbor. Tim and Tracey actually used a VA loan to purchase a house in Texas back in the late 1990’s. The loan allowed us to buy a house with no money down so that we could leave our modest mutual fund investments untouched. The purpose of this article is to point out the potential pitfalls that seem to get glossed over by some lenders specializing in VA loans.

The main benefit of the VA guarantee actually protects a private lender from loss, not the borrower, if a distressed VA mortgage is foreclosed upon. A qualified borrower can purchase a home with no money down using a VA mortgage or refinance an existing mortgage and have the option to take “cash out of your existing equity.” The commercials make it sound like the lenders are going out of their way to provide an earned reward for serving in the military. All the lenders are really offering is a mortgage for a lower down payment than conventional lenders would otherwise offer. In other words, the lenders are offering a military service member or veteran a bigger loan. While the program can help those without a down payment get into a home, it can also turn around and become a major financial burden when it comes time to move.

We have witnessed the financial strain of several military clients who hired Stott Property Management to rent their Hawaii homes purchased using a VA loan. Once they left the islands, these clients lost the generous cost of living adjustment that helped make the monthly mortgage payments and the rent received did not come close to paying all the expenses associated with owning a rental property. Several clients paid $7,000 to $10,000 out of their pocket each year to hold onto a property providing negative cash flow for up to ten years. When the service members or veterans finally sold, their gains did not come close to covering their passive losses over the years and they also paid federal taxes for depreciation recapture.

Tim and Tracey recommend reading Dave Ramsey’s, “Total Money Makeover,” before buying a home with a VA loan or refinancing an existing loan with a VA loan and taking cash out. The book is an easy read and both of Tim and Tracey’s college age children read it over their Christmas break. The book does an excellent job of highlighting the pitfalls of taking on too much debt and describes methods that help individuals take charge of their personal finances in a positive manner. The book also helps take the gloss off the sophisticated ad campaigns run by banks and lenders.

The following advice applies to all buyers who are thinking about buying a Hawaii home, not just those in the military.

  • Consider how long you will be living in Hawaii. It took the housing market seven years to recover from that last downturn. You are gambling with a very expensive asset if you buy a home and plan on moving in a shorter time period.
  • Analyze your exit strategy before committing to a home purchase. Find out the market rent for a property that you plan on purchasing and the costs of maintaining a rental property if you end up moving during a down market. If the numbers don’t work for you, then consider renting until you are financially ready.
  • If possible, buy a property at a fraction of the monthly payment that you can afford. This can help you weather the financial storm if you suffer a temporary setback in earnings or expenses. Lower your mortgage balance by paying off additional principal when possible.

Don’t let the dream of owning a piece of paradise turn into a nightmare. Do some financial due diligence ahead of time before using your “right to apply for a VA loan.”

Hawaii Tax Filings: We find a surprising number of people that own rental property are unaware of the state’s tax filing requirements. You are required to file for and pay the following taxes even if you are not a resident of Hawaii.

  • General Excise Tax (GET)
  • Transient Accomodations Tax (TAT) if applicable
  • State Income Tax

All landlords must pay GET on the rental income collected. The required frequency of filing and payment depends on the total annual GET payments as specified on the form. A rental property owner files Form G-45 monthly, quarterly, or semiannually throughout the year and File Form G-49 at the end of the year to summarize your rental income for the entire year.

Landlords that rent to transient people for a period of less than 180 days must pay the TAT. A transient person has a permanent home elsewhere and does not intend to make the rental in question his or her permanent place of residence. A transient person can be a Hawaii resident. The rental property owner files Form TA-1 monthly, quarterly, or semiannually throughout the year and files Form TA-2 annually to summarize your rental income for the entire year.

All rental property owners, Hawaii residents and non-residents, must report their net rental income or loss and file state income taxes accordingly. Hawaii residents file form N-11 and report their net rental income or loss as part of their adjusted gross income. Hawaii non-residents must file form N-15 to report their net income or loss for state income tax purposes.

More information about the state’s tax reporting requirements can be found in “An Introduction to Renting Residential Real Property.” The web address to the pdf file is provided below.

http://files.hawaii.gov/tax/legal/brochures/renting_residential.pdf

2017 Legislative Changes: The state legislature passed a few bills that impact Hawaii taxpayers, residential rental property owners, and property owners with cesspools.

Income tax rates have been raised on individuals earning more than $150,000, heads of households making more than $225,000, and married couples making more than $300,000. The additional income will fund initiatives to provide tax credits to lower income households.

Late fees on all new rental agreements and renewals effective November 1, 2017 are capped at 8%. The Hawaii Association of Realtors will be amending the rental agreement to reflect the change in the law by the November deadline.

All owners must upgrade, convert their cesspools to septic systems, or connect to sewer no later than 2050. Property owners may apply for an exemption with the Department of Health if upgrading or connecting to sewer is not feasible due to lot characteristics.

Property Management Guidance

Background: Stott Real Estate, Inc. conducts business as Stott Property Management for managing residential rental property. The two divisions have separate staffs and share the same office. Tim Kelley is the Principal Broker of Stott Real Estate, Inc. and runs Stott Property Management. Karen Texeira is the senior member of the staff and has been with the company for over 20 years. Stott Property Management currently manages approximately 415 rental units on the island of Oahu.

There are many superb Property Managers (PMs) on Oahu. Any negative comments made in this article are not directed at PMs as a group. That being said, many of our clients had previously used another PM before hiring us. The article discusses common errors made by Owners and/or their PMs. The article is designed to help Owners increase their rental income by learning from the mistakes of others.

Absentee Owner Managing Property: By far the biggest mistake that we witness on a regular basis is an Owner trying to manage a rental property while living thousands of miles away. The Owner does not typically have a good understanding of the Landlord-Tenant Code (Hawaii’s laws governing residential real estate), must rely solely on the tenant to maintain the property, and does not have the time and resources to address problem tenants. The attorney that we use for evictions states that most of the difficult and expensive legal problems that he is hired to help solve involve Owners acting as a PM that are not familiar with the Landlord-Tenant Code and property check-in/check-out procedures. Tim Kelley and Tracey Stott Kelley do not even attempt to manage their mainland rental properties despite their years of experience. They have two PMs managing their investment real estate portfolio.

Additionally, The State of Hawaii requires an absentee owner to obtain an on-island representative to manage the property. We have witnessed a number of knowledgeable tenants create expensive headaches for Owners that have tried to manage a property themselves.

Poor or Inadequate Tenant Screening: The best way to deal with problem tenants is refusing to allow problem tenants to move into a property. Stott Property Management requires every adult applicant to fill out an application and then checks the following: Credit Score, Employment, Previous Landlord References, and State of Hawaii Court Records. By carefully screening tenants, Stott Property Management helps minimize tenant caused problems and protects their clients from arbitrary discrimination complaints. Failure to properly screen tenants can result in several months of lost rent and thousands in legal fees to correct the situation.

Improper Check-ins and Check-outs: The State of Hawaii requires a Tenant to return the property to the Landlord in the same condition that the property was in at the time the Tenant checked in minus normal wear and tear. “Normal wear and tear” does not include dirt. One common pet peeve of Investment Property Owners involves being charged for cleaning when a property is being made ready for the next tenant. If a property was clean at the time of check-in, then any cleaning required after the tenant checks out should be paid for by a portion of the tenants’ security deposit. The only time an Owner should pay a cleaning bill would be if light cleaning was required because maintenance was conducted in a vacant property, or if a property was vacant for more than a month.

The Landlord-Tenant Code requires that the Landlord must obtain a signed Property Inventory and Condition Form from the tenant at the time of check-in in order to withhold any funds for tenant caused damage after the tenant checks out. If the Landlord withholds all or a portion of the funds, then the Landlord must mail the prior Tenant a letter stating the charges, provide copies of estimates or bills from contractors, and provide a check for any remaining funds within 14 days of the check out. Stott Property Management has witnessed the small claims court judge order a Landlord to return the security deposit in full for failure to have a signed Property Inventory and Condition Form or meet the 14-day requirement even though evidence of tenant caused damage was presented in court.

Failure to Conduct Routine Inspections: A quote that is often used in leadership also applies to rental properties. “It is not what you expect, it is what you inspect.” Stott Property Management has taken over many rental properties that were not inspected because a “great tenant” was living there. It appears that the definition of a “great tenant” to a few PMs and/or Owners is a tenant that stays for an extremely long time and pays their rent. The Owner is then shocked to find out that these tenants trashed their property when they did finally move.

Landlords must regularly inspect properties in order to maintain the properties in good condition. Over several years, normal wear and tear will turn a clean and desirable rental property into a run down looking home that fails to attract good tenants. Failure to identify and address regular maintenance items like painting, replacing worn out flooring, and repairing small leaks can and will lead to lost rent and more expensive repairs in the future.

Failure to Charge Market Rent: In general, rent will increase over time at the rate of inflation. One common mistake that Owners make is charging below market rent to friends and family. One common misconception that some Owners have is the thought that the tenant will be grateful for being able to rent a property for several hundreds of dollars below market rent every month. These very same Owners are then dismayed when their financial situation changes and they must either sell the property or ask the Tenant to move and the Tenant becomes a problem. Instead of receiving gratitude for their charity, the Owners receive scorn for taking away a rental subsidy. If you feel compelled to help someone out, we recommend writing a friend or family member a check for an amount you are comfortable with. You will enjoy the benefits of providing a gift without the liability of offering a subsidy for an indefinite period of time.

Another common mistake that some PMs and Owners make involves failing to increase the rent that a long-term tenant pays when market rents have risen. Stott Property Management has seen some tenants paying half the market rent for a property because a PM or Owner has failed to raise the rent on a tenant that has lived in a property for ten years or more. Stott Property Management compares the actual rent to the market rent every time a lease is about to expire and then makes recommendations to their clients when, in their opinion, a rent increase is warranted.

Tenant Repairs: Asking or allowing a tenant to conduct repairs on a rental property in lieu of rent almost always ends up in failure. The reasons behind the problems include failure to define and document the scope of the work for the agreed upon rent credit, the tenants lack of skill in completing the repair, failure to inspect the final work product, or a combination of these reasons.

We have witnessed some Property Managers make the same mistake as Owners. We have even spoken to one Owner who allowed a “handyman” to move into his property to conduct repairs and then had to evict this same “handyman” who lived in the property without completing any work over the span of several months. The Owner had to bear the costs of an eviction for a tenant that never paid any rent.

Befriending Tenants: Some Owners make it a point to become “personal friends” with their tenants. As a result, they tend to stop treating their rental property as a business and end up losing money by failing to make difficult decisions that negatively impact their “friends.”

Asking Above Market Rent: One of the biggest myths in investment real estate is the idea that a property will attract better tenants by simply raising the asking rent. In most cases, the best-qualified tenant prospects are also the most informed tenant prospects. In order to successfully compete for well-qualified tenants, a landlord must offer a competitive asking rent. Typically speaking, the only tenant prospects that apply for a rental charging over market rent are those people who have limited options due to poor credit and/or poor rental references.

Instead of attracting the best tenants in a reasonable time frame, the landlord ends up with longer than normal vacancy rates, lower quality tenants, and typically higher turnover. Since vacancy periods, problem tenants, and turnover expenses cost landlords more than standard repairs, overpricing a rental should be avoided.

Fully Furnished Apartments: Unless an owner lives in a property for part of each year, or the property is located in a high-end tourist destination, furnishing an apartment makes it more difficult to attract quality long-term tenants. Most people looking to rent long-term have their own furniture. The additional costs and headaches involved with maintaining the furnishings typically result in lower cash flow.

Pets: Some owners do not allow pets because they fear that the animals may cause excessive damage or ruin carpeting if the pet has an accident. The State of Hawaii recently allowed landlords to collect a refundable pet deposit in addition to the refundable security deposit. State Law also allows tenants to move a “pet” into a rental that does not allow pets by obtaining a doctor’s note claiming that the “pet” is an Emotional Support Animal.

Stott Property Management recommends owners to allow a small pet (under 40 lbs.) due to the above mentioned changes in state law. Most tenant prospects that have great credit and rental references are responsible pet owners. The combined security deposit and pet deposit would usually be large enough to replace carpet and padding if the pet has an accident. The higher demand helps raise the rent and reduce vacancy periods and some pet owners will look past flooring defects in order to move into a rental that allows a pet.

Remodeling: Location and views have the largest impact on market rent. In general, tenants look for clean and functional square footage in neighborhoods that meet their needs the best. Installing granite countertops, high-end cabinetry, hard wood floors, high-end appliances and bathroom fixtures do not provide a sufficient return on investment. Since the State of Hawaii limits a security deposit equal to one month’s rent, one careless tenant could end up causing thousands of dollars in damage to a high-end remodel.

If your property shows signs of wear and tear, a coat of fresh paint and decent rental grade carpeting should be sufficient to attract quality tenants. If you don’t want to replace the carpet every five to seven years, then consider installing ceramic tile. Don’t replace “dated” cabinetry and countertops unless they exhibit major functional problems (i.e. stuck drawers, rotten wood, broken hinges that can’t be repaired).

Discrimination: Federal and State Laws prohibit turning down a potential tenant due to race, color, national origin, religion, sex, familial status, or handicap. Some owners of high-rise condos have voiced concerns over the safety of small children and the risks of falling. Even though those concerns may be valid, turning down an applicant with small children for that specific reason violates the law.