July to September 2017 Quarterly Newsletter

Oahu’s median price for single-family homes was $760,000 in September (1.3% higher than September 2016) and for condos matched a record of $425,000 (10.9% higher than September 2016). The number of sales continued to grow in comparison to last year as fence sitting buyers have finally moved forward while supply fails to keep up. Stott Property Management had roughly ten tenants give notice over the past two months because they purchased a home. There are currently only 2.4 months of remaining inventory of single-family homes and only 2.6 months of remaining inventory of condos. Bidding for available homes has been intense. One Kailua foreclosure received 29 offers during the 10-day bidding period.

The University of Hawaii Economic Research Organization (UHERO) reported that Hawaii’s economy is decelerating with job growth finishing the year at less than 1% due to flattening construction and a tight labor market. UHERO predicts that job growth will slow to about 0.5% for the remainder of the decade. Tourism continues to exceed expectations with visitor counts are currently 4% higher than last year and 20% higher than the previous decade. Transient vacation rentals are helping house the growth in visitors since hotels and timeshares are operating at capacity. An increasing percentage of tourists report that they are staying in private homes. The benefits and costs of vacation rentals continue to be a hot button issue in Hawaii.

Price pressures in Honolulu are rising with shelter costs rising 4.2% in the first half of 2017, the fastest pace since 2007. Home prices have risen about 30% since 2011, which has translated into the higher shelter costs for both homeowners and renters. Energy prices have recovered after several years of decline due to low oil prices. UHERO expects a 2.8% inflation rate for 2017 and inflation of 3% for 2018 and 2019.

A Mixed Plate of Talk Story

A July fire in the Marco Polo building, a 36-floor high rise across the Ala Wai canal from Waikiki, has city and state officials looking into mandatory sprinkler system retrofits. The fire killed three people and damaged more than 200 of the 568 units before fire fighters brought the blaze under control. The condo board decided against retrofitting a sprinkler system in 2013 due to the $8,000 per unit price tag. Fire fighters also pointed out that many owners in the Marco Polo building have violated fire codes by installing screen doors outside their front doors and propping the front doors open to improve air circulation. The common practice allowed the fire to spread more quickly through the building. Costs to repair the damage are expected to exceed $100 million. Prospective buyers have taken notice and place a higher premium on sprinkler systems when evaluating high-rise condos. Several prospective buyers pointed out the sprinkler system in a condo where Tracey recently held an open house.

Honolulu City Council members twice voted to defer action on requiring more than 350 residential condo buildings to be retrofitted with sprinkler systems in the next five years. Bill 69, introduced on behalf of Mayor Kirk Caldwell days after the Marco Polo fire, has been deferred until council members can obtain more information. The proposed bill has already received loud protests from condominium owners who fear that they could be forced to pay tens of thousands of dollars to finance the sprinkler retrofit. While not everyone opposes the need for the bill, many contend that the five-year time frame is far too short a period of time to finish retrofitting 358 buildings.

A consultant hired by the state of Hawaii to analyze Hawaii’s tax structure warned that current tax collections would not be sufficient to cover the costs associated with the health insurance and pension funds for government employees. This is the second time in five years that the state has been warned of its unfunded liabilities. The state’s public workers’ pension fund currently has unfunded liabilities of $12.44 billion and the public workers’ health fund has unfunded liabilities of $11.7 billion. Lawmakers, concerned about the shortfall, passed Act 268 in 2013 that requires the state to start setting aside money to cover future obligations. In 2019, that amount will be over $811 million and will grow to over $2 billion in 2022. The consultants concluded that the state would either have to raise taxes or cut spending in order to meet those obligations based on revenue projections for the current tax rates.

It appears that several state and city agencies not to have received the memo from the governor and mayor regarding the affordable housing problem on Oahu. The Hawaii Public Housing Authority board unanimously voted to terminate the six-year old master development agreement to redevelop a low-income housing project in Kalihi with a private developer despite the fact that the developer finished the first phase of the project on time and on budget. Currently 176 obsolete units remain in limbo as the board seeks bids. The state agency charged with providing homesteads for Native Hawaiians, the Department of Hawaiian Home Lands (DHHL) produced no new housing units during the fiscal year ending June 30 and closed out the fiscal year with $30 million in unspent federal housing funds. The number of eligible beneficiaries awaiting residential leases has grown to 22,000 individuals throughout the state and roughly half of the wait-listed applicants reside on Oahu. While half of the beneficiaries live on Oahu, only 4% of the allocated land is located there. Critics of the department decry the loss of $30 million in federal funds because DHHL failed to use the funds to build affordable housing.

The U.S. Department of Housing and Urban Development told the Caldwell administration that it was pulling $2.4 million in federal funding because the city failed to spend it and that the city is at risk of losing another $7.5 million. The money can be used for buying and renovating existing structures for housing, however it may not be used for building new affordable housing. An earlier audit had warned that the city’s current housing policies needed to be changed to more effectively manage the federal block grants.

While the city and state struggle with developing affordable housing, the lawlessness associated with Kakaako’s chronically homeless population has caused the closure of Kakaako Waterfront Park. The homeless encampment has grown to about 180 people and is the largest encampment since the 300-person encampment was dismantled in 2015 following the attack of a state representative. The park is being shut down indefinitely due to safety issues from homeless people vandalizing plumbing and electrical structures to steal water and electricity. Several dog attacks have also been attributed to the homeless. Repairing damage to the parks is estimated to cost taxpayers about $500,000. A scathing editorial in the Honolulu Star Advertiser called out both mayor Kirk Caldwell and governor David Ige for claiming success in dealing with the homeless situation while visual problems are still occurring on their doorsteps.

A former Hilo judge concluded the state’s contested case hearing for the Thirty Meter Telescope (TMT) project in August and recommended that the Board of Land and Natural Resources issue a conservative district use permit subject to 40 conditions. Some of the proposed conditions include a $1 million “community benefits package” from the start of construction through the end of the sublease. The package requires TMT employees to attend mandatory cultural training and fill jobs locally when feasible.   TMT officials were pleased by the ruling, yet a separate contested case hearing must be conducted regarding the sublease. Opponents of the project reacted by contending that the judge was biased and the favorable ruling was all but guaranteed from the start. A state board then approved the building permit for the $1.4 billion Thirty Meter Telescope (TMT) on a 5-2 vote in September after months of testimony in a contested hearing ordered by the Hawaii Supreme Court. The board approval included 43 conditions that TMT International Observatory must meet to build the telescope on the summit of Mauna Kea. TMT officials are hesitant to say when the project will begin since opponents vow to appeal the decision to Hawaii’s Supreme Court and a separate challenge is being mounted to the project’s sublease.

While investors in Hawaii’s eight medical marijuana dispensaries may ultimately be a profitable venture, getting started has proven to be more difficult than originally envisioned. Even though medical marijuana is legal in Hawaii, the drug remains a schedule 1 drug under federal law. Two dispensaries have quickly opened their doors to patients on Maui and Oahu in August. Both of the first dispensaries to open on Oahu and Maui ran out of their initial stock of marijuana products within four days due to tremendous pent up demand. The dispensaries have complained about the state’s slow certification process in approving testing labs while the state tries to pin the blame on the only approved testing lab. The state has yet to certify a lab to test derivative products like oils, tinctures, and lotions for patients that do not want to smoke. Dispensaries are not allowed to sell edibles like cookies, brownies, or candy. Demand for medical marijuana products would even be higher if the state did not have a significant backlog of patients waiting on their medical marijuana cards. The manager overseeing the states registry program recently resigned and the state is scrambling to find a replacement in addition to two additional staff members.

The Honolulu Authority for Rapid Transportation’s (HART) rail project continues to cause major drama as state officials recently passed a package of tax increases to fund the estimated $10 billion project. House finance chairwoman, Silvia Luke, and House Speaker Scott Saiki have been highly critical of Mayor Kirk Caldwell’s handling of the project resulting in a second round of tax increases in the past two years. The bill barely passed the Senate Ways and Means Committee on a six to five vote and then passed the Senate by a vote of 16 to 9. The bill passed the House 31-15 on Friday and Governor David Ige signed it on Tuesday. The bill extends the Oahu’s GET surcharge another three years (expires 12/31/30), raises the state TAT one percent for thirteen years (expires 12/31/30), and is expected to generate $2.37 billion for the rail project. Neighbor island lawmakers are protesting the TAT (also called the hotel room tax) increase arguing that Oahu should completely fund the project and that neighbor island hotel tax revenue should not be used.   Just prior to the opening of the special session on Monday, August 28th, two outspoken critics of the proposed funding measures were removed from their positions on the House Finance Committee. Then in September, House Majority Leader Cindy Evans offer to resign over the TAT provision when she voted against the latest bailout proposal and her resignation was accepted by the House speaker.

Biki, Honolulu’s new bike sharing system, sold more than 47,000 rides to almost 13,000 individual users. 2,340 people have signed up as members, indicating that they are repeat customers when it opened in July. Biki currently charges $3.50 for a single 30-minute ride and unlimited 30-minute trips are available for $15 per month. The bike share program started with 800 bikes in service and 89 stations with the most popular stations being located in Waikiki and Ala Moana/Kakaako. Bikeshare Hawaii added another ten stations to its bike rental operation in August and reported that its program records between 1,800 and 2,100 trips per day. Please visit the following link for bike station locations.

http://community.bikesharehawaii.org/#/tab/mapSite

Mayor Kirk Caldwell has asked Governor David Ige to issue an emergency proclamation to expedite the permitting process associated with replacing two high volume pressurized sewage pipes that have been weakened by corrosion. The sewer mains serve residential neighborhoods in Kapolei and Ko Olina hotels. The two underground sewer mains have experienced six breaks in the last four years resulting in hundreds of thousands of gallons of untreated wastewater spilling on the ground. The concrete cylindrical pipes were put into service in 1988 and 1990 and were designed to handle Kapolei’s growth and last much longer into the future. City officials want to replace the pipes as quickly as possible for fear that heavy rains could cause a major spill that would impact neighborhoods and potentially reach the ocean.

Rocky, a Hawaiian monk seal, gave birth to Kaimana on Waikiki’s Kaimana Beach in late June. The two were a sensation with locals and tourists. Kaimana was found in the crumbling Waikiki Natatorium in July and wildlife experts were worried that Kaimana could get injured if the pup continued to swim there. Officials made the decision to move Kaimana to a remote beach with less human interaction and exposure to man-made hazards once Rocky weaned Kaimana and returned to the open ocean. Hawaiian monk seal pups typically linger behind on their birth beach learning to find food before taking to the open ocean. A team from the National Oceanic and Atmospheric Association (NOAA) captured Kaimana in a ropelike hammock on an August Saturday and drove her away in a pickup truck to her new home. The team tagged Kaimana and vaccinated her before releasing her at her new home in the wild. Kaimana can live off her fat reserves for a few weeks as she learns to hunt food.

The top ten most-visited sites in Hawaii (listed in order of most visited) were Hawaii Volcanoes National Park, Dole Plantation, World War II Valor in the Pacific National Monument (includes the Arizona Memorial), Haleakala National Park, Diamond Head State Monument, Hanauma Bay Nature Preserve, Polynesian Cultural Center, Battleship Missouri Memorial, Honolulu Zoo, and Kualoa Ranch.

Odds & Ends

Repeatability: One trait of a successful business is creating a system by which a person or employees follows policies and procedures that produce successful transactions over and over again. Investment property owners, whether they recognize it or not, are essentially small businesses and should be aware of this concept when making decisions about their investments.

Asking market rent provides consistent, repeatable results by maximizing revenue on an annual basis through lower vacancy rates. Some investors hold out for a minimum acceptable rent in their minds and end up losing out because the lost revenue from a longer than necessary vacancy usually dwarfs any additional income through a higher rent when a tenant finally agrees to move in. Even when a tenant moves in, their stay will tend to be shorter as soon as they find that better values for their hard earned dollars are available. I recently spoke to one agent who “hit a home run” last year by finding a tenant willing to pay about $1,000 more than I thought the unit would rent for. When the agent and her clients tried to repeat that feat in 2017, the unit sat vacant for the entire seven months that it was available to rent. The agent’s clients would have been better accepting 75% of the first years rent and having rental income in 2017.

Targeting the appropriate tenant for a particular neighborhood is critical for repeat business. Stott Property Management recently had a client that was convinced she could boost her income spending a lot of money to remodel fully furnished three rental units in a non-conforming house in a residential neighborhood by marketing to traveling nurses. The strategy worked for the first three months and traveling nurses quickly moved into the three units. However, when one set of roommates checked out three months later, there were not any nurses to move in right away because the available pool of nurse tenants was too small. The client ended up moving into one of the units and taking back management of the property because of the financial strain resulting from the vacancy. The client would have been better off by leaving the units unfurnished, making cosmetic repairs only when normal wear and tear required, and targeting long-term tenants willing to pay market rent.

Buying investment property at prices that provide immediate positive cash flow while hiring a property manager is another example of repeatability. By buying investment property in locations that provide immediate positive cash flow while paying a professional allows you to buy over and over again resulting in multiple cash flow streams. If you buy at too high of a price, than you end up suffering negative cash flow and must use work income to supplement the losses. No person wants to repeat that pattern and end up in a financial hole that offers no escape. Similarly, achieving positive cash flow only through self-management means that there is a limit to the number of investment property that you have the time to manage. Self-management also limits the areas that you can successfully invest since laws and markets differ from one city and state to the next.

Limiting your financial leverage is the key to long-term success in real estate investing. While diversification by investing in different areas can help limit risk, the housing crisis of 2008 and 2009 shows that there will be occasions that require navigating an economic recession. Investors over-leverage themselves by taking on too much mortgage debt can find themselves in a difficult position of a downturn in the rental market results in rental revenue falling below fixed mortgage obligations. A job loss during this time could be enough to force an investor into foreclosure or bankruptcy.

Repeatability can also work against an investor who puts inadequate capital into their property in the form of repairs. Landlords must provide a clean, fully functional rental property that offers amenities consistent with neighborhood and competitive with the overall market. Failure to keep up with wear and tear and offering inadequate amenities will result in below market rent, longer than necessary vacancies, and less than desireable tenants. The lower rental income makes it even harder to pay for future repairs and problem tenants can cause even more damage. The negatively reinforcing pattern makes the whole situation unsustainable and either the landlord ends up spending even more money to recover or ends up having to sell a physically distressed property at a below market price.

Being disciplined enough to buy only properties that provide immediate positive cash flow while utilizing professional management can create a passive financial windfall over time. By following sound business practices, an investor can repeat successful outcomes over the long haul.

Equifax Data Breach: Equifax announced that hackers gained access to its systems earlier this month, potential compromising the personal information of about 143 million consumers. Newspapers around the country have written numerous articles regarding the breach and the Bank of Hawaii encouraged its customers to visit Equifax’s website, equifaxsecurity2017.com, to see if their personal information have been compromised. Tim Kelley visited the website twice and received conflicting information on his potential exposure. When he visited the first time, he was notified that hackers could have gained access to his information, and the company offered free credit monitoring services for a period of time. The company reported that his information had not been compromised during a later visit to follow up on the service offered.

That prompted Tim to first obtain his free annual credit reports from the three reporting agencies, Equifax, Experian, and TransUnion. He had to visit annualcreditreport.com from home so that he had access to his open and closed accounts. As part of the process, each agency verifies the users identity by asking specific questions about potential loans, mortgages, and credit cards used by the individual. Tim had to access old records in order to correctly answer some of the questions regarding closed accounts and mortgages. Once answered, Tim was able to download and review his credit history for any incorrect or potentially fraudulent activity. Fortunately, there did not appear to be any suspicious activity.

One tool a consumer can use to prevent fraud from identity theft is to order a credit freeze. A credit freeze restricts access to your credit report that makes it difficult for thieves to take out lines of credit in your name. Equifax has agreed to waive all fees for people who want to freeze their credit until November 21st. Creditors will refuse to open new accounts or provide loans if they can’t access your credit. However, a credit freeze does not prevent fraud from taking place on existing accounts. Therefore, you should continue to monitor your open accounts regularly for any signs of fraud. Consumers that do not intend to apply for any new loans, mortgages, or credit cards should consider freezing their credit. It just takes a finite amount of time to unlock credit freezes if you want to apply for a new loan, mortgage, or credit card. Please note that you will also have to unlock your credit reports if you want to rent from a property manager like Stott Property Management, who requires a credit report as part of the application process. You can order a credit freeze by contacting the three major credit agencies via the website or by calling their customer assistance departments.

Warning Signs

Tim and Tracey have owned investment real estate for 20 years and Tim has lead Stott Property Management for the past 11 years. During that time, they have learned the value of hiring competent licensed professionals to manage investment real estate owned from a distance. Tim and Tracey always recommend hiring a licensed property manager unless you are within a reasonable driving distance to your rental property.

The purpose of this article is to highlight “red flags” for rental property owners who have hired a property manager. There are excellent property managers and poor property managers throughout the country. Over time, the poor property managers will either lose their license or go out of business. Unfortunately, Stott Property Management has taken over several troubled accounts from poor property managers long after the financial damage has been done. Ultimately, timely communication and transparency from your property manager is the key to both short-term and long-term success.

No Monthly Revenue: Stott Property Management has taken over accounts where the owner did not receive any income for months. In one extreme case, the owner had not received any income for almost a year without any communication from the property manager. The reasons for the lack of income ranged from excessive vacancies, failure to collect rent from dead-beat tenants, allowing friends and relatives to live in a unit rent-free, to outright fraud.

An owner should not go months without receiving rental proceeds and fail to hear from his or her property manager.

Monthly Statements: Your property manager should send you statements once per month at a minimum regardless of how many transactions have taken place in your account. These monthly statements should show your account balance at the beginning of the month, the amount of rent collected, all of the expenses paid on your behalf including the property management fees, the amount of the proceeds that you should have received, and the ending balance. You should also receive copies of all paid invoices for all the expenses that your property manager paid on your behalf. You should review the statements at least once per month and ask questions if anything appears unusual.

Stott Property Management has taken over several accounts where clients did not receive any income or statements for months. Their calls either went unanswered or the property manager would make excuses to why the statements were not being delivered. By the time Stott Property Management took over, the affected owners lost thousands of dollars in lost income for various reasons including outright fraud.

Communication: Effective, two-way communication is the linchpin for any successful investor / manager relationship. Communication comes in the form of reliable statements, e-mail, phone calls, and face-to-face meetings. Tim and Tracey think that effective communication is so important in their business, that Stott Real Estate, Inc. has two full-time receptionists whose primary responsibility is to answer the phones. Other employees are trained to answer the phones if the receptionists are currently fielding phone calls. There is nothing more frustrating that being a customer that has to traverse “voice-mail hell” during normal business hours. On rare occasions, we can’t answer all the calls coming in and Stott Real Estate employees will return phone calls as soon as feasible.

There are property managers that do everything possible to avoid phone calls and meetings. Uncomfortable and unpleasant conversations are part of the business since moving, money, and family issues are some of the most stressful situations that people deal with. A property manager often ends up speaking with someone that is experiencing a combination of all three of the listed issues. Avoiding phone calls can be one piece in a disturbing pattern that could end up costing the owner money down the road. In an effort to encourage communication, Tim checks in with each of his clients every six months or so to see if they have any questions regarding their property. Through proactive communication, Stott Property Management helps avoid issues caused by unanswered question festering in a client’s mind.

Constant Turnover: Many larger property management companies have property managers that are independent contractors while centralizing their bookkeeping and maintenance services. In many cases, a large company will be well run and retain their talented property managers for extended periods of time. One sign of potential problems in an office is a constant turnover of property managers resulting in someone new repeatedly taking over management of your property.   Constant turnover can result in a loss of knowledge regarding your property and your investment can suffer if inexperienced managers are taking over. In a few cases, Stott Property Management has called to transition management of a rental property and the current property management company did not immediately know who was managing the account.

Repair Policies: Some property management companies hire handymen to do work on their portfolio of managed properties while other property managers have poorly defined repair policies. If you don’t know if your property manager has an in-house handyman, or if you don’t know your property manager’s repair policy, then you should ask. Tim and Tracey asked one of their property managers that very question to learn that most of the repairs being conducted at one of their investment properties was being completed by in-house personnel. Additionally, the property manager approved several large invoices without prior authorization and the large surprise bills prompted Tim and Tracey to investigate the issue. They negotiated an agreeable settlement with the property management company and the surprise bills ended. Conflicts of interest occur when property managers and repair personnel work for the same company.

No Repair Bills: Appliances and fixtures break all the time. An owner of investment real estate will have to paint and replace flooring (unless ceramic tile is installed) every seven to ten years. Additionally, appliances (if provided) and fixtures will have to be periodically repaired and replaced due to normal wear and tear. Chances are that if your rental property is suffering if you have a long-term tenant and you have not had any repair requests and repair bills in years.

No Rent Increases: Rents will increase over the long-term at a similar rate of inflation. If you have had the same tenant living in your rental for a decade and the rent for your property has stayed the same, then your tenant is likely paying rent far below market. Failing to periodically raise the rent to keep up with the market results in less money to pay for necessary repairs and will ultimately jeopardize future cash flow. Ask for a rental assessment if you have not received one from your property manager in the past few years.

A good property manager does much more for an investor client than just “collecting the rent.” Property managers add value by inspecting and maintaining the rental property, coordinating necessary repairs, minimizing vacancies, enforcing leases, providing local market information, and when necessary, handling problem tenants. You should consider making a change if you are experiencing one or more of the “red flags” described above.

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