Quarterly Newsletters

The Stott Team has published quarterly newsletters since 1993 designed for absentee owners of rental properties on Oahu. The newsletters contain information about the Oahu housing market as well as what’s been happening recently in Hawaii. The newsletters can be read from your computer screen or downloaded and printed using Acrobat Reader. Most of the newsletters are four pages in length with two double-sided enclosures for a total of eight letter-size pages.

Stott Team quarterly newsletters since 1993

Oahu’s median sales prices in June were $782,388 for single-family homes (1.6% lower than June 2017) and $420,000 for condos (5% higher than June 2017). The mixed results bear watching because the market for the more expensive single-family homes tends to lead the market for condos. Demand for single-family homes dropped for the second month in a row with the number of sales dropping 1.4% from the previous years figure. While the number of condos was 2.1% higher than last year, pending sales (properties under contract but not yet sold) fell for both single-family homes and condos. The number of pending sales for single-family homes was 12.6% lower and the number of pending sales for condos was 8.2% lower than June 2017. Median sales prices could be peaking in Oahu’s demand driven market.

The University of Hawaii Economic Research Organization (UHERO) recently confirmed the DBEDT’s report and further explained the challenges facing Hawaii residents. While construction has increased modestly on Oahu after last year’s drop in activity, homebuilding remains well below the levels needed to meet statewide household formation. Construction jobs on the Neighbor Islands remain far below the previous peak in 2007. Limited income growth and rising interest rates will make it even more costly to build the necessary housing.

Stott Real Estate, Inc. recently celebrated its 40th anniversary in business and Tracey was recognized as one of only nine real estate agents that have been in the top 100 Realtors in the state of Hawaii for the past twelve years. Tim and Tracey also publish a monthly e-mail newsletter that provides more detailed local news with links to photos and videos. Please e-mail Tim and Tracey at home@stott.com if you would like to be added to the monthly newsletter. You will continue to receive the mailed quarterly newsletter.

A Mixed Plate of Talk Story

Scientists at the Hawaiian Volcano Observatory warned of the next lava event when it issued a Volcano Activity Notice on Tuesday, 4/17/18. Instruments recorded inflation of the Puu Oo Cone and the crater floor reportedly rose several yards at the time of the warning. Lava was reported spilling onto the nearby Halemaumau Crater floor at Kilauea’s summit on Monday, 4/23/18, less than a week after the warning. The lava covered about 39 acres on the crater floor. A similar episode preceded a lava flow that threatened the town of Pahoa back in June 2014 and a second lava flow that started in May 2016, reached the ocean, and is currently still active. Tim, Tracey, and their son, Mark walked within a few feet of the previous lava flow back in November. The last vent opening at Kilauea’s summit occurred ten years ago.

Kilauea’s eruptions have been changing almost daily and the original slow moving lava that originally started oozing out of fissures on May 3rd have been replaced by smoother, faster moving lava called pahoehoe. Two pahoehoe lava flows traveled from the vents to the ocean over one weekend cutting off some Puna neighborhoods from the rest of the island and creating a new volcanic hazard, laze. Laze occurs when lava comes in contact with cold seawater creating a lethal plume of steam containing hydrochloric acid and glass particles. A laze plume can travel up to 15 miles according to the Hawaiian Volcano Observatory. Emergency personnel had to scramble on Memorial Day to warn residents that refused to evacuate their homes three weeks earlier when a mandatory evacuation notice was issued. High fountains of lava started erupting from previously stalled vents and the lava flow progessed at the speed of a fast walk and crossed the last major road out of Pahoa. Fissure Eight has been producing up to 250-foot lava geysers for over a month and supplying a lava flow approximately ½ mile wide that completely filled up Kapoho Bay, extending 0.7 miles from the previous shoreline. Periodic earthquakes as large as 5.5 on the Richter Scale at Kilauea’s summit have damaged viewing areas in Volcanoes National Park and sent ash clouds up to 8,000 feet into the air from Halemaumau Crater.

The most recent eruption has currently covered 9.2 square miles of land, destroyed close to 700 homes, and created at least 260 acres of new land along 1.3 miles of the Kapoho coast. Fissure 8 has been spewing about 26,000 gallons of lava per second with more recent fountains of 150 feet in height. Fissure 8’s cinder and spatter cone is about 130 feet at its highest point.

The change in Kilauea’s lava flow has drained the lava lake that viewers used to see from Jaggar Museum’s overlook area. Halemaumau’s crater walls have slumped inward and the crater has repeatedly sent plumes of ash thousands of feet skyward when the crater walls have collapsed. The most recent collapse caused tremors at the summit equivalent to an earthquake of 5.3 on the Richter scale. The acidic volcanic ash has covered Jaggar Museum and the viewing areas. Cracks caused by seismic activity have compromised the structure of the viewing deck and museum and park officials doubt that the current museum will open again due to the proximity to an unstable cliff.

Hawaii’s low unemployment rate is masking many economic challenges that currently exist. Hawaii’s aging population and retiring baby boomers are holding the unemployment rate down and the shrinking labor force as a percentage of the population will make it more difficult to pay for the state’s public pension obligations. Private employer growth prospects have been hampered due to the difficulty in finding qualified employees and the dominant tourism industry generates below average wages. Hawaii has experienced a net decrease in population as some people have left the island because they can no longer make ends meet due to the high cost of living. Gubernatorial candidate Colleen Hanabusa claims that the state’s struggles are a result of the failed leadership of current Governor David Ige. However, changing governors again will not result in any changes to the state’s economy unless there is a shift in the state and counties approaches to government. The tax and spend mentality that dominates the state has resulted in a competitive disadvantage of Hawaii’s employees in comparison to other employees elsewhere in the nation. Leading state economist, Paul Brewbaker, has pointed out that the state’s economy has only grown 1.6% per year on average of the past decade which lags the national average of 2.1%.

The most recent report by the state Department of Business, Economic Development and Tourism (DBEDT) reported that Hawaii’s economy started to accelerate during the first quarter of 2018. The trend is expected to continue as record tourism continues to drive growth for the state. Visitor spending grew 10.1% during the first quarter compared to 2017 and the number of available airline seats grew 10.6%. Not all industries are experiencing job growth as state government lost 1,700 jobs and retail lost 1,000 jobs over the last year.

The University of Hawaii Economic Research Organization (UHERO) recently confirmed the DBEDT’s report and further explained the challenges facing Hawaii residents in a June report. While construction has increased modestly on Oahu after last year’s drop in activity, homebuilding remains well below the levels needed to meet statewide household formation. Construction jobs on the Neighbor Islands remain far below the previous peak in 2007. Limited income growth and rising interest rates will make it even more costly to build the necessary housing. Booming tourism growth is compounding the housing shortage by driving the spread of vacation rentals as landlords turn to tourists to help cover the high costs of maintaining a rental property. The following numbers help put tourisms impact in perspective: 1 in 10 people on Oahu, 1 in 7 people on the Big Island of Hawaii, and 1 in 4 people on Maui and Kauai are visitors.

New U.S. Housing and Urban Development (HUD) guidelines highlight the high cost of living on Oahu and a reason why more individuals and families have been leaving the islands versus coming. An Oahu family of four earning $93,300 is considered by HUD to be low income under the new guidelines and a single person earning $65,350 is considered low income. The HUD guidelines are based on fair market rents.

Hawaii lawmakers passed a bill and Governor David Ige signed the measure to ask voters if the state should be empowered to impose a tax surcharge on investment real estate to help fund public education. State residents will vote for the proposed constitutional amendment although many of those that would be affected by this tax will not have the ability to vote on the measure. Some lawmakers correctly argued that the tax surcharge would be passed on to renters further making Hawaii housing more unaffordable even though they still voted for the bill. The proposed constitutional amendment will be placed on the November 6 ballot.

The Hawaii Legislature passed a bill that raises the Hawaii Real Property Tax Act (HARPTA) withholding from 5% of the gross sale to 7.25% of the gross sale and is waiting on Governor David Ige’s signature.   HARPTA is not a tax, but a means for the state to collect capital gains taxes from out of state residents and corporations. In order to file for a refund, individuals and corporations may also have to show that they are current in their General Excise Tax (GET) payments, Transient Accommodation Tax (TAT) payments, and state income tax filings. This is the second measure passed by the legislature this year targeting taxpayers that can’t vote in state elections. Please e-mail Tim and Tracey at home@stott.com if you have questions about HARPTA. They can send you an article with more detailed information.

Hawaii may be starting a new chapter in its well-documented struggle with homelessness. For the first time since 2009, Hawaii’s homeless population declined according to the latest point-in-time count. The number of homeless individuals dropped from 7,220 to 6,530 over the past year. Homeless numbers dropped 9% on Oahu, 3% on Maui, 9% on the Big Island of Hawaii, and 29% on Kauai.

The transfer of some parks in Kakaako from the state to the city begins a new strategy to address the cycle of chronically homeless people moving from parks to city sidewalks and back to parks over the past three years. Police started sweeping the Kakaako parks on Monday, April 30th and those forced to move were not allowed to set up camps on sidewalks and were told to leave Kakaako and move past Aloha Tower or Ala Moana Mall. While the homeless and some advocates complained about the move, frequent visitors of the parks applauded the efforts.

The cat and mouse game between the City and County of Honolulu and the homeless continued in June. The city’s latest attempt to discourage certain homeless activity and prevent tents being erected on city sidewalks involves two bills. One bill will make it illegal to obstruct any sidewalk on Oahu between the hours of 6 a.m. and 10 p.m. daily if it interferes with the normal flow of pedestrian traffic. The second bill will make it illegal to lodge on city sidewalks at all hours. Lodging is defined as occupying a place temporarily to sleep or rest and to refuse to move when requested by authorities.

Mayor Kirk Caldwell vetoed a bill passed by the city council that would have capped the surcharges by Lyft and Uber during peak hours. In a positive sign for business and consumers, Mayor Caldwell called for less regulation of traditional taxi companies so that they could better compete with their disruptive competitors. The administration is drafting a new bill where passengers can choose the more traditional pay per mile fare system or an upfront pricing system that discloses the price charged per ride prior to the customer accepting the ride. The new bill could be a rare win for taxi companies, ride-hailing companies, and consumers.

Boat transportation was suspended to the Arizona Memorial on May 10th when a crack was discovered in the supporting structure for the visitor-loading ramp. Visitors currently can receive a harbor tour near the memorial until the necessary repairs can be made. The Arizona Memorial is the most visited attraction on the island of Oahu. You can visit the following website to check for repair updates: https://www.nps.gov/valr/faqs.htm

Hawaiian Electric Company (HECO) announced the completion of their new power plant on Schofield Barracks in cooperation with the U.S. Army. The only power plant located inland consists of quick-starting generators that run off conventional fuels and biofuels and will feed into the island’s electrical grid serving all customers on Oahu. The station is projected to reduce oil usage by about 26,000 barrels annually. The power plants ability to quickly adjust to changes in demand will help the continued integration of electricity from solar and wind.

The solar power industry is seeing strong demand this year as photo-voltaic (PV) systems with battery storage devices gain acceptance. The City and County of Honolulu’s Department of Planning and Permitting has issued 21% more permits to date in 2018 than in 2017. There are some concerns that the demand is outpacing the supply of the more popular batteries and that could act as a constraint in getting the systems up and running. Even though the long-term trend indicates more energy storage production, the short-term picture looks to be one of tight supply and higher prices.

Managing Financial Risk

Warren Buffet probably best describes managing financial risk as making investment decisions that put the odds in your favor. While the “Oracle of Omaha” was typically referring to buying businesses or stocks, the same principles can be applied to personal finance, homeownership, and investment real estate.

The best hedge against the eventual recession is to minimize personal debt and business leverage (business debt and loans on investment real estate). Being business owners, Tim and Tracey have always kept a close eye on the amount of accumulated debt in relation to the amount of passive and active income. The passive income comes from their investment property portfolio while their active income comes from their earnings at Stott Real Estate, Inc. and Stott Property Management, LLC. Since most of their income comes from commission based sales, they have always tried to maintain a balance equal to six months of living expenses in a savings account in case of a downturn in the business that resulted in a reduction of active income. Additionally, they did not purchase any investment property using a mortgage unless the expected revenue generated by the new property exceeded the expenses associated with the mortgage payments, property tax payments, and insurance by 25%. That margin helped prevent a short-term cash crunch by providing funds for repairs and periodic vacancies. By following these basic rules, Tim and Tracey were able to avoid financial distress through the inevitable real estate market cycles over the past twenty years.

Tim and Tracey, have had to try and help clients that did not follow these basic rules and were suffering from negative cash flow on one or more investment properties and a reduction of earned income through salary reductions or layoffs during a buyer’s market and a lack of home equity. In some cases, the luckier clients were able to negotiate a short-sale with the lender in order to sell a property. A short-sale is a process where the lender agrees to accept less money than is owed by the property owner during a sale in order to avoid the expense of having to foreclose on the property. In other cases, our clients had to suffer through years of negative cash flow before the real estate market recovered. In a few cases, the lender foreclosed on the property because the client could no longer make the mortgage payments.

One of the biggest myths sold by banks and the lending industry is the flawed financial concept of “tapping your home equity.” Banks and lenders peddle this poor idea in order to convince homeowners to take out larger loans against their property by either refinancing into a larger mortgage and receiving cash, or by taking out a Home Equity Line of Credit (HELOC). Make no mistake. The only way a homeowner can truly receive cash in return for home equity is by selling the home.

Tim and Tracey are currently seeing similar patterns now that occurred in 2007, the year before the last Hawaii (and national) real estate downturn. Hawaii has recently seen a net migration out of the state due to the high cost of living associated with a very expensive housing and rental market. Rents on Oahu have fallen over the past year or two as people either leave the island for more affordable areas, unrelated adults pool their resources as roommates to afford the rent, or multiple generations move into the same household. And, demand for single-family-homes and condos have recently slowed over the past two months. While the drop in demand could be a temporary blip, high prices and rising mortgage rates make a downturn in the Oahu real estate market a possibility.

If you are moving from Oahu and own your home, contact us for a free analysis of likely value both renting and selling your home. If you own a rental property and are currently suffering from negative cash flow, contact us about the possibility of ending the pain by selling the property. If you have a second home on Oahu that you are not currently using, then contact us about renting or selling the home to mitigate or eliminate the expenses. You can reach Tim and Tracey by e-mailing us at home@stott.com, visiting our website at www.stott.com, or calling us at 1-800-922-6811.

Property Management Guidance

Background: Stott Real Estate, Inc. sells residential real estate and its subsidiary, Stott Property Management, LLC, manages residential rental property. The two companies have separate staffs and share the same office. Tracey Stott Kelley is the principal broker of Stott Real Estate, Inc. and Tim Kelley is the principal broker of Stott Property Management, LLC. Stott Property Management currently manages approximately 400 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 proper 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, LLC 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, LLC 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, LLC 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, LLC 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, LLC 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, LLC 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 allows 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.

Oahu’s median sales prices in March were $760,000 for single-family homes (1.1% higher than March, 2017) and a record $435,000 for condos (8.8% higher than March, 2017). Single-family home sale prices have flattened over the past year and may have reached the limits of affordability for Oahu’s current income levels. Supply continues to be extremely tight with only 2.1 months of remaining inventory for single-family homes and 2.6 months or remaining inventory for condos. Recent bills passed addressing “monster homes” and changes to affordable housing rules will dampen development of additional housing. The supply constraints are likely to continue in both the short and long term and the housing cycle will continue to be driven by changes in demand. Affordability will constrain future price increases and rising interest rates pose the greatest threat of an eventual market downturn.

The University of Hawaii’s Economic Research Organization (UHERO) reports strong visitor growth. 5% more tourists visited Hawaii last year than in 2016 and the numbers will likely continue as airlines add to the number of available seats to the islands. Airlines have 10% more seats available in April compared to last year with Kauai seeing a 60% rise from the Western U.S. and Kona experiencing a 30% increase. Economists struggle with predicting when tourists will no longer be able to find places to stay as politicians drive an ever-larger percentage of accommodations market underground. Transient Vacation Rentals remain a major source of controversy on the islands and public dialog still focuses on trying to catch and punish property owners that violate city land and building codes. A Hawaii columnist accurately described a major driver behind the law-breaking trend by quoting one property owner. “People have worked out a way to actually pay their bills and get ahead for once. I don’t see how we can be treated as criminals when we are just trying to purchase property in Hawaii and have help paying for it.

A Mixed Plate of Talk Story

Hawaii real estate investors should keep a close eye on a bill that passed over from the Senate to the House that would seek a Constitutional amendment to increase taxes on investment real estate to fund public schools. The state teachers-union is pushing the bill that would establish a “surcharge” on investment homes valued at more than $1 million and on visitor accommodations. State legislators and public school teachers apparently took notes when the City and County of Honolulu successfully raised taxes on a majority of out of state property owners that can’t vote in Hawaii’s elections.

Carl Bonham, executive director of the University of Economic Research Organization (UHERO) briefed the House and Senate money committees, he outlined the benefits of accelerating the development of 33,000 additional new homes over the next seven years and cautioned that building so many more homes would require changes in the way that the state and the counties regulated development. Bonham estimates that the residential building would add an extra 0.5% to the state growth domestic product (GDP), and increase employment about 1%, and attract about 5,000 people to a state that has been experiencing a decline in population. Unfortunately, state legislators did not take the brief to heart. House Finance Chairwoman Silvia Luke focused on her favorite punching bag, Mayor Kirk Caldwell, by implying that nothing was happening at the city level, yet she failed to mention the regulatory hurdles created by the Department of Land and Natural Resources (DLNR). Senate Ways and Means Chairman, Donavan Dela Cruz, summarized the presentation as “another plea” to cope with the housing crisis. While Bonham framed the issue as an opportunity if lawmakers reduced regulation, the “housing crisis” will likely continue by the lack of action at the county and state levels.

Mayor Kirk Caldwell recently signed a bill into law that imposes a moratorium of up to two years on building permits for houses whose interior square footage exceeds 70% of the lot size. For instance, a house may not be larger than 3,500 square feet on a 5,000 square foot lot. The new law has already affected a couple of sales for property that Stott Real Estate, Inc. has listed with development potential. The moratorium will not help Oahu’s affordable housing problem.

The state house of representatives has submitted a budget that removes the $8 million requested to fund existing homeless programs and provides $30 million for “ohana zones” across the islands against the recommendation of the U.S. Interagency Council on Homelessness and the U.S. Department of Housing and Urban Development. The national agencies report that government sanctioned tent cities don’t work and only distract communities by arguing whose neighborhood should host them. A recently shuttered temporary ohana zone highlights the problems of the tent cities. Of the 51 homeless that stayed at the camp while it was open for eight months, 28 were kicked out for behavioral issues or drug use, arrested, or left voluntarily. While two people found permanent housing, four moved in with family, and 17 others were placed in other temporary shelters, the camp failed to keep the chronically homeless off the streets and failed to help those suffering from drug addiction and mental illness. Most Hawaii residents feel that the homeless situation is getting worse and state officials are failing to take effective steps to alleviate the problem.

Stott Property Management, LLC’s recent experience with the City and County of Honolulu’s approach to housing the homeless made the Honolulu Star Advertiser’s article covering U.S. Vets master lease approach timely. We recently started managing a property that housed a tenant receiving financial support from one of the non-profits funded by the city. The non-profit e-mailed over a contract for Stott Property Management, LLC to sign that required the company to open its books to the city and non-profit if they suspected that the tenant was being treated unfairly. In other words, Stott Property Management, LLC would have to put up with a “fishing expedition” if the landlord tenant relationship went sideways. Stott Property Management, LLC refused to sign the contract and gave the tenant and the non-profit written notice to vacate after reading the onerous contract. The tenant vacated and left truckloads of personal belongings and trash behind when checking out and the non-profit took no action to remedy the situation leaving the owner holding the bag. U.S. Vets on the other hand, signs a “master lease,” and takes full responsibility of the rental property and then houses homeless veterans. The organization pays the monthly rent regardless of occupancy and is required to return the condition back to the landlord in the same condition minus normal wear and tear once the lease arrangement ends. This arrangement is a much better approach to helping those in need get off the streets.

Catholic Charities Hawaii has taken matters into their own hands by building Meheula Vista, a senior affordable rental project in Mililani. The second phase of the four-phase, 301-unit project, was recently dedicated and the charity is breaking ground on phase three. Each phase consists of 75 affordable units that provide one bedroom, one bathroom, a full kitchen, common areas, a community room and a resident manager’s unit. The non-profit decided to start with low-income seniors because they are a growing segment of Hawaii’s population. It is expected that more than 25% of Hawaii’s population will be over the age of 60 by 2020.

A Hawaii appeals court has ruled that bed-and-breakfast business owners may not discriminate against gay couples, even if the owners live at the residence. The judge ruled that owners living in the same dwelling shall not refuse people based on their sex, sexual orientation, or marital status if the rental is on a short-term basis. The judge found that a bed-and-breakfast is subject to the state’s public-accommodation laws like any hotel, motel, or inn.

The Armed Forces Disciplinary Control Board put out an advisory in late December warning service members of violent crimes occurring in Waikiki. According to the notice, the board estimates that there have been more than 1,000 violent drug and alcohol-related arrests in the vicinity of the intersection of Kalakaua and Royal Hawaiian avenues and the intersection of Kalakaua and Kapahulu. Mayor Kirk Caldwell only became aware of the notice in mid-January. Police have responded by using new recruits to increase police presence in Waikiki during the late-night and early-morning hours.

On Saturday, January 13, 2018, many people in Hawaii received the following emergency alert on their cell phones: “BALLISTIC MISSILE THREAT INBOUND TO HAWAII. SEEK IMMEDIATE SHELTER. THIS IS NOT A DRILL.” Fortunately, Tim’s general cynicism concerning the competency of large bureaucracies (government and non-government), and more specifically Hawaii’s government bureaucracies, turned out to be true. Tim told Tracey, the state of Hawaii government just screwed up an emergency drill. It took the state 43 minutes to broadcast that the emergency alert had been sent out in error.

Both the state and the FCC conducted an investigation into the incident. The findings from the state’s internal investigation revealed that the employee who sent out the emergency alert confused an exercise recording that started a drill, with a real threat. Five other employees executed the drill correctly. According to the report, the employee had been a source of concern for more than ten years due to poor performance and had previously confused drills for real events. The investigator documented in the report, “I find a preponderance of evidence exists that insufficient management controls, poor computer software design, and human factors contributed to the false alarm and its delayed retraction.” The FCC weighed in by stating that The Hawaii Emergency Management Agency (HI-EMA) did not establish proper protocol or resources resulting in the false alert and delayed retraction. The HI-EMA administrator and another executive resigned and a third supervisor is facing suspension without pay in addition to the fired employee.

A recent paper published by the University of Hawaii Research Organization by a grad student reported that 2019 is the best time to invest in a PV system with a battery backup. The working paper by a Ph.D. student analyzed the declining costs of battery systems, pending reduction in federal tax credits, and a range of electricity rates. The student concluded that homeowners who invested in a system in 2019 would improve their net savings by 17 – 32% on Oahu compared with buying the same system in 2017. The paper provides food for thought for homeowners on both Oahu and the outer islands.

Record tourist numbers and social media posts that make finding Oahu’s scenic hikes easier to find have resulted in ever increasing numbers of rescues by the Honolulu Fire Department. A typical search and rescue operation for hikers involves 12 to 17 personnel and costs about $1,500 per hour. At the more popular tourist destinations like Diamond Head Crater and the Lanikai Pillboxes, rescue teams typically treat people for heat exhaustion or sprains. However, more dangerous hikes can result in serious falls. In a two-week span this past January, firefighters airlifted three people who fell from 20 to 75 feet on the Pali Notches trail which leads to the highest point on the Koolaus. In fact, several hikers suffering serious falls were taking selfies at the time. Experienced hikers recommend hiking with a club first before tackling more difficult hikes on your own with friends. Officials at the Department of Land and Natural Resources recommends sticking to the state maintained Na Ala Hele trails system where information can be found on www.hawaiitrails.org.

Rising alcohol bills at bars and restaurants show consumer confidence according to economists and local craft breweries and distillers appear to be benefiting from enthusiastic tourists and locals. Tim and Tracey visited Waikiki Brewing Company in Kakaako recently to try out their craft drinks and smoked meat before seeing comedian Bryan Regan at the Blaisdell Concert Hall. The food, drinks, and service were excellent. Waikiki Brewing Company has two pubs located in Waikiki and Kakaako.

Hawaii’s Merrie Monarch festival paid a special tribute to the Hokule’a, the Hawaiian ocean sailing canoe, when it returned to Hilo for the first time since 2014. The Hokule’a left Hilo in 2014 for its world-wide tour showcasing the Polynesian navigating techniques that brought the original people to Hawaii. The crewmembers of the original voyage in 1976 were given special canoe paddles and the hula dancing featured themes of voyaging.

Researchers at Maui’s Pacific Whale Foundation are trying to determine the reason for the drop in Hawaii Humpback Whale sightings over the past three years. Biologists don’t currently think that the whales’ numbers have dropped and are investigating a shift in the whales’ yearly migration patterns. Until recently, February has been the peak whale-sighting month.

The brush-tailed rock wallaby are native to Australia and look like tiny kangaroos. Two wallabies escaped from a private zoo in 1916 and they established a colony that is estimated to currently consist of about 40 animals in Kalihi Valley. An injured male wallaby was found near the Halawa Correctional Facility and zoo officials conducted surgery to remove an injured eye. Zoo officials suspect that the animal was injured in a fight with another animal. The zoo is currently looking for a permanent home once the wallaby completely recovers from surgery.

There were fewer than 60 Nene left on the planet in the 1960s. Today, there are nearly 3,000 and the Nene could be removed from the endangered species list next year.

Tax Changes

Stott Real Estate, Inc. is not licensed to provide legal or tax advice. Licensed professionals such as attorneys or certified public accountants should be consulted concerning questions related to tax strategies.

The Tax Cuts and Jobs Act of 2017: The law changed taxes for both corporations and individuals. At the corporate level, the graduated income tax rates with a top rate of 35% was replaced with a flat tax of 21% and the alternative minimum tax was eliminated. The corporate tax overhaul provided business both tax relief and simplified the tax code. Most of the discussion in this newsletter is limited to changes with the individual tax code and changes that can impact real estate investment since Stott Real Estate, Inc. specializes in residential real estate.

While the law did lower individual tax rates across the board for all income levels, the law did not make filing any simpler. In fact, the law most likely made tax planning more complicated because Congress had to placate many special interest groups in the Republican Party to pass on a party line basis and reconciliation rules required budgetary changes to expire. The law also left the Alternative Minimum Tax and the Obamacare Tax (3.8% tax on interest, dividends, and capital gains on high income individuals) in place. The law did reduce the fine for failing to obtain federally approved medical insurance to zero. The lower rates are set to expire on December 31, 2025.

The new law limits the mortgage interest deduction to interest on $750,000 of acquisition debt ($375,000 for married taxpayers filing separately) for mortgages starting on December 15, 2017. Homeowners whose mortgages started before December 15, 2017 may still deduct mortgage interest on $1,000,000 ($500,000 for married taxpayers filing separately) of acquisition debt.

The law limits itemized deductions for all nonbusiness state and local taxes including property taxes to $10,000. That does not go far in a state with high taxes. A married couple that owns a $700,000 house (below the median sales price on Oahu) will max out their tax deduction at a combined income of $98,875.15.

Real Estate investors can also take advantage of writing off investments per Section 179 of the tax code for roofs, heating and air-conditioning, fire protection, alarm systems, and security systems in addition to improvements of the interior portion of a building previously allowed. Like-Kind Exchanges per Section 1031 of the tax code for investment real estate remains.

Hawaii Act 107: The 2017 legislature raised taxes for high-income individuals and families. Taxpayers filing jointly pay a 9% marginal rate for income over $300,000 ($150,000 if filing separately), 10% marginal rate for income over $350,000 ($175,000 if filing separately), and 11% for income over $400,000 ($200,000 if filing separately). Hawaii taxpayers in these income brackets will already have reached the $10,000 cap on state and local tax deductions.

Residential A Changes: Residential property on Oahu without a Home Exemption is considered Residential A. Residential Property with a Home Exemption is taxed at 0.35% of the assessed value. The Honolulu City Council has raised the property taxes on Residential A properties as follows:

0.45% of the assessed value up to $1,000,000

0.9% of the assessed value for property over $1,000,000

If you are living in your Oahu home and have not filed for a Home Exemption, then you should do so immediately. Not only are you paying high property taxes, those property taxes may no longer be deducted from your federal income tax bill.

Normal Wear and Tear

The term, normal wear and tear, is normally associated with rental properties and we will touch on how to differentiate between normal wear and tear and tenant damage at the end of the article. This article discusses how normal wear and tear can affect owner occupied homes, second homes, and rental properties.

Hawaii’s Climate: Anyone that has lived in Hawaii for more than a few years can attest to the toll the warm, humid climate takes on homes. Exposure to winds directly off the ocean will accelerate the deterioration of paint, fasteners, windows, appliances, and electronics.

Hawaii’s climate allows residents to minimize or avoid the use of air conditioning and the high cost of electricity (3 times that of most areas in the United States) encourages conservation. Additionally, many older homes, including ours, were built using tongue and groove siding supported by 4 x 4 posts known as “single-wall construction.” The lack of insulation associated with single-wall construction makes air conditioning impractical and expensive. While single wall construction houses take advantage of Hawaii’s trade winds to keep a home comfortable, the interior of the home is exposed to the same humid air as the exterior of the home. Appliances, electronics, and fixtures, will rust, break, and fail more often than homes in dryer climates and more often than homes that have central air conditioning and heat.

The high cost of materials and labor compound the expense of cleaning and maintaining a property. One of the most common complaints that we receive from our clients has to do with the cost of repairs. Unfortunately, the price of owning a piece of paradise is expensive in more ways than one.

In the span of 15 years, Tracey and Tim have replaced every appliance once and our dishwasher three times. We have replaced each television once and our personal computer twice. The nails on the side of the house facing the ocean breezes started rusting within one year of painting the exterior. Every subsequent attempt of rust proofing the nails has failed so far. We recently replaced all of our kitchen cabinetry because the cabinets that came with the home literally disintegrated. Gorilla glue can’t delay a kitchen remodel indefinitely.

Detailing our experiences over the past decade is not meant to scare away potential homeowners or solicit sympathy. We are simply trying to establish a realistic expectation of what it takes to maintain a Hawaii home over an extended period of time. Tim often has discussions with investors who are convinced that careless or destructive tenants drive up their repair costs when the real culprit is “normal wear and tear.” We can assure you that we have not been abusing our house or our belongings.

Inspections and Routine Maintenance: Inspections are absolutely critical for people that own investment property and second homes that sit vacant for significant periods of time. One major source of new property management clients comes from owners that have come back to the islands to inspect their rental property and are shocked by how poorly the property looks and functions.

Owners who try to manage their investment property from out of state often rely on tenants to identify and coordinate necessary repairs for them. Some tenants, will not report problems and either try to make repairs themselves or just live with issues because they are afraid that the owner will raise the rent if “they complain too much.” The oblivious owner is happy that the “great tenant” pays the rent on time and keeps repair expenses low until he or she comes and visits the home for the first time in five to ten years. The owner discovers that their investment property is now a “wreck” and the owner does not have sufficient rental income to make the repairs because he or she kept the rent the same for fear of losing the “great tenant.”

Some property managers do not conduct routine inspections and fail to identify and correct maintenance items on a regular basis. Many of these property managers fall into the same trap of thinking that their tenants will notify them when normal maintenance should be completed.

Problems from Deferred Maintenance: The biggest problem from failing to address routine maintenance as required is the snowball effect on the cost and time involved to address several years of repairs all at once. Many people can handle a few hundred to a few thousand dollars and coordinate the efforts of one contractor as needed. Few people can write a check for tens of thousands of dollars and efficiently coordinate the efforts of several contractors when a house has suffered neglect over an extended period of time.

Repairs tend to get more expensive over time when left unaddressed. A simple matter of repainting the exterior when it wears becomes much more expensive if the wood rots when surfaces get exposed. Torn screens can lead to pest control problems and neglected leaks can lead to higher utility bills and water damage.

Renting a property with deferred maintenance invites a host of problems. The most responsible tenants typically have a minimum set of standards that a poorly maintained home fails to meet. The resulting tenant pool is limited to those tenants that have limited options due to financial constraints or credit issues. Additionally, many tenants will feel that they don’t have to care for a rental property if it appears that the owner does not care about it. It is very difficult to identify and properly document tenant damage and withhold funds from a security deposit in a poorly maintained home. Owners that rent poorly maintained properties run a greater risk of having to evict a tenant and suffer large losses from unpaid rent, attorney fees, and cleanup costs.

Strategies for Success: We typically recommend condos and townhouses in well-run associations for investors and people seeking second homes. Maintenance fees cover insurance for the building and external maintenance. Therefore, the only wear and tear that an owner has to worry about addressing personally are the contents of the unit and possibly the windows and entry doors. Owners in an association can also benefit from lower maintenance costs associated with economies of scale.

Investors should hire a property manager that offers routine inspections as part of their routine. Stott Property Management, LLC inspections serve three purposes. We check to see how the tenant is taking care of the property, we look for unreported maintenance issues that should be addressed, and we communicate normal wear and tear items that should be addressed either immediately or during the next vacancy. We have hired property managers to manage our Texas investment properties even though we have extensive property management experience. It is extremely difficult to manage a rental property when you are thousands of miles away.

Consider hiring a home inspector to do an inspection about every five years if you own a second home (particularly if you visit infrequently or make it available to friends and family). We are aware of an inspector that offers a discount to his standard rate for existing homeowners. You will receive an unbiased opinion on the condition of your home and can address repairs before they become more expensive problems.

Documenting Tenant Damage: The state of Hawaii requires that the landlord obtain a signed property inventory and condition from the tenant when a tenant checks in. If the landlord does not obtain a signed copy of the property inventory and condition form, then the landlord may not withhold any of the tenant security deposit for cleaning, repairing tenant caused damage, or replacing missing items. Stott Property Management, LLC takes digital photos or a video of their rental properties when a new tenant checks in to provide a visual record in addition to the signed property inventory and condition form.

The most common make-ready bills that Stott Property Management, LLC charges tenants after they check out involve cleaning and disposing of personal items left behind. We make sure that carpets have been professionally cleaned prior to a tenant checking in so that we can require the tenant to professionally clean the carpet when they move out. Making sure that a property is clean before a check-in helps minimize, but does not entirely eliminate, arguments over cleanliness during the checkout. Keep in mind that dirt is not normal wear and tear.

Disintegrating screens, rusted fixtures, disintegrating curtains, faded paint, and worn and faded carpet, and dry rot, are all considered normal wear and tear. Obvious tenant damage consists of holes in walls and doors, stains, cracked and broken surfaces, and bent window treatments. Trying to charge a tenant for “normal wear and tear,” may land you small claims court. The Hawaii court system is very tenant friendly and a landlord’s documentation must be in order if a tenant ever challenges money withheld from the security deposit.

Selling is an Option: As a general rule of thumb, an investor will need to put down at least 50% of the sales price to break even on a rental property. Oahu investors typically receive a far lower cash flow than investors who buy property in other parts of the United States. We believe that a real estate investment should improve your monthly cash flow. Think twice before turning your existing home into a rental if your calculations project a negative monthly cash flow before repairs. You would be better off selling and placing the tax-free capital gains into a savings account.

Homeowners that live in their homes for more than two years receive a significant tax break if they make money on the sale of their home. The capital gains tax exemption is $250,000 for a single person or $500,000 for a married couple. This huge tax advantage starts to disappear once you turn your home into a rental. Several would-be landlords decided to sell once we helped them crunch the numbers.

Second homeowners should be aware of a recent change in the federal tax code’s treatment of mortgage interest. Taxpayers can still write off the mortgage interest on a second home, but the combined value of the two mortgages (primary and second home) may not exceed $375,000 if filing singly and $750,000 if filing jointly. People that live in expensive zip codes that own a second home on Oahu may find that the reduced tax savings makes maintaining two homes unaffordable.

If after crunching the numbers, you are still unsure as to whether you want to sell or rent, then we can put your property on both the sales market and rental market at the same time. Please contact us at 800-922-6811 or home@stott.com if you would like to discuss selling versus renting in greater detail.

The Oahu median sales price continues to climb as supply constraints force buyers to pay more. The median sales price for single-family homes was $750,000 (2.7% higher than December 2016) and for condos was $405,000 (3.8% higher than December 2016) in December. There is currently only 2.1 months of remaining inventory of single-family homes and 2.3 months of remaining inventory for condos. Stricter lending standards and the relatively unaffordable housing prices appear to be constraining price increases when comparing this current housing price expansion to the previous decade’s.

The University of Hawaii Economic Research Organization (UHERO) has predicted a ninth year of economic expansion at a more subdued rate. Tourism, fueled by a strong economy, additional airline capacity, and the proliferation of non-traditional accommodations (vacation rentals) will grow at about 2%. Average visitor spending continued to drop and the sheer volume of visitors has stressed Hawaii’s existing infrastructure. Total visitor spending is expected to increase about 1% next year. There will likely be many more discussions and arguments over the positive and negative impacts of tourism in Hawaii.

Hawaii’s construction cycle has peaked, but construction should remain strong over the next few years. Residential home construction in Central and West Oahu continued with high-rise construction in Kakaako will keep construction workers busy.

The pace of job creation has slowed due to low unemployment. The lack of productivity growth in Hawaii’s service-oriented economy will dampen wage gains in the current tight labor market. UHERO predicts income will rise 1% while inflation will rise over 3% due to high energy and housing costs.

A Mixed Plate of Talk Story

Outward migration and a strong economy have resulted in the lowest unemployment rate on record. Hawaii’s unemployment rate in November dropped to 2% and the pool of available workers dropped 1,100 from October to November to 670,300. The U.S. Census Bureau estimates that about 13,500 more people have left the islands for other states than have arrived from other states from July 2016 to July 2017 and about 37,000 people have left the islands over the past five years. The state’s chief economist stated that a robust national economy and the lower cost of living elsewhere in the U.S. are contributing to the net losses. A recent study conducted by Harvard University reported that about one-third of tenants must dedicate at least 50% of their take-home pay on rent. Stott Property Management, LLC, lost the services of one of its plumbers when he moved off island. Skilled repair personnel are becoming harder to find across the board resulting in longer wait times.

Zumper has confirmed what many property managers, including Stott Property Management, LLC, have noticed. Zumper recently reported that the median rent for a two-bedroom apartment dropped 11% compared to the same time last year. A second report by Apartment List reported a much smaller decline of 0.3% for one- and two-bedroom apartments. Stott Property Management, LLC has recently had to lower asking rents in order to find new tenants for several vacant properties.

Uber has reached an agreement with the state of Hawaii to pick up airline passengers at Daniel K. Inouye International Airport (formerly known as Honolulu International Airport). According to Uber, you can find directions to the pickup locations within the app.

Southwest Airlines has confirmed that it will start flying to Hawaii next year and is also eyeing the interisland market. The announcement came just before Island Air filed for bankruptcy. Island Air joined the ranks of Hawaii’s failed island airlines after closing its doors on November 10th after 37 years in business. Island Air accounted for about 5% of the interisland market while Hawaiian Airlines had 90% market share before Friday’s closure. Island Air had been profitable while operating older 40-seat aircraft and ran into trouble when those older planes had to be replaced with newer planes that seated many more people. Island Air was unable to keep the newer planes full and ultimately ran out of cash. Hawaiian Airlines and Mokulele Airlines are currently the only commercial interisland carriers as several competitors have failed to gain a foothold over the past decade.

Hawaii is expected to welcome a record, 9.3 million visitors, in 2017, a 4.5% increase over 2016 visitor counts. The Department of Business, Economic Development and Tourism expects another 2.3% increase in 2018.

Castle and Cooke Hawaii broke ground on Koa Ridge, a $2 billion project that will include 3,500 new homes once completed. The project has been stalled for 20 years as the developer had to push through three state regulatory proceedings and two Hawaii Supreme Court challenges. Affordable housing advocates don’t have to look very hard to realize that government red tape is primarily responsible for Hawaii’s housing shortage.

Homelessness continues to capture headlines in the local newspapers and an article in the Honolulu Star Advertiser highlights the need to roll back regulation and unnecessary red tape before meaningful relief can take place. An Oregon based developer completed a 209-unit apartment building, Keauhou Lane, and started taking applications in August for 167 apartments reserved for residents that earn no more than the median income in Hawaii. The remaining 42 are reserved for residents that earn no more than 80 percent of the median income. As of November 11, 2017, when the article was written, only 33 of the apartments have been rented. The developer’s director of property management points out that the city’s income verification process and documentation requirements create unnecessary bottlenecks and wait times for tenants seeking approval. What is more striking is that the rents for a studio start at about $1,400, don’t include utilities, and don’t include parking which is $145 more per month. Stott Property Management, LLC does not have one studio apartment on the island that it manages charging more than $1,350 and several of those studio apartments are located in Waikiki and include assigned parking.

Stott Real Estate, Inc. recently felt the impact of the lawlessness associated with Honolulu’s homeless population when a fire under the H-1 viaduct damaged communication cables supplying Hawaiian Telcom’s phone and internet services. The fire caused cellular, cable TV, phone, and internet disruptions throughout Oahu and on parts of Maui. Our office was without phones and internet for the entire day on November 16th. While the fire remains under investigation, officials believe that the fire was intentionally set. The state recently cleared out 2,050 tons of trash from the area at a cost of $516,000. The state completed its last large homeless sweep in 2017 at a bike path near the H-1 viaduct early this month. 70 people, 20 dogs, and 22 guinea pigs were occupying the area when the sweep began.

The State Tax Director resigned amid concerns over the progress of the department’s IT upgrade and after the consultant for the project accused tax officials of interfering with its independent assessment of the project. The tax department requested changes to the reports before it was made public; a request that the consultant stated was not standard procedure. The consultant was hired after a string of failed information technology projects at the state government level dating back several administrations. The first two phases of the tax modernization project have been completed with hearings on the problems related to the General Excise Tax modernization efforts. The latest report stated, “At present, the program is not operating in an optimal way. There continue to be a number of issues and risks related to the program execution that, if not addressed and remediated immediately, may have a significant negative impact on the program’s ability.” House Finance Chairwoman, Sylvia Luke, a frequent critic of the tax office stated that the report is “shocking and it’s sad.” Luke went further by stating, “It completely undermines the credibility of the report and what they have said in the past, and I’m not sure how the consultant can allow this to happen, and I don’t know how the Department personnel can ethically insert themselves to maneuver and manipulate the information in these reports.” Governor Ige tried to explain away the tax officials’ behavior by stating, “change is hard.”

The Honolulu City Council gave approval for the city to begin condemnation proceedings for an easement over a small lane off Portlock Road to restore public beach access. One of the property owners installed a new locked gate that effectively blocked access to the beach on the advice of police. The owner is objecting to the city’s efforts to condemn part of his property to restore access. The controversy highlights a risk associated with owning beachfront property, particularly when the public uses a portion of the land to access the beach.

Former HPD police Chief Louis Kealoha and his wife, Deputy Prosecutor Katherine Kealoha were arrested on Friday, 10/20/17, and appeared in federal court to face charges of conspiracy, obstruction of justice, making false statements and bank fraud. The former HPD police chief put himself on paid leave in mid-December when he was informed in writing that he was a target of a criminal investigation by federal authorities. Louis Kealoha retired in February and Katherine Kealoha was placed on unpaid leave on Friday, 10/20/17. Many consider the legal developments to be the most significant case of public abuse of power in state history.

The sound of church bells rang on Saturday, November 11, 2017, marking the 100th Anniversary of Queen Lili’uokalani’s death. When she died in 1917, church bells across the islands rang out over the islands she once ruled. Queen Lili’uokalani was the last sovereign of the Kamehameha dynasty that ruled the Hawaiian Kingdom since 1810. By the time that she became queen, a new Hawaiian Constitution had reduced much of the monarchy’s powers. When she tried to restore those powers, a coup supported by the U.S. Marines deposed her in 1893, and a provisional government was established about a year and a half later. The queen signed a formal abdication of her rule in 1895 but asked President Grover Cleveland to help restore her powers. The United States annexed Hawaii in 1898. Queen Lili’uokalani helped raise money for the Soldiers Chapel at Schofield Barracks, one of the churches that rang the bells on Saturday.

Taking care of Hawaii’s aging population has recently been getting more attention and divisions are occurring on similar lines as other recent contentious issues like vacation rentals and affordable housing. A cottage industry has been growing up in response to the expense associated with and lack of availability to traditional assisted living communities and nursing homes. The Honolulu Star Advertiser recently ran a front-page article concerning unlicensed elder care facilities called “aging in place” (AIP) facilities. The AIP model involves having a resident sign a residential lease and a separate agreement with a home health care company specifying a set rate each month for necessary care and assistance with daily living activities. The model appeals to many people that need assistance because they would rather live in a home environment and have help versus being forced to live in a nursing home. Homeowners have had an aging in place option available to them for years. The AIP proponents argue that this relatively new arrangement is more affordable and with more options than traditional licensed assisted living and nursing home options. Opponents of the measure claim that the lack of state oversight leaves unprotected seniors at risk of harm. Attorneys that have helped set up AIP facilities state that the arrangement complies with Hawaii law while some state regulators claim that the facility operators are trying to skirt the spirit of the law. Ultimately, the legislature and courts may decide if seniors that want assistance will be able to continue choosing where they can rent and choosing the type of care that they want at home.

Erosion, which accelerated this summer from king tides, has exposed concrete structures on parts of Waikiki Beach has forced the closure of an area at Kuhio Beach. The Waikiki Beach Special District Improvement Association, funded by a tax on commercial property in Waikiki, discussed replenishing the sand, among other necessary capital projects, during its first meeting on December 5th. The annual taxes generate about $600,000 per year to address Waikiki’s aging infrastructure. Severe erosion at Sunset Beach has forced the City and County of Honolulu to move a bike path closer to Kamehameha Highway, take down a storage shed used by the life guards, and move the life guard tower farther inland.   A 20-foot drop off now marks the area where winter waves removed tons of sand from Sunset Beach. The city is working with the state to come up with a long-term plan since the erosion is expected to continue and there are no easy solutions. City officials short-term goals consist of taking measures to keep people from getting hurt at Sunset Beach and other Oahu locations that have experienced significant erosion over the past couple of years.

Longtime Honolulu resident, Jim Nabors, best known for his role as Gomer Pyle, died on November 30th at the age of 87. Tim and Tracey attended a Merry Christmas show at the Hawaii Theatre starring Nabors. His tremendous singing voice and low-key nature endeared him to many in Hawaii and made him a local fan favorite.

Two Honolulu women were rescued from their disabled 50-foot sailboat 900 miles southeast of Japan after drifting for five months. The pair left Ala Wai harbor on May 3rd destined for Tahiti. The two survived by packing a year’s worth of food on the boat and brought along a water purifier.

Odds & Ends

The Tax Cuts and Jobs Act: This article is meant to highlight changes to the tax code in 2018. However, we are not licensed to provide either legal or tax advice. Licensed professionals like tax attorneys or certified public accountants (CPAs) should be consulted for advice.

The new law doubles the standard deduction to $12,000 for individuals and to $24,000 for married couples. A significant number of homeowners will no longer have to itemize their deductions. This will simplify the tax returns from some homeowners while providing a tax break for renters.

For those homeowners that will continue to itemize their tax deductions, the law limits interest from mortgages incurred after December 15, 2017 to no more than $750,000 that will qualify for the home mortgage interest deduction. Mortgages incurred before December 15, 2017 are unaffected (the $1 million limit still applies). However, interest paid on a Home Equity Line of Credit (HELOC) will no longer be eligible for the home mortgage interest deduction. The law still preserves the mortgage deduction for second homes.

State and Local tax deductions are limited to $10,000. Therefore, residents in high tax states may not be able to deduct all of their property taxes in 2018. Many Hawaii taxpayers will have a smaller deduction in 2018 due to this change in tax law.

The homeowner’s exemption for capital gains and the ability to defer taxes via a 1031 exchange did not change. Homeowners that have lived in a property two of the last five years will be able to exclude $250,000 in capital gains if filing single and $500,000 if married filing jointly.

The treatment of mortgage interest on investment property has changed and is more complicated. An investor’s net interest deduction will be limited to 30 percent of earnings before interest, taxes, depreciation, and amortization (EBITDA) for the next four years and then it will be limited to 30 percent of earnings before interest and taxes thereafter. A rental property owner will still be able to fully deduct property taxes associated with their rental property. Depreciation for residential rental property has been extended from 27.5 years to 30 years and on commercial real estate from 39 years to 40 years.

The law also restricts taxpayers from deducting losses incurred in an active trade or business from wage income or portfolio income. As a result, real estate professionals should be aware of how this change might affect them in the future if they own investment real estate showing a net loss.

Oahu’s Appliance Challenge: Plan on installing stainless steel appliances if you are remodeling your Oahu kitchen in the near future. Major appliance companies are stocking fewer white and black models.

Tastes in the world of kitchen appliances have changed over the past few years and people who are contemplating a kitchen remodel should take notice. White and black kitchen appliances are out and stainless steel is in. Trying to replace a white dishwasher has frustrated Tim and Tracey over the holiday season. Neither Sears nor Best Buy had quiet (below 50 dB) white dishwashers in stock and it takes at three weeks to get one shipped from California. Waiting for an available plumber to install the dishwasher adds even more wait time.

Tracey has been willing to wait for an “acceptable” dishwasher since Tim has dish duty at the Kelley house. She commented recently on how frustrating it is to look at the pile of dirty dishes waiting to be cleaned.

1031 Exchange Overview

Purpose: The purpose of this article is to provide an overview of a 1031 exchange. The article is rather basic and not intended to be a guide to an actual exchange, as it omits rules and that could significantly impact upon a 1031 exchange. We have prepared a more detailed paper in a question & answer format using layman terminology that explains the process in considerably more detail. To obtain a copy, check the applicable block on the enclosed postcard and return it. If you provide us your e-mail address, we’ll e-mail you a copy of both the 1031 paper and the HARPTA paper that discusses the Hawaii law that enables the state to collect estimated capital gains taxes from owners that might not file a Hawaii tax return in the year of the sale.

Note: We have participated in a large number of 1031 exchanges. However, we are not licensed to provide either legal or tax advice. Licensed professionals such as attorneys or CPA’s should be consulted for such advice. This comment applies to the entire newsletter.

Note: This paper will use the terms “old property” for the property being sold and “new property” for the property being purchased. A property may consist of more than one piece of real estate.

Background: Section 1031 of the internal revenue code (IRC) provides for the deferment of long-term capital gains taxes on the sale of investment real estate when it is exchanged for other investment real estate of equal or greater value than the real estate being sold. A common misconception is you will have to find someone to trade properties with you. Most 1031 exchanges involve two entirely separate transactions. In one transaction, you sell your old property and in the other, you purchase your new property. There is normally no reason for the buyer of your old property and the seller of the new property to have any contact with each other. Often, the properties are located in two different states; e.g., most of our exchanges involve property in Hawaii being exchanged for property on the mainland.

Qualified Intermediary (QI): The IRS mandates that you use a completely independent third party to supervise the exchange. Because this third party must be completely independent, it cannot be your real estate agent, accountant or attorney. The independent third party is usually referred to either as an intermediary or as qualified intermediary (QI); however, in some areas of the country the third party may be called either a facilitator or an accommodator. This paper will use the term “QI.” The QI can be located anywhere in the country; they do not need to be located near you or near either of the properties involved in the exchange.

The following steps have been changed; however, they help explain the role of the QI. The QI takes title to the old property for a brief instant in the process of having it sold from you to the buyer; i.e., title passes from you through the QI to the buyer. Similarly, the QI takes title to the new property for a brief instant in the process of having it sold from the seller to you. Therefore, the QI has owned both the old and the new properties and can exchange one for the other. Today, the QI no longer has to hold title to both properties. In 1991, the real estate industry successfully lobbied Congress to have the law changed, as escrow companies were charging double escrow fees; i.e. Seller to QI and then QI to you. Today, in lieu of taking title to both properties, the QI is tasked to provide instructions so that both transactions are closed in a manner that conforms to section 1031 of the IRC.

Properties & Timing: Both the old property and the new property must be investment real estate; in most cases they are rental properties. The two properties do not need to be the similar; e.g., you could exchange a house in Hawaii for two or more Mainland condos and vice versa. Almost any type of real estate qualifies such as a house, condo, store, office or even vacant land. However, your personal residence or a second home does not qualify. You could rent the new property first so that it qualifies as investment property and then occupy it yourself. Many of our clients do this; i.e., they use equity in their Oahu property to assist them in purchasing a future Mainland residence. The new property must be rented for at least a year prior to being occupied in order for it to qualify as investment real estate.

With some very few exceptions, all of the exchanges made by our clients have been deferred exchanges where the old property is sold prior to purchasing the new property. It is possible to do this in reverse order and purchase the new property first; i.e., prior to selling the old property. This is called a reverse exchange and is far more complicated and expensive than a deferred exchange. This article is based upon deferred exchanges. Over half of our deferred exchanges involved absentee owners conducting their first 1031 exchange.

When the old property closes, the proceeds from the sale go to the QI who banks the funds until you’re ready to purchase the new property. To defer all your capital gains taxes, you must buy new property that is equal to or higher in value than the old property. You must also reinvest all the cash proceeds from the sale into the purchase of the new property. The QI maintains the funds from the sale of the disposable property and then makes those funds available in order to enable the purchase of the new property. You cannot have access to any of the proceeds from the sale of the old property or those funds will be taxed.

There are two key time frames both measured from the closing date of the old property. Failure to meet either of these two time frames negates the tax-deferred 1031 exchange.

  1. Within 45 days, the new property must be identified in writing to the QI. You can make changes to your identification any time within the 45-day-period; however, on the 46th day, you are locked-in to whatever has been identified as new property.
  2. Within 180 days, the new property must close. You can identify more than one property; so if your preferred new property falls out of escrow, you could shift to a replacement new property that was identified during the 45-day-period; however, it would still have to be closed within the 180-day-period. Most exchangers identify more than one new property.

Deferring Taxes: A 1031 exchange enables an owner to be able to defer both the federal and state capital gains taxes that they have on the sale of their old property and roll those taxes over into the new property. Note that the taxes are deferred, not excluded. The current federal capital gains tax rate for most exchangers is 15% on all component of gain except depreciation recapture, which is taxed at 25%. The federal capital gains rate does jump to 20% above certain income thresholds depending on how you file. The Hawaii capital gains tax rate is 7.25% on all components of gain including depreciation recapture.

Recent rules: Three relatively recent rules apply to principal residences. The tax relief act of 1997 enabled a homeowner to sell their principal residence and exclude up to $500,000 of gain (married) or up to $250,000 (single) providing they had occupied the home for an aggregate 24 out of the prior 60 months. So an owner only needed to own the property for three years, one year as a rental to qualify for the exchange and then two years as a principal residence to qualify for the tax relief act of 1997. In October 2004, there was a change to the 1997 law. An owner who acquired their principal residence by way of a 1031 exchange must now own the property for at least five years before they sell it in order to be eligible for the exclusion. The owner still needs to rent it for one or more years so it qualifies for the exchange and then have it be their principal residence for at least two years. The exchanger also has to pay depreciation recapture on depreciation claimed (after May 6, 1997) while the property was a rental; i.e., depreciation recapture while the property was a rental will not be excluded.

The Housing and Economic Act of 2008 reduces the capital gains that can be excluded when a homeowner sells a principal residence that they held as an investment property for a period of time as the amount of the tax exclusion will be adjusted by the non-resident use of the property. This law became effective 1/1/09. The amount of time of non-resident use after 1/1/09 is the numerator or top of a fraction with the bottom or denominator of the fraction being the total time since property acquisition. That fraction times total gain (exclusive of depreciation recapture after May 6, 1997) is the gain that will be taxed to the homeowner.

Example: Single Mary bought her Oahu home on 1/1/93 for $200,000 and rents it for 18 years until 1/1/11 when she occupies it as her principal residence. Five years later, on 1/1/16, Mary sells the property for $500,000 and has $300,000 of gain.

The non-residence use of the property by Mary prior to 1/1/09 does not apply to the new law. Therefore, Mary has only two years of non-residence use (1/1/09 to 1/1/11) when she then occupies it as her principal residence. Five years later on 1/1/16 Mary will have owned it for a total of 23 years. Therefore, the fraction for non-resident use is 2/23. Or, the taxable gain is $300,000 x 2/23 or $26,087. The remaining $273,913 exceeds the $250,000 limit for single Mary, so Mary ends up with $50,000 taxable ($26,087 + $23,913) and $250,000 that is excluded. Mary would also owe depreciation recapture after May 6, 1997.

The example uses a long period of ownership before the eligibility date. If the property were acquired after the 1/1/09 eligibility date, the fraction will be much larger. For example, assume the property is acquired on 1/1/09, rented for three years and then occupied for two years, the non-resident use would be 3/5 or 60%. However, if it is rented for only one year and then occupied for four years, the non-resident use would only be 1/5 or 20%. Every day it is a rental property after 1/1/09 increases the capital gains taxes to the owner.

Granted, the new law has no impact if the owner never sells the property; however, few homes remain suitable for the same family over any extended period of time. Over time, most families desire a different location and/or a larger/smaller/more prestigious or a completely different type or style of home particularly after they retire or become empty nesters.

Reasons to Exchange: Most exchangers use 1031 exchanges to defer capital gains taxes. Many have long-range plans to eventually exclude their deferred taxes by converting a rental property into a primary residence even with ownership now a required five years. With proper planning, this is still a very viable investment tool, particularly for property bought prior to January 1, 2009.

Some final thoughts: A 1031 exchange is not the right investment tool for everyone. Over the years, we have assisted many owners in making a decision not to conduct an exchange. Often, all that was required was for us to estimate the owner’s capital gains taxes. Contact us toll-free (1-800-922-6811), locally (808-254-1515) or via e-mail (home@stott.com). Since recent tax law changes have made estimating capital gains taxes exceedingly complex, we recommend speaking with a Certified Public Accountant (CPA) or tax attorney prior to deciding on a course of action. Due to the value of real estate on Oahu, you will likely be pushed into the higher tax brackets if you have owned the investment property for a significant period of time and the resulting tax bill could be costly if you don’t conduct a 1031 exchange.

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.

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.

Median sales prices continue to hover in record territory as demand continues to be strong with limited supply. March’s median sales price for single family homes was $752,000 (3.7% higher than March 2016) and for condos was $400,000 (3.9% higher than March 2016). The number of closed sales grew modestly and there are currently only 2.7 months of remaining inventory for both single family homes and condos. Demand will likely remain strong since the number of pending sales (properties under contract that have not yet closed) is 30% higher for houses and 24% higher for condos in March 2017 as compared to March 2016.

In a sign of flattening economic activity, Young Brothers Ltd. reported shipments between interisland ports dropped 0.6% in 2016. The announcement lends support to the University of Hawaii Economic Research Organization’s (UHERO) that economic deceleration is underway after seven years of sustained economic growth. Tourism revenue has been essentially flat when compared to the decade before the Great Recession despite Hawaii hosting significantly more visitors now than a decade ago. The amount of revenue generated per visitor has steadily declined, partly due to the strong dollar. Oahu, which receives most of the visitors, saw spending decline 3% when compared to 2015 while the neighbor islands, which are more dependent on domestic visitors, have seen gains between 4% and 9%. Construction and health care are expected to moderate after strong gains over the past two years. The biggest economic uncertainty comes from federal spending. 55% of federal dollars spent in Hawaii is associated with the Department of Defense. Hawaii has recently seen a net migration of military and support personnel leaving the islands. A federal hiring freeze and shifting priorities could have a negative impact on Hawaii’s economy. Falling energy costs have recently kept a lid on inflation. That trend is ending and inflation is expected to pick up due to rising home prices and rents. The forecast through the end of the decade predicts slowing economic growth.

A Mixed Plate of Talk Story

A study by local housing analyst, Ricky Cassiday, concluded that online booking site Airbnb has had no material impact on Hawaii’s housing market in contrast to claims made by some local politicians. Homes booked through the website represented only 1.53 percent of the statewide housing stock and 88 percent of those homes were booked less than half the year. Cassiday concluded that Airbnb listings represent a miniscule amount of the housing stock in Hawaii and it is clear that owners are using these homes most of the time. Cassiday stresses that the supplemental income provided by renting out rooms is equivalent to a 12 percent raise for the median local household and serves as a vital economic lifeline to many hosts. He notes that housing availability and affordability are not impacted by the number of short-term rentals, but are impacted by complex housing regulations and zoning laws, limited supply, and a lack of infrastructure.

The number of Airbnb listings on Oahu has nearly tripled over the past two years with the majority of active listings consisting of single bedrooms in houses and condos. The average daily rate has also jumped 24% from 2015 to $237 per day. The Hawaii Tourism Authority chimed in that they are concerned that the lack of regulation in the vacation rental market could take away years of quality control built by the hotels despite 95% of Airbnb listings having four-and-a-half or five star ratings. The comment speaks volumes to the state’s protection of the hotel industry at the expense of the island entrepreneur. Hawaii will always be an expensive place to live. It may be time to recognize that those living on the islands should be able to open up their homes to visitors so that they can afford to live in one of the most expensive places in the country. Local and state politicians remain focused on a continuous failed effort to provide government funded or mandated affordable housing. Tim and Tracey have very different views concerning vacation rentals in residential neighborhoods and vigorously debate the issue constantly.

In related news, The University of Hawaii Economic Research Organization (UHERO) posted two excellent articles regarding tourism in Hawaii and transient rentals in Hawaii neighborhoods. The blog posts are titled “How Many Tourists is Too Many” and “Regulating Home-Share Rentals in Hawaii.” You can find the articles at UHERO’s website: http://www.uhero.hawaii.edu/news

Foreclosure activity in Hawaii grew 29% in 2016 compared to 2015 while foreclosures at the national level dropped 14%. About 55% of the foreclosures in Hawaii are from loans that were originated between 2004 and 2008. The Hawaii legislature passed bills that Governor Neil Abercrombie signed back in 2011 that essentially eliminated non-judicial foreclosures in the state with the advertised goal of improving consumer protection. All that the changes in the law have really done is delay the inevitable. Lenders are finally working through the legal mess that the legislature created and the courts are working through the backlog of cases.

The contested case hearing for the Thirty Meter Telescope project (TMT) concluded in March after 44 days of witness testimony. 71 people testified in the case and it is estimated that it could take court reporters five to six weeks to complete the written transcripts. Once the written transcripts have been completed, the parties in the case have 30 days to submit their proposed decisions, followed by a two-week period in which the parties can object to the other party’s proposal. After the process is completed, the hearings officer will make the decision on whether TMT will receive the permit to begin construction. Even if the hearings officer approves the permit, another judge ruled that another contested case hearing should have been held over the project’s sublease with the University of Hawaii. TMT is taking concurrent steps to build the telescope in the Canary Islands on the same time scale. TMT’s international board is making the case that the mountain in the Canary Islands would be an excellent alternative and Spanish lawmakers have embraced the project. TMT officials have reached an agreement to build their giant telescope on the island of La Palma in case they are unable to begin construction on Mauna Kea next year. It would be a shame if Hawaii’s governments’ focus on bureaucratically driven, politically correct processes once again get in the way of a project that receives strong support from a majority of the residents. Remember the SuperFerry?

A UHERO report criticizes the state for keeping 10% of the General Excise Tax (GET) surcharge for the island of Oahu as being excessive. Act 247 suggests that the costs recouped by the state should reflect the additional burden imposed by collecting and administering the surcharge. However, the fee collected by the state for the surcharge has exceeded the entire budget for the State Department of Taxation each and every year the surcharge has been collected. UHERO calculates that it costs the state 0.35% of the GET surcharge revenue to administer the additional tax. In other words, the state pocketed 9.65% of Oahu taxpayers’ money for spending other than rail. The report highlights the hypocrisy of state lawmakers who rail against the much-maligned elevated train project while reaching into the pockets of Oahu taxpayers. The City and County of Honolulu is now asking the state to make the GET surcharge permanent in order to complete the Honolulu Authority for Rapid Transit’s rail project to Ala Moana Center.

House Finance Chairwoman Silvia Luke has demanded that financial and computer experts investigate the $59 million project to replace the computer systems at the state Tax Department. Luke said she had difficulty registering on the new tax system and that a security code that was supposed to be sent to her phone never arrived. Even when she finally did successfully register, she struggled to make the new system work. Stott Property Management has been working since August to register their clients into the new system. One glitch is that the new system does not currently allow you to specify the period being filed. That issue has already resulted in one letter from the tax office claiming that the payment was late. In other cases, state tax employees have assigned incorrect federal Tax IDs to the new state Tax IDs and are requiring letters from the IRS before correcting their errors. State officials agreed to look into the issues and see what progress the Tax Department is making.

The wheels of progress may finally be starting to grind now that the state agency that oversees Aloha Stadium has approved a plan to build a new 30,000 to 40,000-seat facility that would ultimately replace the rusting Aloha Stadium. It appears that the departure of the Pro Bowl and rejection by the U.S. Women’s Soccer Team may have finally woken up complacent state officials to one example of the state’s neglected infrastructure. The resolution comes at a time when both city and federal deed restrictions may be lifted which would allow more development of the 100 acres of land at the stadium. A HART rail transit station will be built on the site. Hopefully some of the new development will include adequate parking. The Honolulu Star-Advertiser reports that a consultant has warned in a report that the 43-year-old Aloha Stadium has “served its useful life and is now a liability for fan experiences, a potential danger to public health and safety and a financial burden for maintenance and operations.” The report notes that inspections have identified pieces of the building that have fallen into public areas of the facility highlighting the risks to the public. The appointed nine-member authority is not bound by the reports. Can you imagine what would happen to a rental property owner if they received a report from a structural engineer citing immediate risks to a tenant’s health and well-being? Stott Property Management has seen the City and County of Honolulu withhold rent payments for arbitrary and minor inspection deficiencies. It appears that there is a double standard.

The state Department of Transportation had awarded a contract to build a $73 million maintenance and cargo facility at the Honolulu Airport six years ago. The facility should have been finished in 2015 and is now languishing as the state, contractor, and sub-contractors sue each other over the construction debacle. The construction delays have effectively stalled other airport improvement projects that can’t begin until the maintenance and cargo airport project have been completed. In 2013, state officials predicted that the $739 million airport modernization project would be completed next year. Hawaiian Airlines is now being asked to take control of the project from the state to complete the project. Hawaiian Airlines has reported that the work completed so far has been pretty shoddy and they are most concerned about the significant cracks that have appeared in the hangar’s concrete flooring. The cracks could be the result of the foundation settling. Hawaiian Airline’s CEO estimates that the final bill for the hangar project will be about $120 million, about 65% over budget. The Honolulu Airport Modernization project was initially announced when Linda Lingle was Governor and the entire project was expected to take four years. Neil Abercrombie took office in 2010 and he ordered a pause in the plan for a review that delayed the project for a couple of years. It looks like Hawaii taxpayers will be footing the bill.

University of Hawaii’s iconic women’s volleyball coach, Dave Shoji, has announced his retirement after 42 years as the Rainbow Wahine’s head coach. Shoji’s legendary career includes the second most number of wins ever, 1,202, and four national championships. Robyn Ah Mow-Santos, a former All-American, Olympian, and assistant coach will try to continue the program’s success as only the third head coach for UH in the women’s volleyball program’s history. Ah Mow-Santos is considered one of the greatest players in school history. UH fans hope that she can continue her success as the head coach.

Aloha Beer Company opened a Honolulu tap room January 19th on Queen Street in Kakaako. The tap room offers a variety of beers brewed in-house and crafted cocktails and the menu includes smoked meats, pickles, salads, and sandwiches. The tap room is just another member of a vibrant microbrewery industry in Hawaii.

Maui Brewery Company quickly followed suit and opened their first brewpub on Oahu in a space at the Holiday Inn Resort Waikiki Beachcomber in Waikiki on January 31st. Tim is eagerly awaiting their second brewpub that is scheduled to open in downtown Kailua in early 2018.

If you’re looking for a caffeine fix and want to try something other than Starbucks, Island Brew offers a local alternative specializing in 100 percent Hawaiian grown coffee and espresso. Island Brew just opened its third Oahu store in Ala Moana Center next to Bloomingdale’s on the third level. Island Brew also has stores in the Hawaii Kai shopping center and Kaimuki Atrium.

Stott Real Estate Fun Fact: In apparent anticipation of the Chinese New Year, a rooster had taken up residence on the grounds outside of Stott Real Estate’s office. We received a daily reminder that it is the year of the rooster according to the Chinese calendar. The rooster eventually disappeared in March.

Odds & Ends

Private Mortgage Insurance: Many lenders require a borrower to purchase private mortgage insurance (PMI) if a borrower makes a down payment of less than 20% when buying a home. The policy protects the lender if the borrower defaults on the mortgage, the lender forecloses, and the lender has to sell the home at a value less than the loan principal. The borrower typically pays a monthly premium that is tacked onto the principal and interest payment at a rate that is based on the borrowers credit score. That monthly premium can be several hundreds of dollars on a Hawaii mortgage.

A lender is required to automatically cancel the PMI when your outstanding loan balance drops to 78% of the home’s original value. You can speed up the cancellation of mortgage insurance by keeping track of your loan balance and asking the lender to cancel the mortgage insurance when the loan balance reaches 80% of the home’s original value. The following criteria must be met for cancelling PMI:

  • The cancellation request must be in writing.
  • You must be current on your payments and have paid your mortgage on time.
  • You may have to prove you don’t have any other liens on the home (home equity loan for example).
  • You might have to obtain an appraisal to show your loan balance is 80% of the home’s current value.

You can reduce the amount of PMI you pay over the life of the loan by refinancing if the home’s value has increased enough. The new lender won’t require mortgage insurance and you may also lock in a lower interest rate. Even if the interest rate is slightly higher, the additional interest may still be lower than the monthly PMI premium payment.

You can also reduce your loan balance quicker by making additional principal payments every month. Principal payments are a small percentage of the monthly payment for the first few years of a mortgage. Modest additional month payments of $50 to $100 per month can significantly shorten the time that you must make the mortgage premium payments. Once the PMI is removed, you can then increase your additional principal payments by the amount of the insurance premium to more quickly pay off your mortgage.

Please note that recent FHA-insured loans require mortgage insurance premiums for the life of the loan. Therefore, you will have to refinance your mortgage to eliminate the FHA mortgage insurance premiums if you have a FHA-insured mortgage.

Furnished versus Partially Furnished Rentals: Prospective rental property owners often ask us if they should rent their property furnished, partially furnished, or unfurnished. An unfurnished rental property implies that the tenant must also install appliances in the rental property in Hawaii. There are very few unfurnished rental properties in Hawaii and Stott Property Management recommends rental property owners provide the appliances. The decision to rent a property furnished versus partially furnished depends on a number of factors including the length of the lease offered, the location of the property, and the owners’ plans for the property.

In general, we recommend renting a condo or house partially furnished if the owner is offering to lease a property for a year or more. Most long-term tenants have their own furniture and want to move those furnishings into their new rental property. Additionally, once a tenant has moved into a property, they are less likely to move out of the rental property because they will have to move their furniture as well. Stott Property Management’s experience shows that fully furnished rentals have higher vacancy rates and similar rents compared to partially furnished rentals. The owner of a fully furnished rental property does not receive sufficient rental income to offset the wear and tear of the furnishings when renting long-term. In fact, worn out or dated furniture will make a rental property harder to rent even if the property is in good condition. Stott Property Management frequently recommends to clients with fully furnished units to throw away worn out furnishings and rent their property partially furnished if the association requires a minimum lease of at least three months.

We sometimes get asked if we could rent a partially furnished property for less than one year. Our experience has shown that most tenants want to sign a one-year lease if they are going to take the time, money, and effort to move their furnishings into a new home. Most tenants won’t sign a lease knowing that they will have to move again in the near future.

We recommend renting a property furnished if the owner plans on using the property for personal use during a specified period or periods every year. Stott Property Management has clients that live in the unit every year for a few months and then rent their unit during the remainder of the year. The rental income helps defer some of the costs associated with owning a second home.

We also recommend renting a property furnished if the condo is located in buildings that allows short-term rentals (less than one month). Most of the buildings are located in Waikiki, however, there is one building in Ko Olina that allows weekly rentals and there are condos and townhouses in Turtle Bay that also allow rental periods less than one month in duration. In most cases, the daily rental rate is significantly higher for a short-term rental than it is for a long-term rental and the annual net income is still higher even with higher vacancy rates and management fees. Please note that Stott Property Management does not manage vacation rental properties. Stott Property Management’s minimum lease period is three months.

Military Pops Cost of Living Bubble: The Department of Defense has reduced the cost of living allowance, known as the acronym BAH, in each of the last two years and it is having a noticeable effect on rents at the higher end of the scale. In 2015, an E6 (mid-level enlisted member) received a cost of living adjustment of $3,048 per month. That figure dropped to $2,904 per month in 2016 and rose slightly to $2,961 in 2017. In 2015, an O4 (mid-level military officer) received a cost of living allowance of $4,062 per month. That figure dropped to $3,786 in 2016 and dropped to $3,615 in 2017. I chose these two categories because several of our clients express their desire to rent to a military family. You can pull up all the BAH information by googling BAH rates for the given year and selecting the pdf file link on page 1 of the search.

Stott Property Management has had to significantly reduce asking rents for houses and condos that previously rented for more than $3,000 in late 2016 to early 2017 to attract paying tenants. Stott Property Management’s clients with properties in the higher rent category have experienced monthly reductions in rental revenue ranging from $200 to $500 per month, which directly corresponds to the reduction in Oahu military members BAH. This trend has been particular noticeable in neighborhoods near military bases like Kailua, Kaneohe, and Aiea.

The last two years would make an interesting case study for an economist or graduate student regarding the effects of government subsidies on housing affordability. The Department of Defense seems to have realized that it was competing against itself in the Oahu rental market as individual military families bid up market rents in neighborhoods with limited supply. By reducing BAH, the Department of Defense effectively reduced the amount of money a military family could spend on housing and the market rents in these neighborhoods fell accordingly.

Truth in Advertising: Many headlines have been written in the paper over the years when a large company is fined by the government or sued by customers for exaggerating the benefits of their products or services. Both landlords and sellers should carefully consider this concept when it comes to renting or selling a property.

How does “truth in advertising” apply to rental properties? The state of Hawaii codifies the concept in the Residential Landlord-Tenant Code and failure to abide by the law can be costly to owners of investment property in Hawaii. One chapter of the code requires that, “landlord to supply and maintain fit premises.” The state goes further by specifying that the landlord shall “maintain all electrical, plumbing, and other facilities and appliances supplied by the landlord in good working order and condition, subject to reasonable wear and tear.” In practical terms, if a landlord does not want the responsibility of repairing a fixture in their rental property, then the fixture should be removed before showing the property to prospective tenants and signing a lease. Otherwise, the state allows the tenant to repair a fixture and reimbursing themselves by reducing future rent payments by the cost of the repair subject to certain limits. Therefore, landlords may not refuse a repair request to repair or replace an air conditioner, for example, even if the landlord writes a clause in the lease specifying that the air conditioner will not be repaired or replaced. Please note that wear and tear applies to the appearance of a fixture and not its functionality. The landlord is obligated to address function problems with any fixture or appliance if the fixture or appliance was present at the time the tenant checked in.

The concept applies to Sellers in the form of the Seller’s Real Property Disclosure Statement. The document is five pages long and may only be filled out and signed by the seller or sellers of a residential property. There are over 100 items pertaining to the condition of a property that the seller must consider and respond to. While the disclosure statement is not a warranty of any kind by the seller, it can be an effective defense if the buyer claims that the seller misled them regarding some perceived defect in the home and the seller can show that he or she documented it in the Seller’s Real Property Disclosure Statement.

Contractor Shortage: The Wall Street Journal published an article in their editorial section about the growing shortage of labor in both agriculture and construction. While food is a concern for most, the labor shortage in construction has been an issue on the islands for several years.

The Bureau of Labor Statistics reported that there are roughly 150,000 unfilled construction jobs across the country, double the number five years ago. One factor driving the issue is that the current construction workforce is graying (Hawaii’s median age is higher than the national average) and many of the workers that lost their jobs during the recession have simply retired or found other areas of employment.   A January survey of the Associated General Contractors of America found that 75% of the firms had a hard time finding qualified workers and that worker shortages were a bigger concern than government regulations. The problem is expected to get worse since most high schools have dropped vocational training and most colleges don’t teach technical skills.

Stott Property Management has seen the worker shortage manifest itself in many ways on Oahu. One client recently asked us to obtain an estimate from his contractor friend to replace kitchen and bathroom cabinetry. The contractor friend replied that he would not be able to inspect the condo and provide an estimate for five months because he is backed up with committed home improvement projects.

Stott Property Management uses a couple of plumbing companies that provides emergency after hour repair services. There have been two cases in the past two months where Stott Property Management authorized emergency repairs to be done over the weekend, but the companies did not have enough plumbers available to get to the property until the following Monday. Phone calls to other plumbers resulted in the same answer. Stott Property Management continues to contact and interview plumbers regarding 24-hour emergency service.

We are witnessing more and more cases of workers simply being unavailable. Try to be patient if you need repair work ranging from simple repairs to major remodels. You will likely have to wait much longer than you have previously.

The Price of Paradise: What is the price of paradise? A basic rule of thumb that seems to work reasonably well is add 40% to the cost of any item advertised in the Continental U.S. A recent example is the KFC promotion for their $5 Fill Ups promotion that is advertised in Hawaii as well. The Kailua KFC offers a $7 Fill Up menu. Even though this example supports the basic rule of thumb, recent home repair numbers suggest that 40% is a little low.

Stott Property Management recently received a complaint from a client regarding the replacement of a self-closing toilet seat. The client researched the cost of a similar toilet seat on Home Depot’s website and found that it was $32. The handyman that replaced the toilet seat provided a receipt from Home Depot showing the local store charged $55.26. A similar toilet seat in Hawaii ended up being 73% more expensive that the advertised price on Home Depot’s website.

Tim and Tracey own rental property in Texas and routinely review paid invoices submitted by the property managers. In Texas, one handyman charges a labor rate of $45 per hour. Stott Property Management routinely uses several handymen on Oahu and their labor rates vary from $75 per hour to $85 per hour. The labor rate for a basic, reliable, handyman is at least 67% higher on Hawaii than it is in Texas.

Therefore, if you are contemplating an investment property or second home on Oahu, factor in maintenance costs of at least 70% higher than comparable maintenance work elsewhere in the United States. Otherwise, your expensive Hawaii real estate asset could suffer from deferred maintenance over time due to a lack of funds.

The median sales price on Oahu continues to climb as strong demand continues in a market with constrained supply. The median sales price in December for single family homes was $730,000 (4.3% higher than December 2015) and for condos was $390,000 (1.0% higher than December 2015). December demand was particularly strong as single family home sales surged 15.4% and condo sales soared 23.5% higher than December 2015. Sales should remain higher in the next few months and pending sales for houses is 15.4% higher and for condos is 20.2% higher than last year. The supply of homes continues to drop as new listings can’t keep up with the current pace of sales. There is currently 2.5 months of remaining inventory for single family homes and 2.6 months of remaining inventory for condos.

The University of Hawaii Research Organization (UHERO) predicted in September that housing prices would continue to climb as job growth and rising income provide potential buyers more purchasing power while housing supply remains constrained.

While the sales market is soaring, the long-term rental market has turned and rents have been dropping for the last quarter as a sudden surge of available rental properties has flooded the market. Stott Property Management had more vacant rental properties in December than the last time the rental market turned. Tim Kelley, who regularly updates his clients, has never seen so many Oahu vacancies advertised for rent in December. A large number of military tenants have received orders to leave the island over the past few months and it appears that military home owners who have purchased a home over the past few years have decided to try and rent their homes versus selling when they received orders. Honolulu has seen a net migration out of the city as high rents have convinced many people to move and seek their fortunes elsewhere. Tim and Tracey saw a similar sales and rental market in 2006.

A Mixed Plate of Talk Story

December 7th marked the 75th anniversary of Japan’s attack on Pearl Harbor. The 75th commemoration of the attacks on Pearl Harbor includes events and memorials dedicated to the USS Utah, USS Oklahoma, and USS Arizona. Both local and national newspapers have been documenting the heroics of those that died and survived on December 7, 1941 and of those 90 plus year old men and women that returned to take part in the numerous events honoring and remembering those heroes. Tim and Tracey sat down at Wailuna Coffee Shop in Waikiki with the son-in-law of a Pearl Harbor survivor on Friday, December 2nd. He shared that he had to drive his father-in-law home the previous evening when strangers kept buying scotch to thank him for his service. His father-in-law served on the USS Tennessee and woke up in a hospital bed after a torpedo struck the battleship and blew him into Pearl Harbor.

Hawaii Volcanoes National Park opened a new lava viewing area following the collapse of a large lava viewing area into the ocean on New Year’s Eve. Park Rangers had to chase after five visitors and force them to turn around 15 minutes before the area that the visitors were standing on collapsed into the ocean. Nearly 26 acres of a lava delta are now gone in addition to more than four acres from an older coastal cliff area. The new viewing area is approximately 900 feet east of the current lava flow. The New Year’s Eve collapse lasted several hours creating blasts of volcanic rock, waves, and plumes of debris and gas.

The 9th U.S. Circuit Court of Appeals ruled that three Hawaii counties may not regulate genetically modified crops or pesticides. As a result, Maui’s ordinance banning genetically engineered farming, Kauai’s notification requirements for pesticide use, and Hawaii County’s prohibition of open-air testing for genetically modified crops will not go into effect. The decision was a victory for seed companies Monsanto and Syngenta.

Thirty Meter Telescope (TMT) officials have chosen Spain’s Canary Islands as an alternative site for the $1.4 billion observatory. TMT would still prefer to build on the summit of Mauna Kea but will move if the permitting process doesn’t get started soon. In December 2015, the Hawaii Supreme Court ruled that TMT’s conservation district permit was improperly awarded eight years after the permitting process began. TMT has reported that it has invested $170 million for construction and manufacturing. When completed, the observatory will house the most advanced and powerful optical telescope on the planet with a 30-meter diameter primary mirror.

Local election results in Hawaii show that the state continues to be dominated by one party rule. When Stanley Chang defeated incumbent Sam Sloan, a Republican, Hawaii became the only state in the nation with an entirely Democratic state Senate. Mayor Kirk Caldwell fended off challenger Charles Djou, and Brian Schatz, Colleen Hanabusa, and Tulsi Gabbard (all Democrats) cruised to victory. The domination of the Democrats in Hawaii runs counter to Republican gains in the rest of the country where Republicans have gained steadily since 2008. There are currently 33 Republican governors, Republican majorities control 69 of the 99 state legislatures, Republicans control both the House of Representatives and the Senate, and Donald Trump was elected President.

David Ige pledged in his January 2016 State of the State speech to cool 1,000 classrooms by then end of the year and was subsequently funded by the state legislation to the tune of $100 million. On November 15th, the Department of Education (DOE) had reported that they finished cooling 42 classrooms statewide. General contractors involved with the process have complained that the overly complicated project specifications caused significant delays and resulted in initial bids coming in significantly over budget. The DOE now projects that 1,000 classrooms should have air conditioning by the end of 2017.

Kakaako’s building boomlet has prompted the City and County of Honolulu to renovate and upgrade Ala Moana Regional Park across from the Ala Moana Shopping Center. Renovations and improvements include new sand volleyball courts, renovating bathrooms, repairing the Magic Island exercise path, irrigating the great lawn, fixing rocky beach areas, building a new playground, and hiring staff to maintain the park and improve safety. Good luck finding parking. The park is already one of the most heavily used parks in Honolulu.

Hawaii currently is ranked #48 in a category that makes many people’s skin crawl. According to Orkin, Honolulu ranked #48 among cities with the most bed bugs. Orkin’s bed bug revenue rose more than 10% compared to last year. Bed bugs were virtually unheard of in the United States ten years ago.

The Honolulu Police Department (HPD) earned some recognition for quickly responding to criticism from neighborhood boards and to an article by the Honolulu Star-Advertiser for failing to list violent crimes on its crime data map. The Honolulu Star-Advertiser first ran the article in October noting that the Honolulu Police Department (HPD) does not include violent crimes on their crime mapping site. HPD’s website is the only site among more than 150 police websites that the newspaper investigated that excludes violent crimes. In November, HPD added ten new categories to the site including arson, assault, drug / alcohol violations, homicide, and robberies. The welcomed change now puts HPD’s crime mapping site on par with other departments around the country.

Honolulu’s police chief, Louis Kealoha, has decided to retire from the Honolulu Police Department (HPD) as he focuses on defending himself in a federal grand jury investigation into alleged conspiracy and corruption that centers around Louis Keoloha, his wife, Katherine Kealoha, Deputy Prosecutor, and several police officers. Louis Keoloha sworn in as police chief in November 2009 amongst enthusiast support from the police union, State of Hawaii Organization of Police Officers (SHOPO) and police officers. A large contingent of police officers was present to congratulate Kealoha after he was sworn in at the mayor’s office. Unfortunately, Keoloha’s years as police chief have not lived up to the high hopes of his supporters. His term has been marked by a long string of news stories about illegal activity, abuse of power, spousal abuse, and other infractions by Honolulu police officers. In late 2014, Keoloha and his wife became involved in a messy family dispute with Katherine’s uncle, Gerard Puana. The dispute spilled over in court when the Kealoha’s accused Puana of stealing their mailbox. Puana’s public defender accused the police chief of intentionally causing a mistrial when he testified as a witness on the stand. The public defender turned over FBI documents suggesting further wrong doing by the department, which has apparently resulted in the grand jury investigation. No decision has been made regarding Kealoha’s retirement or separation package. Kealoha’s second term was expected to run through November 27, 2019.

Hawaiian Electric Company, HECO, announced its new time-of-use rates for Oahu. The current rate is 24.1 cents per kilowatt-hour (kwh). The first 5,000 customers that sign up for the following plan will be charged the following rates under time of use. Customers will pay 14.9 cents per kwh for usage between 9:00 am to 5:00 pm, 37.3 cents per kwh between 5:00 pm and 10:00pm, and 23.7 cents per kwh between 10:00 pm and 5:00 am. The rates are indicative of the large penetration of roof-top photovoltaic systems (PV) on Oahu’s grid. Prior to PV, the higher demand for electricity would result in higher prices during the day and lower prices in the evening as air conditioners consumed less energy. Some electrical grid experts argue that time-of-use billing is necessary to more fully integrate renewable energy and encourage consumers to adjust their electrical demand to match available supply.

Customers wanting to install new roof-top photovoltaic systems (PV) currently have only one option available. Oahu reached the arbitrary grid-supply cap back in October and new systems must be self-supply. In other words, the new systems must come with battery systems to store any excess electricity generated during the day for night use. Hawaiian Electric Company (HECO) has received 322 applications as of mid-November and approved about 100 of those applications.

The Kauai Island Utility Cooperative (KIUC) has been able to lower electricity rates by 18% since 2008 by integrating renewable energy into its grid and decreasing the amount of diesel fuel used. KIUC stated that renewable energy now accounts for roughly 36 percent of the island’s electricity supply and includes large scale solar systems and a new 7-megawatt biomass plant. On some sunny days this year, KIUC was able to generate 97 percent of the electricity used from renewable sources (77 percent from solar). Now, on an average clear day, KIUC can shut down all but one of its diesel generators.

Hawaiian Electric Company (HECO), on the other hand, is seeking a 7% increase to its base rate. It appears that the state sponsored monopoly’s margins continue to be squeezed by homeowner’s adoption of rooftop solar. Rate increases during historically low oil prices help those argue that the cooperative model is superior to the regulated monopoly model. The difference in Kauai’s results and Oahu’s results appear to support the cooperative model.

As if on cue, the Hawaii Island Energy Cooperative (HIEC) was recently granted tax exempt nonprofit status by the Internal Revenue Service, a major step in becoming an operating non profit utility similar to KIUC. HIEC’s electricity plan includes new solar, wind, and energy storage to reach the states 100% renewable energy goal. Notably absent was geothermal energy. The Big Island is the only island utilizing geothermal energy and could supply the entire island with clean, renewable energy. Hawaiian Electric Light Company (HELCO), a subsidiary of HECO, did not comment on HIEC move to purchase and take over management of HELCO’s assets.

Ko Olina is cementing its position as a luxury resort destination on Oahu with the announcement of Atlantis Resort & Residences on Oahu. The developer has released plans to develop 800 hotel rooms, 524 luxury residences, an aquarium, water park, restaurants, bars, a spa, gym, wedding chapel, and conference facilities. Atlantis Resort & Residences will join Four Seasons Hotels & Resorts, Disney’s Aulani Resort & Spa, and Marriott Ko Olina.

Alexander and Baldwin Inc.’s Hawaiian Commercial & Sugar Co. harvested its last crop of sugar cane in December. Both the sugar processing plant and the power plant were mothballed on December 23rd. The remainder of the approximately 700 employees was laid off on December 30th. Cheaper sugar production elsewhere in the world led to the demise of Hawaii’s once booming sugar industry. Alexander and Baldwin Inc. plans on dividing up the plantation into smaller farms with a variety of agricultural projects.

Andy Mohan Inc., a men’s clothing store specializing in custom tailored suits, is closing its downtown store after nearly 50 years in business. Founder Andy Mohan died in 2013 and Alies Mohan who owned the store with Andy is retiring. Tim Kelley was fitted for his first business suit at Andy Mohan back in 1995 when he was resigning his commission from the U.S. Navy and preparing for business interviews. He remembers getting fitted personally by Andy. Business attire on Oahu has changed significantly over the past 50 years as most Hawaii business professionals have shed the business suit in favor of slacks and aloha shirts. Tim is also grateful for the change in business fashion even though he is saddened by the closure of an iconic business.

Odds & Ends

Note: Stott Real Estate, Inc. is not licensed to provide tax or legal advice. The following article is for information only and Stott Real Estate, Inc. recommends that you speak with a licensed tax advisor and/or an estate planning attorney before making any decisions.

Avoiding Probate in Hawaii: The state of Hawaii requires probate when an individual dies and has more than $100,000 in assets or owns real estate in Hawaii. In general, probate will be required in every state where the decedent owns real estate. Probate is typically a costly and time consuming process in Hawaii. The minimum time to complete probate is typically six months and it can take as long as nine to eighteen months depending on the complexity. As a result, individuals who own real estate or have more than $100,000 in assets should consider steps to avoid probate if possible.

One method to avoid probate became possible in 2011 when the state legislature passed and the governor signed the Uniform Real Property Transfers on Death Act. The intent of the law is to allow for a property to transfer to a designated individual upon the time of death by the current owner by recording a deed called a “Transfer on Death Deed.” While recording a Transfer on Death Deed helps to avoid the time and cost of probate, estate planning attorneys recommend against this option for the following reasons:

1. Although the transfer on death deed can be revoked, it requires the revocation to be signed, notarized, and recorded in the same manner as the original transfer on death deed.2. Although the statute provides that the beneficiary receives the property to existing encumbrances, most lending institutions will not lend on a property subject to a transfer on death deed. As a result, an individual would have difficulty refinancing an existing mortgage or obtaining a new loan against the property.3. If an individual becomes disabled or incapacitated, the property is in “limbo” because no one has authority to sell the property or obtain a reverse mortgage to pay for health care needs.4. There are issues if the beneficiary of the transfer on death deed dies before the property owner.

One interesting note regarding transfer on death deed. The beneficiary is divested of the right upon divorce from the transferor or conviction of a homicide of the transferor.

Therefore, estate planning attorneys still favor setting up a revocable trust. Assets, including real estate, avoid probate if they are held in a revocable trust. The only downside to a revocable trust is the high initial cost to create the trust and transfer property into the trust. However, this cost is usually less than the cost of probate and much easier on an executor of the will. The revocable living trust has two advantages:

1. The avoidance of Probate Court costs and associated delays.2. Management of living-trust assets if the trustor becomes incapacitated.

When a revocable trust is created, the trustor is the individual who is placing his or her assets in the revocable living trust. The trustor names a successor trustee to manage the trust when he or she dies or becomes incapacitated, and the beneficiaries of the trust. The beneficiaries of the trust receive the assets from the trustee when the trustor dies without Probate Courts interference.

1031 Exchange Overview

Purpose: The purpose of this article is to provide an overview of a 1031 exchange. The article is rather basic and not intended to be a guide to an actual exchange, as it omits rules and that could significantly impact upon a 1031 exchange. We have prepared a more detailed paper in a question & answer format using layman terminology that explains the process in considerably more detail. To obtain a copy, check the applicable block on the enclosed postcard and return it. If you provide us your e-mail address, we’ll e-mail you a copy of both the 1031 paper and the HARPTA paper that discusses the Hawaii law that enables the state to collect estimated capital gains taxes from owners that might not file a Hawaii tax return in the year of the sale.

Note: We have participated in a large number of 1031 exchanges and usually have several such transactions in escrow at any given time. However, we are not licensed to provide either legal or tax advice. Licensed professionals such as attorneys or CPA’s should be consulted for such advice. This comment applies to the entire newsletter.

Note: This paper will use the terms “old property” for the property being sold and “new property” for the property being purchased. A property may consist of more than one piece of real estate.

Background: Section 1031 of the internal revenue code (IRC) provides for the deferment of long-term capital gains taxes on the sale of investment real estate when it is exchanged for other investment real estate of equal or greater value than the real estate being sold. A common misconception is you will have to find someone to trade properties with you. Most 1031 exchanges involve two entirely separate transactions. In one transaction, you sell your old property and in the other, you purchase your new property. There is normally no reason for the buyer of your old property and the seller of the new property to have any contact with each other. Often, the properties are located in two different states; e.g., most of our exchanges involve property in Hawaii being exchanged for property on the mainland.

Qualified Intermediary (QI): The IRS mandates that you use a completely independent third party to supervise the exchange. Because this third party must be completely independent, it cannot be your real estate agent, accountant or attorney. The independent third party is usually referred to either as an intermediary or as qualified intermediary (QI); however, in some areas of the country the third party may be called either a facilitator or an accommodator. This paper will use the term “QI.” The QI can be located anywhere in the country; they do not need to be located near you or near either of the properties involved in the exchange.

The following steps have been changed; however, they help explain the role of the QI. The QI takes title to the old property for a brief instant in the process of having it sold from you to the buyer; i.e., title passes from you through the QI to the buyer. Similarly, the QI takes title to the new property for a brief instant in the process of having it sold from the seller to you. Therefore, the QI has owned both the old and the new properties and can exchange one for the other. Today, the QI no longer has to hold title to both properties. In 1991, the real estate industry successfully lobbied Congress to have the law changed, as escrow companies were charging double escrow fees; i.e. Seller to QI and then QI to you. Today, in lieu of taking title to both properties, the QI is tasked to provide instructions so that both transactions are closed in a manner that conforms to section 1031 of the IRC.

Properties & Timing: Both the old property and the new property must be investment real estate; in most cases they are rental properties. The two properties do not need to be the similar; e.g., you could exchange a house in Hawaii for two or more Mainland condos and vice versa. Almost any type of real estate qualifies such as a house, condo, store, office or even vacant land. However, your personal residence or a second home does not qualify. However, you could rent the new property first so that it qualifies as investment property and then occupy it yourself. Many of our clients do this; i.e., they use equity in their Oahu property to assist them in purchasing a future Mainland residence. The new property must be rented for at least a year prior to being occupied in order for it to qualify as investment real estate.

With some very few exceptions, all of the exchanges made by our clients have been deferred exchanges where the old property is sold prior to purchasing the new property. It is possible to do this in reverse order and purchase the new property first; i.e., prior to selling the old property. This is called a reverse exchange and is far more complicated and expensive than a deferred exchange. This article is based upon deferred exchanges. Over half of our deferred exchanges involved absentee owners conducting their first 1031 exchange.

When the old property closes, the proceeds from the sale go to the QI who banks the funds until you’re ready to purchase the new property. To defer all your capital gains taxes, you must buy new property that is equal to or higher in value than the old property. You must also reinvest all the cash proceeds from the sale into the purchase of the new property. The QI maintains the funds from the sale of the disposable property and then makes those funds available in order to enable the purchase of the new property. You cannot have access to any of the proceeds from the sale of the old property or those funds will be taxed.

There are two key time frames both measured from the closing date of the old property. Failure to meet either of these two time frames negates the tax-deferred 1031 exchange.

a. Within 45 days, the new property must be identified in writing to the QI. You can make changes to your identification any time within the 45-day-period; however, on the 46th day, you are locked-in to whatever has been identified as new property.

b. Within 180 days, the new property must close. You can identify more than one property; so if your preferred new property falls out of escrow, you could shift to a replacement new property that was identified during the 45-day-period; however, it would still have to be closed within the 180-day-period. Most exchangers identify more than one new property.

Deferring Taxes: A 1031 exchange enables an owner to be able to defer both the federal and state capital gains taxes that they have on the sale of their old property and roll those taxes over into the new property. Note that the taxes are deferred, not excluded. The current federal capital gains tax rate for most exchangers is 15% on all component of gain except depreciation recapture, which is taxed at 25%. The Hawaii capital gains tax rate is 7.25% on all components of gain including depreciation recapture. State taxes are a deduction for federal taxes; therefore, the combined tax rate is about 21% rather than 22.25% (15% + 7.25%).

Recent rules: Three relatively recent rules apply to principal residences. The tax relief act of 1997 enabled a homeowner to sell their principal residence and exclude up to $500,000 of gain (married) or up to $250,000 (single) providing they had occupied the home for an aggregate 24 out of the prior 60 months. So an owner only needed to own the property for three years, one year as a rental to qualify for the exchange and then two years as a principal residence to qualify for the tax relief act of 1997. In October 2004, there was a change to the 1997 law. An owner who acquired their principal residence by way of a 1031 exchange must now own the property for at least five years before they sell it in order to be eligible for the exclusion. The owner still needs to rent it for one or more years so it qualifies for the exchange and then have it be their principal residence for at least two years. The exchanger also has to pay depreciation recapture on depreciation claimed (after May 6, 1997) while the property was a rental; i.e., depreciation recapture while the property was a rental will not be excluded.

The Housing and Economic Act of 2008 reduces the capital gains that can be excluded when a homeowner sells a principal residence that they held as an investment property for a period of time as the amount of the tax exclusion will be adjusted by the non-resident use of the property. This law became effective 1/1/09. The amount of time of non-resident use after 1/1/09 is the numerator or top of a fraction with the bottom or denominator of the fraction being the total time since property acquisition. That fraction times total gain (exclusive of depreciation recapture after May 6, 1997) is the gain that will be taxed to the homeowner.

Example: Single Mary bought her Oahu home on 1/1/93 for $200,000 and rents it for 18 years until 1/1/11 when she occupies it as her principal residence. Two years later, on 1/1/16, Mary sells the property for $500,000 and has $300,000 of gain.

The non-residence use of the property by Mary prior to 1/1/09 does not apply to the new law. Therefore, Mary has only two years of non-residence use (1/1/09 to 1/1/11) when she then occupies it as her principal residence. Five years later on 1/1/16 Mary will have owned it for a total of 23 years. Therefore, the fraction for non-resident use is 2/23. Or, the taxable gain is $300,000 x 2/23 or $26,087. The remaining $273,913 exceeds the $250,000 limit for single Mary, so Mary ends up with $50,000 taxable ($26,087 + $23,913) and $250,000 that is excluded. Mary would also owe depreciation recapture after May 6, 1997.

In my example, I used a long period of ownership before the eligibility date. If the property were acquired after the 1/1/09 eligibility date, the fraction will be much larger. For example, assume the property is acquired on 1/1/09, rented for three years and then occupied for two years, the non-resident use would be 3/5 or 60%. However, if it is rented for only one year and then occupied for four years, the non-resident use would only be 1/5 or 20%. Every day it is a rental property after 1/1/09 increases the capital gains taxes to the owner.

Granted, the new law has no impact if the owner never sells the property; however, few homes remain suitable for the same family over any extended period of time. Over time, most families desire a different location and/or a larger/smaller/more prestigious or a completely different type or style of home particularly after they retire or become empty nesters.

Reasons to Exchange: Most exchangers use 1031 exchanges to defer capital gains taxes. Many have long-range plans to eventually exclude their deferred taxes by converting a rental property into a primary residence even with ownership now a required five years. With proper planning, this is still a very viable investment tool, particularly for property bought prior to January 1, 2009.

Some final thoughts: A 1031 exchange is not the right investment tool for everyone. Over the years, we have assisted many owners in making a decision not to conduct an exchange. Often, all that was required was for us to estimate the owner’s capital gains taxes. Contact us toll-free (1-800-922-6811), locally (808-254-1515) or via e-mail (home@stott.com). Since recent tax law changes have made estimating capital gains taxes exceeding complex, we recommend speaking with a Certified Public Accountant (CPA) or tax attorney prior to deciding on a course of action. Due to the value of real estate on Oahu, you will likely be pushed into the higher tax brackets if you have owned the investment property for a significant period of time and the resulting tax bill could be costly if you don’t conduct a 1031 exchange.

Median sales prices on Oahu continue their steady climb, as the supply of available homes remains tight. The median price in September for single family homes was $750,000 (2.7% higher than September, 2015) and the median price for condos was $383,250 (4.7% higher than September, 2015). Affordability appears to be having an impact as the number of condo sales rose 6.7% higher than the year before while single family home sales were flat. Active listings of single family homes dropped 7.2% and of condos dropped 6.7%. Strong demand and weak supply have resulted in only 2.9 months of inventory for single family homes and 3.0 months of inventory for condos. There appears to be little relief in sight for aspiring home owners while the time is right for those looking to cash out.

The University of Hawaii Economic Research Organization (UHERO) predicts that one of the main drivers of the states recent economic growth, construction, is nearing the peak of its cycle. Deteriorating home affordability, rising construction costs, and expected monetary tightening (rising interest rates) will ultimately start the next construction industry downturn. UHERO predicts that construction activity will start falling in 2018 as the surge in condo and resort building wanes, rising home prices discourage more buyers, and global economics become more challenging.

Good news came out of the Hawaii Tourism Conference that recently ended. Despite some hotel operators’ fears that the next downturn is around the corner, a hotel industry researcher points to strong demand filling up the new hotels being built around the nation and in Hawaii. Hawaii is also home to the best performing group of timeshares in the nation and account for 9.4% of the visitors to the state. The visitor industry is on pace to set another record in 2016 and similar results are expected for 2017.

 

George Winfield Stott Jr.

Wednesday, July 20th, was a sad day for family, friends, current employees, and past employees. George Winfield Stott Jr. passed away two days after his 83rd birthday. Tracey read George a personal letter that Monday detailing the reasons why he was such a wonderful father and role model for her. Mike and Donna Stott called and sang happy birthday with George joining in at the end singing “happy birthday to me.”

Long before his distinguished naval and real estate career, George was born in San Diego to a military family. George lived on Oahu as a child and attended Punahou in the second grade. George graduated from the United States Naval Academy and received his commission in the U.S. Navy in 1955. A little known fact is that George and his roommates watched over a young plebe by the name of John McCain during their senior year. George and John were both boxers and he helped John through several scrapes.

George married Mary Lou Dempf upon graduation and the two blossomed during George’s military career that culminated in being the Captain of two nuclear powered submarines. George and Mary Lou ultimately settled on Oahu in 1970 where they raised three children on the Windward Side. George retired from the United States Navy in 1976, completed his MBA at the University of Hawaii, and opened Stott Real Estate, Inc. in 1978. During his distinguished 36-year real estate career, George trained and mentored many agents, several who opened their own thriving businesses. Under George’s tutelage, Mike and Donna Stott, Tim and Tracey Kelley, honed their skills. Mike and Donna moved to Atlanta, GA to open their own real estate company and real estate agent coaching business. Tim Kelley and Tracey Stott Kelley now own Stott Real Estate, Inc. as a second-generation family business.

George will be remembered as a loving husband, caring father, inspirational business leader, and a great friend. He leaves behind his wife of 60 years, three children, seven grandchildren, and two great-grandchildren. While his passing will be mourned, his life will be celebrated in the legacy he is leaving behind.

On Monday, August 8th, family and friends said their final farewell to George. A group of young Navy sailors conducted a tear wrenching ceremony, featuring “Taps” and a 21-gun salute, honoring a submarine commander that they never knew. One young man in the honor guard shed a tear and another fine gentleman presented Mary Lou with an American flag. Father Emmanuel, a new pastor from Zimbabwe, then held a beautiful mass that included a soaring a capella version of “Amazing Grace” by George’s past employee, Lokahi Valentine. Two outrigger canoes paddled out to spread George’s ashes and flowers in the ocean about a quarter mile off the shore from his home per his wishes. Several years ago, George told Tracey that he only wanted his ashes given to the sea. He later changed his mind and told Tracey “he wanted it all.” The celebration of life was a great farewell to a great man.

We appreciate all the words of support and comfort during the past ten weeks. George helped many people over his career and the caring response has helped his family find peace.

A Mixed Plate of Talk Story

A recent study of the decade from 1996 through 2006 shows the impact of government regulations on Honolulu’s homebuilding. While home prices shot up 146% during the time period, the percentage change of housing units grew only 12.6%. Economist Carl Bonham contends that the regulatory burden that Hawaii puts on the developers is a major part of the problem. Multiple regulatory agencies, the city, the State Land Use Commission, and the Hawaii Community Development Authority tie up construction projects in multiple layers of red tape. Places that have really tight regulations have higher home prices and Honolulu comes out on top of the regulatory burden.

Tim sent an e-mail to Stott Property Management’s clients in April 2015 about seeing signs of a slowing rental market. Apartment website, Zumper, just confirmed that rents appear to have peaked for one and two bedroom condos in July and August of 2015. Stott Property Management has noticed that some tenants have reacted to the higher rents by finding roommates to help make ends meet. The trend is not unique to Hawaii. Zumper reports that median rents for one and two bedroom apartments fell nationwide.

The Hawaii Tourism Authority announced that visitor arrivals set a record in July. 835,417 people visited the state, which represents a 2.1 percent increase over the previous record recorded last July.

The Hawaii Tourism Authority launched a free app on August 8th named GoHawaii. The app offers travel and safety tips for Oahu, Maui, the Big Island, Kauai, Lanai, and Molokai. The free app can be downloaded in the Google Play Store and the Apple iTunes Store and is offered in a number of languages. The apps destination screens allow users to see various Hawaii sites, activities, and special events. One feature provides users with Hawaii-styled emojis that users can share with family and friends.

U.S. Representative, Mark Takai died on July 20th, nine months after being diagnosed with pancreatic cancer and two months after announcing that he would not seek re-election because the cancer had spread. A special election to fill Mark Takai’s seat will be held at the same time as the general election on November 8th. The winner of the special election will serve out the remaining two months of Mark Takai’s term. Eleven candidates have filed to run in the general election for the term starting in January 4, 2017.

The Hawaii Public Utilities Commission (PUC) ruled against the proposed $4.3 billion acquisition of Hawaiian Electric Company (HECO) by NextEra Energy, Inc. Even though PUC acknowledged that NextEra Energy is “fit, willing, and able to perform the service currently offered by the utility being acquired,” PUC stated that NextEra failed to demonstrate that the application is reasonable and in the public interest. While some say that NextEra failed to embrace Hawaii’s regulatory requirements, Paul Brewbaker, one of the leading economists on the island contends that the deal fell apart because the state wanted to consolidate its political power over the utility. Brewbaker states that Hawaii’s economy continues to suffer as politics drive changes instead of the consumers and businesses. Several ventures have been cancelled as a result of the PUC’s decision including HECO’s major liquefied natural gas (LNG) project, the Oahu-Maui interisland transmission cable, a proposed Lanai Wind Project, and power supply improvement plans on Oahu. Hawaiian Electric Company, spent $22.4 million on the merger, which will ultimately be passed on to Oahu consumers.

The city of Honolulu awarded Hawaii Gas a contract to supply the city with biogas from its Honoluliuli Wastewater Treatment plant in Ewa Beach. Biogas, or biomethane, is generated when biodegradable waste is broken down through chemical reactions and by microbes. The natural gas produced at the site is currently burned off and not utilized. Hawaii Gas is looking to replace most of its current fuel base with renewable natural gas has issued its own request for proposals. It also has a $200 million plan to ship LNG in bulk amounts to Hawaii starting in 2019.

The Honolulu StarAdvertiser and the state Division of Consumer Advocacy have documented concerns with the Hawaii Green Infrastructure Authority’s management of the GEMS funding. The funding, paid for by Hawaiian Electric customers to the tune of $1.30 per month, was intended to provide underserved customers loans to finance sustainable energy projects like photo-voltaic solar. As of June 30th, the Hawaii Green Infrastructure Authority has spent $1.7 million to approve a total of $388,800 in loans. Instead of recognizing that there really is not a need for this program as evidenced by the state’s rooftop solar penetration, the authority is looking to change the eligibility requirements to allow more loan approvals. A novel concept would be to recognize failure and return the money to Hawaiian Electric’s customer base. The program currently has collected $144.6 million from the monthly fees.

Hawaii Electric Light Company and Maui Electric Company announced that the arbitrary caps for the grid-supply program that services roof-top solar were reached. The program that replaced net metering, allowed customers to sell excess solar energy generated during the day back to the utilities at wholesale prices. Customers must now pay for battery storage systems due to the grid-supply caps. Oahu is 22% away from reaching Hawaiian Electric Company’s cap of 25-megawatts.

Dan Grabauskas, executive director and CEO of the Honolulu Authority for Rapid Transportation (HART) resigned on August 18, 2016. Grabauskas took much of the heat for being unable to meet unrealistic budget forecasts set by then Mayor Mufi Hanneman and current Mayor Kirk Caldwell. 2016 has been seen all of HART’s senior leadership turn over as fiscal reality struck and the city and state politicians starting looking for scapegoats. Grabaskaus gratiously stated, “It has been an honor and pleasure to have worked on this transformational project for nearly four-and-a-half years.” While Dan is moving on, Oahu residents will get to find out what transformation will mean to them in the years to come.

The Federal Transit Authority (FTA) shot down the delegation of Mayor Kirk Caldwell, City Council Chairman Ernie Martin, HART Chairperson Colleen Hanabusa, and acting HART Executive Director Michael Formby who flew to San Francisco to request additional federal dollars for the financially strapped rail project. They also made it clear that stopping at Middle Street was not an option and if the project stopped short, the $1.55 billion already committed would be in jeopardy. Caldwell and Martin plan on coming back to ask the legislator for an additional extension to the General Excise Tax surcharge beyond the additional five years granted by the legislature two years ago. State lawmakers are already getting geared up for a fight this winter claiming that the City and County of Honolulu administration and HART provided false information to the state legislature when the original extension to the GET surcharge was approved. HART has raised the total price tag of the project another $700 million to $8.6 billion and board chairwoman, Colleen Hanabusa cautioned that the numbers can still change.

The Environmental Protection Agency (EPA) provided the latest example of why 70% of Americans on both sides of the political spectrum think that the country is headed in the wrong direction. The EPA recently required HoyHoy Trap-A-Roach, a staple in Hawaii households for over 20 years, to destroy 190,000 traps because it deemed that the packaging labels “misleading.” Meanwhile, Hawaii consumers are having to suffer through the peak cockroach season without their go to pest control trap against the flying American roaches known as B-52 Bombers. Retailers are waiting for shipments to restock their shelves.

WalletHub ranked Honolulu #10 out of the 100 largest U.S. cities for recreation due to the abundance of hiking trails and water sports. The personal-finance website compared cities using 35 metrics ranging from the price of a movie ticket to the number of tennis courts per capita. Not surprising to Oahu residents, Honolulu ranked #1 in bike rental facilities, fishing sports, hiking trails, boat tours, and water tours.

Fatboy’s Restaurant Group Hawaii has opened a new Fatboy’s plate lunch restaurant in Haleiwa. The restaurant is a family favorite of the Stott family and oldest sibling, Mike Stott, insists on Fatboy’s garlic chicken for his first dinner when he comes to visit. Tim and Tracey were quite puzzled over Mike’s obsession with the dish until they tried it themselves. It quickly became a potluck staple for the Kelley family at various sporting and party events. The Kailua restaurant sports a framed note saying, “A cow has four stomachs … Lucky bastard.” We recommend trying it out the next time you are on Oahu and looking for an excellent plate lunch.

The Hawaii Department of Health has confirmed 252 confirmed cases of Hepatitis A since June and has traced the source of the outbreak to imported frozen scallops that were served raw at Genki Sushi. The Department of Health has ordered ten restaurants on Oahu and one restaurant on Kauai closed until further notice. The outbreak has spread to workers at a number of restaurants, Costco, and Hawaiian Airlines. Two individuals sickened are currently scheduled to have liver transplants. Genki Sushi received permission from the Hawaii State Department of Health to reopen on Oahu 24 days after it was shut down. The Kauai restaurant will remain closed to complete renovations that are already in progress. Tim & Tracey recently received their Hepatitis A vaccination from their healthcare provider, Kaiser Permanente, who has encouraged their members to get vaccinated.

A group of six volunteers recently emerged from a small dome on the slopes of Mauna Kea after living 365 days in isolation. The study was one of four completed by the NASA funded Hawaii Space Exploration Analog and Simulation (HI-SEAS). HI-SEAS has compiled data from four simulated missions to study food choices and its effect on morale, water usage, and crew cohesion. The latest study was the longest simulated mission that included 40-minute communication delays with the outside world to mimic the delays experienced with a manned expedition to Mars. The crew consisted of people of different nationalities and personalities with sharing one common trait, low drama. Astronauts tend to be positive and stoic and one goal of the study was to detect conflicts between easy-going people before they become real problems. The dome was equipped with composting toilets and showers and relied on solar power for electricity. The only fresh things to eat were what the crew could grow inside the dome.

Waikiki Brewing Company signed a lease to open a second location in Kakaako that will include a brewery, canning operation, and tasting room. Tim and Tracey recently dined and enjoyed brews at Kauai Beer Company while visiting a friend on Kauai in September and thoroughly enjoyed the experience. While in Kauai, Tim was wearing a Staycation shirt from Karbach Brewing Company in Houston and was stopped by a couple from Houston on the Napali Coast. Visiting microbreweries and buying their T-shirts has become a fun activity and conversation piece. Ironically, Tim and Tracey have not visited Lanikai Brewery and Waikiki Brewing Company yet. That will change.

Odds & Ends

A Great Starter Investment Property: Tracey and Tim have owned investment real estate for 17 years and Tim has lead Stott Property Management for the past ten years. During that time, they have learned that the only investment property worth holding onto is one that provides positive cash flow immediately and with reasonable management, for a lifetime. An investment property should provide the means to work less over time to generate the same personal income versus having to work harder to pay the bills and cover a money-losing venture.

As with all investments, due diligence should be done ahead of time to make sure that the investment supports your long-term goals. The largest impact on your financial return will be the price you pay for the property (both sales price and initial make ready repairs). Patience is required in order to be successful. The cyclical real estate market does not provide these opportunities all the time. In fact, with asset prices near their all-time highs, Tim and Tracey are not currently looking to expand their investment real estate portfolio. Their last duplex purchase occurred in late 2011, after the mortgage crisis lowered sale prices. They won’t likely buy again until after the next buyer’s market returns prices to levels that make investment sense. In the meantime, Tim and Tracey are positioning themselves financially to make the move when the time comes.

The following financial requirement worked well for Tim and Tracey early in their investing career. They would buy a long-term rental property (versus a vacation rental) if the projected fixed expenses (mortgage payment, monthly property taxes, monthly insurance premium, utility costs not paid by tenant) was less than or equal to 75% of the monthly market rent. Believe it or not, this actually occurs. Tim and Tracey purchased in 1997, 1999, 2001, and 2011. The only time a poor purchase was made occurred in 2006 when they were given poor market advice during a 1031 exchange and bought a money losing four-plex (over the short-term) using the sale proceeds of a profitable single family home. This formula will help provide a buffer to cover the approximately 5% in maintenance costs that is typical for an investment property and contribute to your personal bottom line. Tim and Tracey did have to manage the properties themselves initially to make the numbers work, but now have licensed property managers taking care of the daily operations.

Tim and Tracey also have concluded that the following physical characteristics worked best for them. Their best investments have been duplexes, with ceramic tile flooring throughout, and quality middle grade fixtures. The ceramic tile flooring was installed when the original flooring that came with the purchase wore out.

If you are looking to purchase your first investment property or expand your portfolio, then do it right the first time. Avoid turning a home into a rental property when you move. Buy the property with the intention of renting it out immediately and have the financials help make the decision.

“Rich Dad Poor Dad”, “The Total Money Makeover:” Tim and Tracey recommend these two books to anyone because they both offer excellent advice and simple to understand concepts that if followed, will make your life easier. They read “Rich Dad Poor Dad” years ago and just recently finished “Total Money Makeover”. The concepts discussed in these books gave them the motivation and tools to manage their personal finances and invest early in their adult careers and as often as possible. Some basic concepts that have helped them understand and succeed are summarized in the following paragraphs. However, you really should read the books to determine if there are other or different lessons that will work for you.

Defining a personal financial asset and a personal financial liability was an “aha moment.” A personal financial asset adds money to your bank account while a personal financial liability takes money out of your bank account. This concept differs from the traditional definition of assets and liabilities. Examples of assets include salaries, positive cash flow producing investment properties, dividend generating stocks, savings accounts, money market accounts, bonds, etc. Examples of liabilities include your car, the house you live in, cell phone, personal loans, and student loans. A person can’t sustain a living over the long-term if their assets don’t equal or exceed their liabilities.

Avoiding or paying off debt is another key concept. Both Tim and Tracey avoided the pitfall of accumulating excessive debt early on without reading these books. However, the concept reinforced their determination to save for major purchases, avoid personal debt, and pay off mortgages ahead of time. If you have a considerable amount of debt, then the debt snowball concept by Dave Ramsey could be extremely helpful.

Establish and maintain an emergency fund. The most common rule of thumb passed around is to have at least three months, up to six months of liquid cash on hand to pay for an actual emergency. The money must be held in an account that does not charge penalties for immediate withdrawals. Emergencies include car wrecks, illness, natural disasters, fires, flooding, etc. A furniture sale is not an emergency.

Investing as early as possible and as often as possible is critical to reaching financial independence. Put money into your IRA, 401k, mutual fund accounts, and buy investment real estate or dividend paying stocks. One concept Tim and Tracey picked up from both Robert Kiyosaki and Dave Ramsey involved researching and understanding the investments before proceeding. Research, put the odds in your favor, and control the fees and expenses paid on your investments.

Don’t confuse controlling your expenses with refusing to pay for services and expertise that will help you avoid more costly mistakes down the road. The best example that illustrates this point is the mistake some people make in asking a local friend to manage their investment property versus hiring a profesional property manager. Stott Property Management has cleaned up many expensive messes created by friend managing properties who failed to screen tenants, did not know how to evict deadbeat tenants, and failed to regularly inspect properties for necessary maintenance.

Tim and Tracey have talked and helped many clients whose finances have caused real and immediate stress. Reading these books and applying the concepts can help avoid or solve personal financial crisis.

Building A Rental Portfolio To Last: Investment Real Estate has been a major component of Tim and Tracey’s investment portfolio and has and continues to contribute to their bottom line. A major key to building this portfolio without causing undo stress on their budget has been following the simple rules outlined in the first two articles and taking one additional step.

After reading “Rich Dad Poor Dad” and sitting down to discuss the possibilities of owning investment real estate, Tim and Tracey decided that a significant portion of their retirement funds would come from rental property. Buying one duplex, would not even come close to providing the cash flow necessary to pay for their expenses after the mortgage was paid off. Therefore, they decided to dedicate the positive cash flow from their rental properties into paying off the mortgages on those same rental properties early. Additionally, they also used part of their sales bonuses to further accelerate those mortgage payments. In a span of six years, they paid off the mortgages on their first eight rental units. Following this strategy, they then paid off the loan on their latest duplex in two years.

The funds from these ten units currently help pay for their two children’s college tuition without taking on any student debt. Once the tuition is paid for, Tim & Tracey can continue to build their retirement portfolio.

Revocable Living Trusts: A revocable living trust is a popular estate-planning tool that defines who will receive your property when you pass away. There are rules of thumb, typically associated with your net worth, when you should consider creating a revocable living trust. Revocable means that you can change the property in the trust as your circumstances and desires change. Living means that you can make the changes while you are alive.

The trust document is written, signed by the trust maker and a notary public. The document lists the property in the trust, lists the trustee, and names who will get the property after the trust maker dies. The trustee is normally the trust maker while the trust maker is alive and then a successor trustee takes over when the trust maker dies or becomes incapacitated. The successor trustee can be an individual that the trust maker has confidence in handling the trust or can be a financial institution, like a bank.

The main advantages of a revocable living trust are that property in a trust avoids probate and it reduces the chances of a court dispute over your estate when you die. Many items can be simply listed with the trust document, however, titled property like real estate must be retitled in the name of the trust. If the titled property is not properly renamed, then it could end up in probate. Therefore, it is important that your real estate is properly recorded to avoid any problems. There can also be tax advantages if your property has been held in trust, however, those advantages can change since politicians can’t resist tinkering with the tax code.

While you can create a revocable living trust yourself, we recommend speaking with an attorney that specializes in estate planning. They keep current and the latest tax advantages, if any, and often ask questions, make suggestions, and point out possible pitfalls when creating and maintaining a trust. Since they bill for their time, a good estate attorney will periodically remind you that it is time to review your trust to make sure that it is still current. A well-executed will and revocable living trust can help ease some of the stress and pain of your loved ones when you die while assuring that your wishes are carried out.

Joint Bank Accounts and Online Banking: Aging people will often have a power of attorney identifying a trusted person, often a child, who can make decisions for them. In addition to the power of attorney, they may also add that individual to their joint checking and savings account to facilitate bill paying and money transfers.

One wrinkle occurs when the lead account holder dies. The bank, once notified of the death, may suspend all online banking activities until a new account holder is named as the primary.

Oahu median sales prices for single family homes and condos surged to new records in June. The median price for single family homes rose to $760,000 (8.6% higher than June 2015) and the median price for condos climbed to $405,500 (19.8% higher than June 2015). Demand remained strong and the supply continued to be limited. There are currently 3.0 months of inventory for single family homes and 3.1 months of inventory for condos. Competition for more “affordable” properties should remain intense since only 39% of the available single family homes and only 43% of available condos are asking less than the current median sales price.

The Economic Research Organization at the University of Hawaii (UHERO) predicts that Oahu’s economy should continue to grow incrementally over the next couple of years. Construction enjoyed a strong year fueled by Kakaako condos, rail, and commercial projects and is currently near its cyclical peak with job counts climbing past its previous record. Personal income grew about 3.5% last year and is expected to grow by another 2% in 2016. UHERO predicts that private health care will be one of the strongest industries over the median term as Oahu’s population continues to age. Tourism should experience incremental gains as a strong U.S. economy will help offset a struggling Japanese economy and slowing Chinese economy. A strong U.S. dollar will put more pressure on foreign spending. Budget pressures will limit state and local government’s job growth. The largest challenge that Oahu currently faces is the rapidly rising price tag of the Honolulu Authority for Rapid Transportation’s (HART) struggling rail project.

Tracey Stott Kelley was recently recognized as only one of 15 real estate agents in Hawaii for remaining in the top 100 selling agents over the last ten years. Thank you to all of our clients who helped make 2015 another successful year.

A Mixed Plate of Talk Story

An iconic radio partnership ended on May 15th after 33 years on the morning airwaves as Hawaii’s top rated program. Larry Price announced that he will be leaving the “Perry & Price Morning Show” and launch a new sports show with Rick Hamada on FOX Sports 990. Michael W. Perry will continue hosting the morning radio show solo.

Hawaii’s tourism industry received another boost as Virgin America started daily flights between Los Angeles International Airport (LAX) and Honolulu International Airport on May 5th. Additional flights between LAX and Kahului, Maui began on June 14th.

Hawaiian Airlines is offering a new and innovative way for passengers to upgrade to first-class for less money. Bid Up, Hawaiian’s new program, allows passengers whose itinerary includes a leg between Hawaii and North America to bid for available first-class seats. Eligible fliers will receive a Bid Up e-mail about 10 days prior to their departure and the winning bidders will be notified 48 hours prior to their departure.

Hawaii Gas, the state’s only regulated gas utility, has reduced its estimate for a new liquefied natural gas (LNG) terminal by 1/3 to $200 million. An 18-month study showed that Oahu electricity customers would have saved $132 million in fuel costs by switching from oil to natural gas. The Hawaii Public Utilities Commission recently approved Hawaii Gas’s application to increase LNG deliveries from one LNG container a month to two LNG containers per day. Hawaii Gas recently announced that it saved Oahu customers about $50.8 million in 2015 by using gas energy instead of electricity generated from oil. Oahu would have needed approximately 861,000 barrels of oil for electricity to generate the same energy that was generated from synthetic natural gas and propane. Synthetic natural gas and propane are cleaner burning fuels and the production process is about 85% efficient versus the 32% efficiency from electricity generated from oil. Governor David Ige has argued against the money saving projects because he feels that the efforts would distract the state from his goal of providing 100% of the state’s electricity from renewable sources.

Hawaiian Electric Company’s (HECO) response to some vocal proponents of increasing roof-top photo-voltaic (PV) system caps would make a classic case study in the social costs of state sponsored monopolies. Hawaii regulators, who capped the net metering regime for rooftop solar to current customers, concluded that customers without PV subsidized the cost of maintaining the grid for customers with PV. Alan Oshima, president and CEO of HECO had several enlightening quotes during a Pacific Business News panel discussion. He describes people without PV as “stranded customers.” He goes on further to state that “everyone in this space has to contribute to a 100 percent future. Let’s change the conversation if we truly are working together. We have to understand that. I don’t think there’s an understanding of that. The clean energy initiative put the onus on the utility to get to 100 percent. We all have the responsibility, not just the electric utility.” Since HECO is the only game in town, Oshima does not need to figure out how to integrate the customer’s choice of power generation, just limit it. He is simply able to tell his critics to toe the line because the state of Hawaii has put the renewable energy burden on HECO’s shoulders. Oahu’s customer base is witnessing first-hand how a state sponsored monopolist limits the supply of a popular power generation alternative (PV) to protect its profit margins. Maybe the state should take a look at closer look at separating the electrical distribution business from power generation, open the maintenance of the grid to competitive bidding, and open the power generation market to the most efficient providers (in this case, individual households).

Hawaii businessman, Duane Kurisu, will team up with the state of Hawaii and the City and County of Honolulu to develop and operate an affordable housing project of 200+ units, named Kahauiki Village, on reclaimed land off Nimitz highway between Keehi Lagoon Park and Sand Island. The Board of Land and Natural Resources (BLNR) has approved a plan where the city takes ownership of the 13 acres of land and will lease it to Kurisu for ten years with an option to extend the lease for another ten years. The land rent will be $1 per year. The homes, a collection of single-family-homes and duplexes, will be rented to families in need of shelter for $500 per month and the families will be responsible for utility costs. The wife of former Gov. Ben Cayetano, Vicky Cayetano, will offer all adults living at Kahauiki Village employment at her company, United Laundry. United Laundry is only a few minutes away on foot from Kahauiki Village. Duane Kurisu will take all financial risks for the project and his foundation will be in charge of the village’s operations.

Political drama surrounding the Honolulu Authority for Rapid Transportation (HART) reached a fevered pitch in April with Ernie Martin, Honolulu’s City Council chairman, called for the resignation of HART Board Chairman Don Horner and HART Executive Director Dan Grabauskas for failing to contain cost overruns associated with the struggling rail project. Don Horner, a volunteer, decided that he no longer needed the negative attention and resigned days afterwards. In his resignation letter to Mayor Kirk Caldwell, Horner stated, “too often in politics, the focus becomes shooting the messenger of unpleasant news rather than collaboratively working on solutions.” Former U.S. Representative Colleen Hanabusa was named Don Horner’s replacement and then announced that she would step down a month later to run for the Congressional post vacated by Mark Takai. A financial audit released on April 15th to the Honolulu City Council was extremely critical of HART by saying that the agency was using outdated financial figures and that the latest estimates of how much over budget the project is most likely too low and will climb as time goes on. Mayor Kirk Caldwell has failed to distance himself from the project.   Hawaii columnist David Shapiro reminded newspaper readers that Caldwell made himself the “point person” on rail when serving as Mayor Mufi Hanneman’s managing director. Kirk Caldwell led the campaign to convince wary taxpayers that the project should be approved with unrealistic cost projections and construction timelines.

Mayor Kirk Caldwell is in full panic mode as the election season started heating up in June and the over-budget rail project continues to dominate the headlines. He is currently trying to compound the problems with the project by proposing that it end several miles short of the planned Ala Moana destination, essentially making the rail system a useless white elephant. The City and County of Honolulu and HART could not have orchestrated a bigger mess if they tried. The first, and possibly fatal mistake was to start the project out in Kapolei versus Ala Moana. Had the project started in the other direction, and the transit route had to be shortened, commuters could have boarded rail to avoid the heavily congested downtown Honolulu commute. Now, commuters who would want to take rail will essentially follow a more complicated option than what The Bus already offers. At this point, cooler heads would help see the project through as planned even though taxpayers will face a much higher bill. Voting does have its consequences.

We attended an event held by Pacific Business News on June 17th titled Windward Oahu Means Business. The event featured five panelists who answered questions from the moderator and from the sold out audience. The most sought out member of the panel was Alexander & Baldwin’s director of asset management who announced that Lau Hala Shops, a collection of shops and restaurants, should be completed in late 2017 in the downtown Kailua building that Macy’s vacated. A & B expects new tenants to move into the complex in early 2018. Other topics included the highly contested vacation rental debate, challenges associated with the homeless, and the thriving feral chicken population in downtown Kailua. Tracey and Tim even admired a gorgeous looking feral rooster on our way back to the office from the event.

The State of Hawaii Department of Land and Natural Resources recently updated its hawaiitrails.org website which also has a mobile-responsive design. Tim briefly navigated the site and it looks pretty useful for locating and planning hikes. So next time you are in Hawaii and someone tells you to “Take a Hike,” you know which website to visit.

Solar Impulse 2, the solar powered plane that arrived from Japan on July 3rd of last year departed Honolulu on April 21, 2016 and arrived at Moffet Field in Mountain View California on April 24, 2016. The pilots, Bertrand Piccard and Andre Borschberg, have logged over 317 hours in the air and traveled over 24,000 km in their quest to travel around the world using the sun’s energy. The plane stayed in Hawaii over the winter to repair the batteries and to wait for longer days before making the trip to California. The plane then completed the next leg of their flight from Mountain View, CA to Phoenix, AZ on May 2nd and 3rd.   You can continue following the pilots’ around the world quest at www.solarimpulse.com.

Have you ever wanted a pet donkey? The Humane Society and Big Island residents are rounding up the last 50 of approximately 500 wild donkeys that have been living off the land (golf courses, residents’ yards, etc.) since being released from Hawaii coffee and agricultural plantations decades ago. The feral donkey herd went unmanaged for about 40 years when drought conditions forced the donkeys into residential areas in search of water. The animals wandered on roads, tore up golf courses, and drank from swimming pools. The Humane Society has found adoptive homes for about 450 of the animals and about 40 of the remaining 50 have already been spoken for. The donkeys must be adopted in pairs or have another animal to keep them company because they are very social animals and need a friend. Doesn’t everybody need a friend?

The local alcoholic beverage industry continues to be a bright spot in Hawaii’s business community. Maui-based Kolani Distillers signed a contract to stock Hawaii Wal-Mart shelves with their Old Lahaina Rum this summer. Kolani Distillers was the only company from Hawaii to win a contract from Wal-Mart’s Open Call for U.S.-based products. Kauai-based, Koloa Rum Company, won four gold medals at the 2016 Miami Rum Renaissance Festival for its Kauai White Rum, Kauai Gold Rum, Kauai Dark, and Kauai Spice Rum. It won a “Best in Class” gold medal for its Kauai Coffee Rum. Maui Brewery Company recently redesigned their beer cans through a collaboration with a Polynesian tattoo artist who created new icons for their beers, raised their brewing capacity to 100,000 barrels per year, and is on track to brew and sell 45,000 barrels in 2016. The company plans on expanding its offerings to include sodas, ciders, and meads. Maui Brewery Company’s recently renamed Coconut Hiwa Porter is one of Tim’s favorite beers. The developments continue a trend of strong growth in Hawaii’s local brewery, wine, and spirits industry.

Looking for great pizza and beer during your next visit to Oahu? J.J. Dolan’s, a downtown Honolulu pub, continues to rack up awards for the best tasting pizza in the state. Not in the mood for pizza, try Me’s Bar-B-Que, a Korean barbecue restaurant in Waikiki. It just landed on the culture website Thrillist’s 2016 list of “The 33 Best BBQ Joints in America.”

Hawaii fun fact: On average, each person in Hawaii consumes five cans of SPAM per year. Seven million cans of SPAM are sold in Hawaii every year, making the state Hormel’s #1 market for SPAM. The Waikiki SPAM Jam was held on April 30, 2016 to celebrate Hawaii’s continuing love affair with the canned meat.

Odds & Ends

Multi-Generation Homes: Hawaii has historically had a significant number of homes with adult children living with their parents. This type of living arrangement is becoming more common throughout the United States for economic reasons that have prevailed on the islands for decades. The Pew Research Center analyzed census data and reported interesting and for some, alarming data concerning the living arrangements of young adults.

For the first time on record, living with parents is the most common arrangement for people ages 18 to 34. Nearly one-third of all millenials live with their parents, a slightly higher percentage than those adults that live with a spouse or partner. It is the first time that more young adults live their parents than those that live with a spouse since statistics were first tracked in 1880.

The most common reasons cited by economists may sound familiar to Hawaiian households. Higher housing prices and escalating rents coupled with stagnant wages have “forced” young people to move back home and save enough money to start out on their own. Additionally, young people are waiting longer to get married as they place education and careers ahead of raising a family. Today, the average women gets married at 27.1 years and the average man marries at 29.2 years (compared to 20.1 years for women and 22.5 years for men in 1956). Part of the reason that older adults have not sold their family homes to downsize for retirement is that they still have adult children living with them. Approximately one-fifth of homeowners age 55 to 64 still have adult children living at home.

Looking forward to an empty nest? Statistical trends suggest that you may have to wait a little longer than you initially planned.

Revisit Hawaii Property Goals: We have talked to many owners over the years that have decided to rent or sell after realizing that the original reason for owning their Oahu property no longer applied. The reasons for owning property vary from holding onto a piece of paradise after moving in the hopes of returning to buying a 2nd home. In some cases, these properties are left vacant.

What holds for financial best practices can also be applied to real estate since real estate can be used for more than just holding a roof over our heads. We recommend evaluating the value that your Oahu property provides every couple of years to make sure that the property’s current use still applies to the your short and long-term goals. Value can be emotional in addition to financial. For example, some people continue renting an inherited childhood home because it reminds them of fond memories and provides a connection to the Hawaii that they want to hold onto. If a quick assessment confirms that the property still aligns with your goals and desires, then stay the course.

Some people discover that they no longer visit as often as they used to because of work or family. Others realize that they will not retire on Oahu. Still others, are not quite sure what the right answer is. If you find yourself in one of these situations, then we can provide market information to help with a decision. Armed with that information, you can then decide if holding onto a vacant property makes more sense than generating funds for new ventures.

One client decided that she wanted to sell her condo and use the cash proceeds to pay for family vacations with her children and grandchildren. Other clients decided to start renting a property that they no longer visited and wanted to generate cash flow for their children’s education. Please call (800-922-6811) or e-mail (home@stott.com) us if you would like our assistance.

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: Allowing pets will increase the number of prospective tenants and often enables an owner to get a higher rent while retaining carpeting that otherwise would need to be replaced. Recent changes in Hawaii’s statutes regarding comfort animals and pet deposits increase the incentives for allowing pets. Tenants with pets will often agree to pay the higher rent and live with the old carpeting if the owner will allow pets.

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.

The U.S. Department of Housing and Urban Development (HUD) has extended protections to handicapped people with assistance animals. “Conditions and restrictions that housing providers apply to pets may not be applied to assistance animals.” A landlord must allow a service animal if a disabled tenant applies and qualifies for rental that does not allow pets. In the latest wrinkle, HUD has effectively eliminated the landlord’s right to refuse renting to convicted felons. Under disparate impact, HUD has decided that refusing occupancy based on criminal background checks unfairly impacts certain races since they make up a disproportionate percentage of inmates.

The median price in March for Oahu single family homes was $725,000 (compared to $700,000 in March 2015) and for Oahu condos was $385,000 (compared to $380,000 in March 2015). Demand for both houses and condos grew about 20% compared to last year and supply shrunk by around 25%. As a result, there is only 2.1 months of remaining inventory of single family homes and 2.3 months of remaining inventory of condos. Additionally, the prices of active listings are skewed to the higher end of the market. Currently only 31% of the available Oahu houses are priced under $800,000 while only 41% of the Oahu condos are priced under $375,000. Competition for “modestly” priced homes appears to be heating up for the busy spring and summer season.

Hawaii economists predict steady economic growth of 2 to 2.5 percent in 2016 but there are risks on the horizon. The shrinking military (currently 46,000, down from a high of 51,000 in 2014), slowing construction (fewer building permit applications), and lower visitor spending pose risks to continued expansion. Paul Brewbaker, one of Hawaii’s leading economists, thinks that lower spending by tourists is the single most important strategic economic development for Hawaii. Real visitor spending has dropped 0.7% per year on average from 1997 to 2014 when inflation is taken into account. Hawaii has been unsuccessful in finding an industry that would diversify the local economy beyond tourism.

Please take the time to visit our upgraded company website and new property management website when you get a chance (www.stott.com and www.stottpropertymanagement.com). Our goal is to provide customers and clients a platform that allows them to quickly and efficiently review the content that they want to see. The new websites are the product of three months of hard work and collaboration by the staffs of Stott Real Estate, Inc. and Wind on Water Communications.

A Mixed Plate of Talk Story

Monstrous waves pounded the North Shore prompting the closure of 11.5 miles of roads on Monday, February 22, 2016 as waves with 60-foot faces slammed into Waimea Bay. The large surf ripped surfboards from contestants of The Quiksilver in Memory of Eddie Aikau as the surf contest was held for only the ninth time in 30 years. The waves in Waimea Bay must have a sustained face height of 30 to 40 feet for eight hours in order to hold the event. Some wave faces that reached 60 feet in height intimidated seasoned professional big wave surfers. Haleiwa’s own John John Florence won the event and took home the $75,000 check. 66-year old Clyde Aikau, Eddie’s brother, competed in his last “Eddie.”

Some participants in one of Hawaii’s largest annual hula completion, the Merrie Monarch Festival, won’t use the ohia lehua tree blossoms in their costumes to help prevent the spread of the ohia lehua blight. There is no current cure for the fungal disease that has infected about 34,000 acres of forest on the Big Island. The state is trying to contain the spread by prohibiting the transport of ohia products and plant parts without a permit from the Big Island. The Big Island is currently the only island affected by the fungal disease. Stopping the spread can be tricky because a tree can be infected months before showing any signs of the disease. Ohia is important to Hawaii’s water supply because it is very effective at soaking rain-water into the ground and replenishing the water shed. The tree’s nectar is a critical food source for many native birds and animals.

One of the most popular attractions on Oahu, Hanauma Bay, is struggling to find the right balance between visitor satisfaction and protecting the environment. Approximately 384,000 people visited Hanauma Bay in 1975. That number grew to over three million in 1988 and the onslaught of visitors was damaging the reef, polluting the water, and creating unnatural fish behavior. Several rules have been put in place to help protect the bay’s fragile ecosystem. In 1990, the city banned tour buses from dropping off beachgoers resulting in about 2 million fewer visitors. The ban, along with a ticket window, and requirement to watch a video that emphasizes the need to stay off the reef and not feed the fish has helped turn things around. Hanauma Bay helps limit the number of visitors in the park by allowing only 125 visitors to watch the video every 15 minutes. While this helps with crowds in the park, long lines regularly occur causing widespread frustration. Gone are the days that Tracey fondly remembers as a kid back in the day. She would often go to Hanauma Bay without waiting in line and fed the fish with a bag of frozen corn or peas. Tracey often jumped in the “toilet bowl” which has been closed to the public.

The National Oceanic and Atmospheric Administration (NOAA) is preparing to propose rules to help protect spinner dolphins while they sleep in shallow waters off the Hawaii coast. The dolphins are nocturnal and spend the night hunting fish and they need their rest after foraging all night. During sleep, half the dolphins’ brain shuts down while the other half stays awake to surface and breathe. The dolphins appear to be awake because they continue to move. One indication that the dolphins are sleeping is the synchronization of the dolphin pods’ dives and swims. The dolphins are a popular attraction for tourists and several tour operators take people to the shallow waters so they can swim with the dolphins. NOAAs concern is that the tour operations are disturbing the dolphins’ sleep, which could cause long-term health issues. Their goal is to allow people to observe the dolphins in their natural habitat while allowing the dolphins to get their sleep through education and regulation.

A team at the Oceanic Institute of Hawaii Pacific University (HPU) has successfully bred a batch of yellow tangs after a decade of trying. The state currently sustains its $2 million aquarium industry by harvesting hundreds of thousands of fish from reefs each year. The yellow tang is one of the most recognized of all Hawaii reef fishes and one of the world’s most popular saltwater aquarium fishes. HPU’s success could be a boon for reef conservation efforts. Tim and Tracey recently marveled at dozens of yellow tang and other reef fish while snorkeling during a recent Big Island vacation.

Hawaii’s Department of Land and Natural Resources has established a new coral nursery on Sand Island to help restore damaged reefs and serve as a bank for Hawaii’s native corals. Nursery staff members are using techniques designed to double the growth rate of coral in its natural setting from a rate of one to two centimeters per year to almost three centimeters per year. The staff harvests coral from Hawaii harbors and places small fragments of the coral into tanks filled with water that includes minerals to maximize survival and exposed to lighting to optimize growth. The growing fragments are later placed in large outdoor seawater tanks where they naturally fuse together. The larger the coral, the less likely that it will be affected by sediment and invasive species when introduced back into the wild.

The Third Circuit Court completely vacated the Thirty Meter Telescope project’s conservation district use permit on February 22, 2016. The Board of Land and Natural Resources must hold a new contested hearing before the permitting process can begin. TMT hopes to secure a new conservation district use permit by early 2017 and target construction for April 2018. TMT may consider other sites if they are not granted access to Mauna Kea later next year. The court action has negatively affected Hawaii’s business reputation as the arbitrary ruling by the courts has placed TMTs investment at risk. TMT has already invested $170 million to date for construction and manufacturing.

Both the University of Hawaii’s men’s and women’s basketball teams completed a very successful year by winning their respective conference tournaments and qualifying for the NCAA tournament. The men’s team won its first ever NCAA tournament game over the University of California – Berkeley before losing to Tracey’s alma mater, University of Maryland in the second round. The men’s team finished the year with a record 28 wins. Hawaii men’s coach, Eran Ganot, won the UH rookie coach of the year award for the men’s basketball team’s historic run. The women’s team lost to University of California – Los Angeles (UCLA) in the first round. The women finished the season with a 21 – 11 record.

In January, University of Hawaii (UH) President, David Lassner, presented a request for $16.2 million in budget add-ons, including support for the struggling UH Cancer Center and money losing athletic program, despite pulling back on planned tuition increases for the next two years. The money would be added to the already approved $428 million in general funds over the next two years. Not surprisingly, several legislators are protesting the use of taxpayer funds to fill a hole from UH’s failure to execute the planned tuition increases. Apparently, in response to the negative feedback, Lassner announced in late February that UH will propose a two-percent tuition increase every year for three years beginning in 2017 to help address a $505 million backlog in deferred maintenance. UH must hold 11 public hearings prior to submitting the proposal to the board for approval.

Plans to build a $50 million center on the University of Hawaii-Manoa campus to honor the late U.S. Senator Daniel K. Inouye have been shelved indefinitely due to criticism of the growing UH repair backlog. Some lawmakers have sensibly questioned the pursuit of new building projects when the university has done such a poor job of maintaining its existing facilities.

The New York Times recently chimed in on HART’s struggle with ballooning construction costs in an article titled “Hawaii struggles to keep rail project from becoming a boondoggle.” The article presented concerns about the 20-mile elevated train line, its design, delays, and escalating costs. HART’s chairman responded that the cost overruns have been addressed by extending the General Excise Tax surcharge and that operational costs savings will be achieved “by utilizing new synergies with TheBus and other City services including the introduction of a systemwide Smartcard.” He added that federal funding will pay for a projected operational loss of $71 million for the first full year of rail operations. The Honolulu Star Advertiser ran an article not a week later highlighting that the recent General Excise Tax extension may not cover the most recent cost versus revenue projections. The budget deficits won’t end with construction. In January, rail officials stated that property taxes will have to increase 9% just to cover the projected operating hole every year once the over-budget construction project reaches completion. The Honolulu Authority for Rapid Transportation (HART) projects that the operations will be in the red to the tune of about $1 billion every decade. HART officials initial budget plans to have fares cover only about 30% of the cost of operations (similar to TheBus operations).

Federal Regulators approved a planned $1.6 billion offshore wind farm that will be located about ten miles southeast of Barbers Point in West Oahu. The project still needs a power purchase agreement with Hawaiian Electric Company (HECO) in order to provide electricity to Oahu’s grid at an expected price below 20 cents per kilowatt-hour. While that rate is expensive in most states, it still represents a modest savings over what HECO’s customers currently pay (about 24 cents per kilowatt-hour). HECO needs to find new sources of renewable energy since it recently cancelled several purchase agreements from renewable sources last month.

Hawaii’s High Technology Development Corp. (HTDC) has sponsored a demonstration of the Air Force’s $6.8 million investment in a waste to energy generating system. The project demonstration will show how ten tons of waste per day can be converted to electricity through gasification technology. Applications of the system include solid waste, animal and crop waste, cellulosic biomass, tires, non-recyclable plastics, and industrial waste. The system was installed at Joint Base Pearl Harbor-Hickam late last year and is currently going through initial testing. The system will soon run specific programs to collect data and then eventually will be used to produce liquid jet fuel from waste. The demonstration will run through summer 2016.

Mari’s Garden, one of the nation’s largest aquaponics farms in the nation has removed itself from the electric grid with the help of Wisconsin-based EnSync Energy Systems. The Mililani farm uses 25 kilowatts of photovoltaic (PV) solar panels and a 25-kilowatt battery storage system to power the farm’s pumps. Tim and Tracey should visit the farm to see how it is done. Tim and Tracey set up an aquaponics garden with their daughter Ashley, five years ago. They are great at growing salad greens and tilapia but absolutely terrible at harvesting anything. Tim goes out to the garden every morning to feed the fish. It may be a matter of time when Tim names all the fish, officially making them pets. At this time, there is still a small possibility that the fish may make the dinner table.

One of the most interesting visitors to Pearl Harbor is the Sea-Based X-Band (SBX) Radar platform, a powerful part of America’s Ballistic Missile Defense System. It comes to Pearl Harbor for routine maintenance and calibration between operations off the Aleutian Islands. The vessel looks like a giant white egg on stilts and can be seen from many places on Oahu when it is in port. The self-propelled platform is about the size of two football fields and is operated by a crew of 86 when underway.

Odds & Ends

Clutter: Tim observed that Tracey often watches the show “Hoarders: Buried Alive” on weekends and recently asked why she watches the show. Her response was quite interesting. Tracey replied, “the show helps me understand some of my clients and their tenants when I list properties that have a lot of stuff and it helps me come up with solutions to help the property sell while preserving the individuals dignity.” A huge reason why Tracey helps people sell their homes, and Tim does not, is due to her patience and her ability (both natural and honed over years of experience) to empathize with her clients and residents whose lives are experiencing some stress and turmoil.

We started thinking about how clutter can complicate the lives of homeowners, tenants, and managers and negatively impact their finances. The clutter can take many forms and the root causes are just as numerous. Some common types of clutter and suggested solutions will be discussed in this article.

The most common form of clutter comes from the accumulation of belongings as people live in their homes over long periods of time. Pictures, knick-knacks, artwork, furnishings, tools, utensils, and paperwork start collecting to the point that the house runs out of room. Some people build a shed and store the excess items there, some people rent out storage spaces, and some people just let their belongings pile up on every horizontal surface in the house until family members must follow paths to get from one room to the next. While hoarding is a mental condition that requires treatment, spring-cleaning by the family can prevent many issues from getting out of control. Tim and Tracey periodically go through their closets, bookcases, and shed together (with their kids when they used to live at home) and donate or throw away items that are in poor condition, broken, or have not been used in the past year or two. It usually only takes a couple of hours to identify and remove the items and it gives them a sense of accomplishment.

Families in the process of moving should take a hard look at what they should move and what items are better off left behind. We often observe buyers who will buy a home that is not necessarily the right fit for their living circumstances to accommodate existing furniture and belongings. There are some pieces that one should not part with due to their sentimental value or because they are valuable and irreplaceable antiques or artwork. However, there are more cases where buyers don’t want to part with run of the mill furnishings that just don’t fit in a great property under consideration. We recommend doing the hard work and making the tough decisions when it comes to identifying, selling, throwing away, or donating furnishings that can be easily replaced and don’t fit in a new home. We observe families tripping over poor fitting furniture, commuting unnecessarily, paying more they need to for a home, spending more than they need to move their stuff, and spending thousands each year storing items that never get used again.

Tim and Tracey often see rental properties where owners store tools so that they can work on their homes when they visit, or store furniture and personal items in locked rooms that they will use when they return to the islands even though they have no concrete plans on returning. Stott Property Management manages some properties that owners have accepted hundreds of dollars in lower monthly rents over many years because tenants don’t have access to the entire property. In the end, the stored belongings are often destroyed by Hawaii’s elements and Stott Property Management ends up hiring handymen to throw them away. In some cases, the owners have passed away and their children have to clean out the rooms and storage areas. In rare cases, storage areas have been broken into and owners have wrongly accused tenants of stealing or destroying their belongings. If you are going to move and rent your previous home, then do yourself a favor and take all of your tools, vehicles, and belongings that you need and sell or donate the rest.

Capital Gains versus Equity: Capital gains and Equity are two important financial measurements that homeowners and investment property owners should estimate before deciding to sell a property in order to successfully plan for and complete a transaction. The capital gain from selling a property is important for estimating a potential tax bill and the equity helps determine how much money the seller will receive or have to pay when selling a home. There are cases where a seller will have to write a check to the title company to sell a home and still have to pay federal and state capital gains taxes.

The capital gain from selling a home is determined by subtracting the buying basis from the selling basis. The buying basis equals the price that a buyer paid for the home plus any closing fees associated with purchasing the property. The selling basis equals the sales price of the home minus realtor fees, closing fees, and the cost of any capital improvements on the home. If the resulting figure is negative, then the seller suffered a capital loss.

An owner’s equity in a property represents the difference between the market value of the property and any loans taken out against that property (mortgage, home equity line of credit, etc.). The seller will have to write a check to sell a home if there is negative equity in the property and the lender won’t forgive a portion of the debt owed (short sale).

There are occasions when a seller will have a capital loss on the property and still receive money from the sale of a home. This scenario can result when a seller makes a large down payment when buying and the market falls making the property less valuable at the time of the sale. It can also result from a seller being unable to recoup the costs of a major remodel when it comes time to sell. Likewise, a seller can have capital gains and still write a check to sell a home. A common scenario that played out in 2009 and 2010 involved homeowners who took out a home equity line of credit or refinanced a home and took cash out. The following market downturn left many of these owners underwater and they either wrote a check or received loan forgiveness even though they had to report a capital gain on the sale.

Recasting a Mortgage: Recasting a mortgage is a little known option available to some homeowners that want lower monthly mortgage payments, have paid off extra principal or have a large lump sum of cash available, and don’t want to refinance their mortgage.

Normally, if you pay off extra principal on a mortgage, the monthly payment remains the same and you simply end up paying off the mortgage sooner. While this strategy will save you interest paid over the life of the loan, it won’t shrink your monthly payments.

Recasting, or re-amortization, involves reducing your monthly payment by paying off a sizeable chunk of the principal on the loan, and then requesting the lender to recalculate the principal and interest owed using the same interest rate and time remaining to pay off the loan. The end result is that you pay a lower monthly amount, make your final loan payment on the date specified in the loan documentation, and save some interest over the life of the loan. The added principal could have been paid off over time or the borrower could have a large lump sum available from savings, a recent bonus, or asset sale. We recommend contacting your lender first before paying off a large chunk of your mortgage if your goal is to recast your loan. Not all lenders will offer the option and some lenders may charge an administrative fee. Bank of Hawaii for instance, will allow a borrower to recast their mortgage once for certain mortgages over the life of the loan.

Mortgage Pay-offs: Let us be the first to congratulate you if you recently paid off a mortgage on your home or an investment property. We recommend that you verify your mortgage company recorded your pay-off in addition to basking in some well-earned glory. If your lender failed to record your pay-off, then you will have a problem when you sell that property because the property still shows that it has a mortgage on paper. It is much easier to get hold of your past lender if you discover this problem before many years have passed because loans are sold between lenders, lenders get sold, lenders go out of business, and paperwork gets misplaced.

Tracey recently helped two sellers with paid off mortgages that were not recorded by switching from one title company to another while in escrow. One title company would not provide title insurance because the mortgage payoffs were not recorded while another company reviewed the circumstances and agreed. In one case, we were able to track down the lender and get the mortgage release recorded after the closing.

Accessory Dwelling Unit (ADU): Mayor Kirk Caldwell signed an ordinance on September 14, 2015 allowing homeowners to build and rent out a separate living space with a full kitchen, bedroom, and bathroom to help defer the high cost of home ownership on Oahu and to help add sorely needed rental inventory to help satisfy unmet demand.

The City and County of Honolulu have placed some important restrictions on ADUs:

1)         An ADU can be no larger than 400 square feet on lots between 3,500 and 4,999 square feet and no larger than 800 square feet on lots larger than 5,000 square feet.

2)         Only one additional dwelling unit is allowed. An ADU can’t be added to a lot with multiple units already present.

3)         An owner or designated representative must live on the property. Hiring a property manager is not sufficient in meeting the requirements.

4)         The lease may be no less than six months in length.

5)         There must be one off-street parking space available.

The requirement that a designated representative must live on the property does make renting an ADU using a property manager a little more complicated. A client of ours recently filed the paperwork to convert an existing attached unit into an ADU so that they could provide a full kitchen versus a wet-bar. Even though Stott Property Management manages the property, the City and County required that the owners designate one of the tenants as the designated representative.

http://www.honoluludpp.org/ contains more information if you are interested in adding an ADU to your property.

Marketing versus Selling: The American Marketing Association most recently defined Marketing as “the activity, set of institutions, and processes for creating, communicating, delivering, and exchanging offerings that have value for customers, clients, partners, and society at large.” Selling is the final stage in marketing that essentially involves closing the deal. Marketing and selling are often used interchangeably because both have the same goal. However, understanding the differences can be the key between success and failure.

How does marketing apply to real estate? Many people have heard the real estate phrase, “location, location, location.” The largest component of real estate marketing actually occurs when a buyer purchases a home or investment property. Location makes up the largest component of positioning the product, in this case, a home. Architecture, interior design, amenities, and condition of the home play an important but smaller role. You can have the best of all worlds when it comes to the features of a home, however, if the property is located in a poor location, then the homeowner or investor has simply over-improved the property. That is the reason that regardless of size and condition, a house will sell within a certain range in a specific location and a condo will sell within a certain range in a specific complex regardless of what the interior and exterior look like. For example, the same exact house located in Kahala will be worth more and cater to a different clientele than the house located in Mililani. Is there anything right or wrong with Kahala over Mililani? The answer lies in the eyes of the beholder. That being said, a homeowner may not be able to sell a luxury home in Mililani for several million dollars to a movie star or mogul regardless of how much money is spent on the construction, decorations, and advertising.

Maintenance does play an important role in a rental properties market campaign. In general, tenants look for clean, functional, square footage in the neighborhoods that they have interest.   Maintaining a rental property is critical in attracting qualified tenants. Most of the tenant issues that Stott Property Management has to deal with (late rent, tenant damage, etc.) occur in rental properties located in less desireable neighborhoods and in properties that suffer from deferred maintenance.

Choosing the right agent or property manager to sell or rent your home is the final piece of the puzzle. A well maintained home in a great neighborhood can still sit empty for longer than necessary if the home is not priced properly or if the ads don’t contain quality photos and enough detail. A well-advertised property will interest more prospects, generate more showings, provide better market feedback, and increase the chances of a quicker sale or quicker lease signing. Since people have differing tastes, markets change, and determining market prices are not an exact science, asking for and adjusting to feedback may be critical in successfully selling or renting a home. A great agent or property manager can help identify the things that you can’t control (location, traffic, local economy) with the things that you can control in an economically efficient manner. It is interesting how modest price changes and minor cosmetic repairs often result in much greater demand for a particular home.

The sale or tenant check-in is the ultimate goal in a successful real estate marketing campaign. In the end, the property must sell itself. Prospective buyers or tenants will make their own judgment about how a property looks, feels, sounds, and smells once they walk through the front door. Ultimately, that is why economists state that a willing and able buyer or renter will help determine the market price for a property.

Oahu’s strong real estate market continues with median sales prices rising and the median sales price for condos setting a new record. December’s single family home median sales price was $700,000 (1.4% higher than December 2014) and the condo median sales price was $386,250 (6.9% higher than December 2014). The number of sales, number of pending sales, and number of new listings all increased compared to the previous year as both buyers and sellers appear to be motivated to do business. Median sales prices should continue to rise as supply remains relatively constrained. There is 2.6 months of remaining inventory for single family homes and 2.9 months of remaining inventory for condos.

Relief from high rents and home prices will continue to be an issue for the foreseeable future based on Governor David Ige’s response to recommendations from leading economists and developers who recommend removing the State Land Use Commission. The commission was put into place in the 1950’s when Hawaii counties were not properly staffed to carry out the zoning responsibilities that most local governments in other states manage. Today, the Land Use Commission duplicates many of the review functions carried out at the county level and provides a second venue for special interests to veto much-needed housing projects. The Hawaii Supreme Court just ruled against an appeal made by the Sierra Club Hawaii Chapter and former state Senator Clayton Hee who argued that the Land Use Commission’s reclassification of land for D.R. Horton-Schuler Homes’ long-planned 11,750-home-master-planned Hoopili project in Ewa Beach violated the state constitution. Unless something is done to streamline the zoning process and remove the unnecessary duplication at the state and county level, then chances are slim that developers can deliver the 66,000 homes economists forecast will be needed in the next ten years.

A Mixed Plate of Talk Story

Hawaiian Airlines will have a different competitor next year when Allegiant Air discontinues service to and from Honolulu in August 2016. The carrier currently offers flights between Honolulu and Las Vegas and between Honolulu and Los Angeles. Allegiant has decided to retire its Boeing 757 fleet rather than conduct scheduled maintenance due later next year. While Allegiant Air is exiting the market, Virgin America, has entered the market and is expanding with the announcement of its second Hawaii route. Virgin America completed its inaugural flight from San Francisco to Honolulu on November 2nd with CEO Sir Richard Branson onboard. Travelers should enjoy Virgin America’s entry since the airline ranks near the top of customer satisfaction surveys.

The United States Supreme Court issued an injunction that halted the race-based Native Hawaiian-only election on behalf of five Hawaiian residents and one Texas resident of Hawaiian descent who opposed the election-process as discriminatory. The purpose of the election was to select delegates to a planned constitutional convention that would lay the ground rules for a separate Native Hawaiian entity.

The budget for Honolulu’s rail transit project seems to get worse every month. The projected cost of the project is currently $6.57 billion according to a report by KITV. The $1.4 billion dollar cost over-run equates to a 27% increase over the original plan sold to taxpayers. Drama and grandstanding continue at the City and County of Honolulu. The Federal Transit Administration (FTA) is withholding its next $255 million in funding until the city council approves the five-year extension of the General Excise Tax (GET) surcharge. Chairman, Ernest Martin, suggested foregoing the federal funding, sticking Oahu taxpayers with the full bill, and then making the rail transit system less useful by shortening the length of the project by one mile. The city council is scheduled to vote on the GET extension in January, but Caldwell is urging the council to expedite the process. HART is expected to spend more than $2.5 billion this fiscal year compared to an approved $1.8 billion budget. HART says that the project can’t fund contracts for the next section of the rail route and may have to delay the schedule.

The 2015 Energy Resources Coordinator’s Annual Report highlighted Hawaii’s progress in creating electricity from renewable sources. The state generated 21.1% of its electricity from renewable sources, far exceeding the original goal of 15% by the end of 2015. Wind and rooftop solar voltaic systems generated over 56% of the state’s renewable electricity. Despite having active volcanoes, Hawaii only generates 12.3 % of its renewable energy from geothermal and has only one new geothermal plant in the works out of a total of 60 new planned renewable energy projects.

Hawaii’s Public Utility Commission (PUC) ended the current net energy metering (NEM) program for new rooftop solar customers effective October 12, 2015. The discontinued program allowed rooftop solar customers to receive credits equal to the full retail value of excess electricity supplied to the grid. While Hawaiian Electric Company (HECO) claims that customers without rooftop solar paid a $38.5 million subsidy to rooftop solar customers, critics of the change counter that HECO benefited from receiving free electricity generation, lower utility fuel costs, and lower transmission costs because rooftop solar decreases the demand for centralized utility generation. Starting October 21, new rooftop solar customers can apply for fast-track approval under a “self-supply” option or a standard review for the “grid-supply” option. The self-supply option allows customers to receive the cost savings of using PV to meet their energy needs and allows a limited amount of excess electricity to be added to the grid for zero compensation. The grid-supply option is intended to provide customers with the option of exporting excess energy to the grid in exchange for energy credits equal to a fixed rate of 15 cents to 18 cents per kilowatt-hour depending on the island that the customer lives on. Customers operating under the old, discontinued, NEM agreement are not affected by this ruling.

Two of the solar leasing companies whose profitability depends on the solar tax credits and previous NEM program quickly filed suit against the PUC’s decision to modify the NEM program. The new ruling makes these solar leasing arrangements much less profitable for leased systems because the companies will have to install more panels on homes to provide similar savings. The leasing plans have recently become less attractive because HECO’s electric rates have dropped with the price of oil. HECO currently charges about 25 cents per kilowatt-hour for electricity used in October. Electricity rates were as high as 35 cents per kilowatt-hour last year before oil prices collapsed.

A statewide poll shows that a strong majority of Hawaii residents agree that there should be a way that science and Hawaiian culture can co-exist on Mauna Kea and support the construction of the Thirty Meter Telescope (TMT) project. The poll shows that 44% of Native Hawaiians also support the project with 49% opposed to the project. The poll also noted that most residents felt that failing to move forward with the project after all regulations were followed would hurt Hawaii’s already poor reputation as a place to do business. The Hawaii Supreme Court ruled that the board acted improperly when it issued a permit prior to holding a contest case hearing. TMT will have to go back to square one and repeat all the same steps before proceeding. As if on cue, those protesting the new telescope declared that they will never accept the TMT project and will resort to illegal means if the project eventually gets approved. The legal setback reminds many state voters of the Hawaii Supreme Court’s ruling that caused the Hawaii SuperFerry to cease operations and sell the state of the art ships to the U.S. Navy. In that case, an overwhelming majority of residents also supported the SuperFerry.

The Hawaii Health Connector’s woes continue as executive director, Jeffrey Kissel, testified to the challenges associated with manually enrolling the 30,000 individuals that signed up for health insurance through the Hawaii Health Connector through the federal website, healthcare.gov. Currently, the average enrollment time is roughly 1.5 hours for each individual and can take as much as four hours for non-English speaking customers. Persistent problems with the healthcare.gov website and limited language resources require Hawaii Health Connector employees to sit with customers and coach them through the entire process. State officials do not think that all Hawaii Health Connector customers will be enrolled by the January 31st deadline. Jeffrey Kissel announced his resignation as executive director effective December for a new job in Washington, the Hawaii Health Connector laid off its entire staff on December 4th, and it transferred all functions to the state.

Pacific Business News summarized the disastrous implementation of Obamacare by the Hawaii Health Connector in a November article. Of the 37,800 individuals that signed up for coverage under the new federal law, roughly 17,000 individuals signed up through the connector and only 8,802 had paid for the insurance. The Connector spent $130 million of the $204 million in federal grants before the remaining $70 million was frozen when the Hawaii Health Connector failed to achieve financial independence. The state of Hawaii effectively spent $14,769.37 to enroll each person in Obamacare via the Hawaii Health Connector. Additionally, those insured individuals will have to dig deeper into their pockets to pay for health insurance as Kaiser received approval for a 34.4% rate hike in October.

Governor Dan Ige officially made homelessness a statewide emergency and about $1.3 million has been outlined to extend current outreach provider contracts through next July. One of the needs that have not been adequately addressed is the lack of shelter space for families and children. The governor’s announcement followed the final city and state sweep of the homeless encampment in Kakaako. The Honolulu Star Advertiser documented another issue in a recent article describing how a man from Florida purchased a one-way ticket to Hawaii without having a job lined up or place to stay ahead of time. The man ended up in a temporary shelter after running out of money. The state is working on ways to discourage this type of behavior.

State officials plan to enforce park rules at Kakaako Waterfront Park and nearby Kewalo basin in mid-November. Many of the homeless people that were removed by the city of Honolulu in October’s sweep of Kakaako, simply moved to these sites controlled and maintained by the state. The state coordinator on homelessness will lead outreach efforts to those individuals living at the two sites and try to place them in shelters and with nonprofits that help the homeless find more permanent solutions. The park areas are closed between the hours of 10:00 pm to 5:30 am.

630 acres of Oahu’s North Shore has been preserved in perpetuity according to a finalized agreement between the Turtle Bay Resort and the state of Hawaii. Turtle Bay Resort will retain the development rights to build 725 more hotel units, about 20% of the original plan in return for the preserved site. The coastline area, which represents about 4% of Oahu’s coastline, will be designated as a public park for recreational use.

A University of Hawaii data visualization project received $600,000 from the National Science Foundation for development. The University of Hawaii will contribute an additional $257,000 for a system that will be the most modern in the United States when complete. The project comes at a time when enrollment in information and computer science at UH is growing rapidly. Approximately 950 researchers and students are in line to use the system for projects in oceanography, astrobiology, mathematics, computer science, electrical engineering, biomedical research, archeology, and computational media. The computer system is scheduled to be operational within the next three years.

The University of Hawaii Rainbow Wahine volleyball team saw their fantastic season end a week before they would have liked. UH fell to the University of Minnesota in four sets in the Elite Eight of the NCAA tournament a day after sweeping two-time defending champion Penn State. The Rainbow Wahine finished the season with a 29 – 2 record.

Hawaii’s biodiversity is quite astounding considering its small footprint and relative isolation from the rest of the planet. The number of known specimens recently grew with the discovery of 74 new beetle species of round-wasted predatory beetles found living on Haleakala volcano. Currently there are 239 known species of beetles in Hawaii, all of which descended from a single common species.

A newly discovered fungus is killing hundreds of thousands of Ohia Lehua trees on the Big Island. The disease, called rapid ohia death, was found to have affected 50% of the ohia trees across 6,000 acres of Big Island forest and is believed to have spread further. Stopping the spread can be tricky because a tree can be infected months before showing any signs of the disease. Ohia is important to Hawaii’s water supply because it is very effective at soaking rain-water into the ground and replenishing the water shed. The tree’s nectar is a critical food source for many native birds and animals.

Odds & Ends

Domestic Violence in a Rental Property: A recent law change allows victims of domestic violence to break a lease without penalty if the tenant or an immediate family member of the tenant has been a victim of domestic violence in the past 90 days. The tenant shall give 14-days written notice to vacate and provide one of the following documents demonstrating domestic violence:

Copy of a valid order of protection issued by a court of any state;Copy of a police report filed in any state; orCopy of the conviction of a person.The tenant must also provide a written statement describing that the tenant believes the person who committed the violence knows the address of the victim unless the person who committed the violence lives in the same rental unit.

If the tenant is one of multiple tenants, then the landlord can check to see if the other tenants can pay the rent. If the remaining tenants are unable to afford the rent, the landlord can give the remaining tenants 14-days notice to vacate. The security deposit is handled in the same manner as other check-outs unless the tenants instruct the landlord differently in writing.

Owner Rights Versus Responsibility: A recent e-mail exchange got us to thinking of the delicate balancing act between a rental property owner’s expectations as a client of a property manager and their responsibility to their customer, the tenant. The e-mail exchange started when an owner quickly scanned a paid plumbing invoice and incorrectly concluded that the plumber overcharged for a simple plumbing repair. The owner then demanded three estimates for all repairs (simple or otherwise) before authorizing any repair work to be done.

If the landlord was the only customer in this scenario, then this type of reasoning makes sense. However, when a rental property is concerned, the ultimate customer turns out to be the tenant, not the owner. In most leases, the tenant must cooperate with the landlord to get necessary repairs completed and this often includes taking time out of their work day. Since the tenant pays rent in return for a safe, functioning property, the tenant has the right to expect that the landlord will address any functional deficiencies in a quick and efficient manner. Requiring three estimates before approving a simple repair would require the tenant to meet three contractors, most likely at three different times to obtain estimates, and then a fourth time for the chosen contractor to complete the repair. We are not aware of many tenants that would tolerate this process for a simple repair.

A good property manager helps maintain the delicate balance between controlling costs and providing customer satisfaction in the following ways.

Develop a network of reliable, cost competitive contractors to quickly address routine maintenance and repair items.Develop repair policies that balance controlling costs while addressing required repairs as quickly and efficiently as possible.Put a system in place to track all repairs until completed.Provide monthly statements that include paid invoices.At the end of the day, Stott Property Management properly managed the repairs in question. The three plumbing deficiencies were quickly addressed and the owner concluded that he did not get ripped off.

1031 Exchange Overview

Purpose: The purpose of this article is to provide an overview of a 1031 exchange. The article is rather basic and not intended to be a guide to an actual exchange, as it omits rules and that could significantly impact upon a 1031 exchange. We have prepared a more detailed paper in a question & answer format using layman terminology that explains the process in considerably more detail. To obtain a copy, check the applicable block on the enclosed postcard and return it. If you provide us your e-mail address, we’ll e-mail you a copy of both the 1031 paper and the HARPTA paper that discusses the Hawaii law that enables the state to collect estimated capital gains taxes from owners that might not file a Hawaii tax return in the year of the sale.

Note: We have participated in a large number of 1031 exchanges and usually have several such transactions in escrow at any given time. However, we are not licensed to provide either legal or tax advice. Licensed professionals such as attorneys or CPA’s should be consulted for such advice. This comment applies to the entire newsletter.

Note: This paper will use the terms “old property” for the property being sold and “new property” for the property being purchased. A property may consist of more than one piece of real estate.

Background: Section 1031 of the internal revenue code (IRC) provides for the deferment of long-term capital gains taxes on the sale of investment real estate when it is exchanged for other investment real estate of equal or greater value than the real estate being sold. A common misconception is you will have to find someone to trade properties with you. Most 1031 exchanges involve two entirely separate transactions. In one transaction, you sell your old property and in the other, you purchase your new property. There is normally no reason for the buyer of your old property and the seller of the new property to have any contact with each other. Often, the properties are located in two different states; e.g., most of our exchanges involve property in Hawaii being exchanged for property on the mainland.

Qualified Intermediary (QI): The IRS mandates that you use a completely independent third party to supervise the exchange. Because this third party must be completely independent, it cannot be your real estate agent, accountant or attorney. The independent third party is usually referred to either as an intermediary or as qualified intermediary (QI); however, in some areas of the country the third party may be called either a facilitator or an accommodator. This paper will use the term “QI.” The QI can be located anywhere in the country; they do not need to be located near you or near either of the properties involved in the exchange.

The following steps have been changed; however, they help explain the role of the QI. The QI takes title to the old property for a brief instant in the process of having it sold from you to the buyer; i.e., title passes from you through the QI to the buyer. Similarly, the QI takes title to the new property for a brief instant in the process of having it sold from the seller to you. Therefore, the QI has owned both the old and the new properties and can exchange one for the other. Today, the QI no longer has to hold title to both properties. In 1991, the real estate industry successfully lobbied Congress to have the law changed, as escrow companies were charging double escrow fees; i.e. Seller to QI and then QI to you. Today, in lieu of taking title to both properties, the QI is tasked to provide instructions so that both transactions are closed in a manner that conforms to section 1031 of the IRC.

Properties & Timing: Both the old property and the new property must be investment real estate; in most cases they are rental properties. The two properties do not need to be the similar; e.g., you could exchange a house in Hawaii for two or more Mainland condos and vice versa. Almost any type of real estate qualifies such as a house, condo, store, office or even vacant land. However, your personal residence or a second home does not qualify. However, you could rent the new property first so that it qualifies as investment property and then occupy it yourself. Many of our clients do this; i.e., they use equity in their Oahu property to assist them in purchasing a future Mainland residence. The new property must be rented for at least a year prior to being occupied in order for it to qualify as investment real estate.

With some very few exceptions, all of the exchanges made by our clients have been deferred exchanges where the old property is sold prior to purchasing the new property. It is possible to do this in reverse order and purchase the new property first; i.e., prior to selling the old property. This is called a reverse exchange and is far more complicated and expensive than a deferred exchange. This article is based upon deferred exchanges. Over half of our deferred exchanges involved absentee owners conducting their first 1031 exchange.

When the old property closes, the proceeds from the sale go to the QI who banks the funds until you’re ready to purchase the new property. To defer all your capital gains taxes, you must buy new property that is equal to or higher in value than the old property. You must also reinvest all the cash proceeds from the sale into the purchase of the new property. The QI maintains the funds from the sale of the disposable property and then makes those funds available in order to enable the purchase of the new property. You cannot have access to any of the proceeds from the sale of the old property or those funds will be taxed.

There are two key time frames both measured from the closing date of the old property. Failure to meet either of these two time frames negates the tax-deferred 1031 exchange.

a. Within 45 days, the new property must be identified in writing to the QI. You can make changes to your identification any time within the 45-day-period; however, on the 46th day, you are locked-in to whatever has been identified as new property.

b. Within 180 days, the new property must close. You can identify more than one property; so if your preferred new property falls out of escrow, you could shift to a replacement new property that was identified during the 45-day-period; however, it would still have to be closed within the 180-day-period. Most exchangers identify more than one new property.

Deferring Taxes: A 1031 exchange enables an owner to be able to defer both the federal and state capital gains taxes that they have on the sale of their old property and roll those taxes over into the new property. Note that the taxes are deferred, not excluded. The current federal capital gains tax rate for most exchangers is 15% on all component of gain except depreciation recapture, which is taxed at 25%. The Hawaii capital gains tax rate is 7.25% on all components of gain including depreciation recapture. State taxes are a deduction for federal taxes; therefore, the combined tax rate is about 21% rather than 22.25% (15% + 7.25%).

Recent rules: Three relatively recent rules apply to principal residences. The tax relief act of 1997 enabled a homeowner to sell their principal residence and exclude up to $500,000 of gain (married) or up to $250,000 (single) providing they had occupied the home for an aggregate 24 out of the prior 60 months. So an owner only needed to own the property for three years, one year as a rental to qualify for the exchange and then two years as a principal residence to qualify for the tax relief act of 1997. In October 2004, there was a change to the 1997 law. An owner who acquired their principal residence by way of a 1031 exchange must now own the property for at least five years before they sell it in order to be eligible for the exclusion. The owner still needs to rent it for one or more years so it qualifies for the exchange and then have it be their principal residence for at least two years. The exchanger also has to pay depreciation recapture on depreciation claimed (after May 6, 1997) while the property was a rental; i.e., depreciation recapture while the property was a rental will not be excluded.

The Housing and Economic Act of 2008 reduces the capital gains that can be excluded when a homeowner sells a principal residence that they acquired via a 1031 exchange, as the amount of the tax exclusion will be adjusted by the non-resident use of the property. This law became effective 1/1/09. The amount of time of non-resident use after 1/1/09 is the numerator or top of a fraction with the bottom or denominator of the fraction being the total time since property acquisition. That fraction times total gain (exclusive of depreciation recapture after May 6, 1997) is the gain that will be taxed to the homeowner.

Example: Single Mary bought her Oahu home on 1/1/93 for $200,000 and rents it for 18 years until 1/1/11 when she occupies it as her principal residence. Two years later, on 1/1/16, Mary sells the property for $500,000 and has $300,000 of gain.

The non-residence use of the property by Mary prior to 1/1/09 does not apply to the new law. Therefore, Mary has only two years of non-residence use (1/1/09 to 1/1/11) when she then occupies it as her principal residence. Five years later on 1/1/16 Mary will have owned it for a total of 23 years. Therefore, the fraction for non-resident use is 2/23. Or, the taxable gain is $300,000 x 2/23 or $26,087. The remaining $273,913 exceeds the $250,000 limit for single Mary, so Mary ends up with $50,000 taxable ($26,087 + $23,913) and $250,000 that is excluded. Mary would also owe depreciation recapture after May 6, 1997.

In my example, I used a long period of ownership before the eligibility date. If the property were acquired after the 1/1/09 eligibility date, the fraction will be much larger. For example, assume the property is acquired on 1/1/09, rented for three years and then occupied for two years, the non-resident use would be 3/5 or 60%. However, if it is rented for only one year and then occupied for four years, the non-resident use would only be 1/5 or 20%. Every day it is a rental property after 1/1/09 increases the capital gains taxes to the owner.

Granted, the new law has no impact if the owner never sells the property; however, few homes remain suitable for the same family over any extended period of time. Over time, most families desire a different location and/or a larger/smaller/more prestigious or a completely different type or style of home particularly after they retire or become empty nesters.

Reasons to Exchange: Most exchangers use 1031 exchanges to defer capital gains taxes. Many have long-range plans to eventually exclude their deferred taxes by converting a rental property into a primary residence even with ownership now a required five years. With proper planning, this is still a very viable investment tool, particularly for property bought prior to January 1, 2009.

Some final thoughts: A 1031 exchange is not the right investment tool for everyone. Over the years, we have assisted many owners in making a decision not to conduct an exchange. Often, all that was required was for us to estimate the owner’s capital gains taxes. Contact us toll-free (1-800-922-6811), locally (808-254-1515) or via e-mail (home@stott.com). Since recent tax law changes have made estimating capital gains taxes exceeding complex, we recommend speaking with a Certified Public Accountant (CPA) or tax attorney prior to deciding on a course of action. Due to the value of real estate on Oahu, you will likely be pushed into the higher tax brackets if you have owned the investment property for a significant period of time and the resulting tax bill could be costly if you don’t conduct a 1031 exchange.

Oahu’s median sales price for single family homes set a new record of $730,000 in September (7.6% higher than September 2014) and for condos was $366,000 (5.5% higher than September 2014). Demand for both single family homes and condos remained robust while available inventory grew slowly. With single family homes having only 3.2 months of remaining inventory and condos having only 3.5 months of remaining inventory, Sellers maintain the upper hand in negotiations. Demand for homes should remain strong in the short-term, as the number of pending sales (properties under contract) is higher than the same period last year.

Robust home sales, low interest rates, and high commercial demand have created more work than Hawaii’s limited supply of contractors can handle. Builders and contractors have been able to raise prices significantly and many homeowners are being told that they must wait up to a year or more before their new home or remodel will be complete. Pacific Business News has reported several commercial projects including a hotel and shopping center that have been canceled because of the skyrocketing building costs.

University of Hawaii’s Economic Research Organization (UHERO) reported continued strength in Hawaii’s economy driven by record tourist numbers and strong construction demand. The unemployment rate continues to drop as the construction industry reported a 6.5% increase in jobs. The private sector is driving the bulk of the employment gains as both state and federal government jobs have continued to drop. While the current news is positive, UHERO sees some problems on the horizon. Stock market volatility caused by slowing global economic growth has fueled a sharp drop in U.S. consumer sentiment. An already strong dollar could continue to strengthen if the Federal Reserve starts raising interest rates making Hawaii a more expensive international tourist destination. Tourism could take a hit if current trends continue.

A Mixed Plate of Talk Story

Honolulu has ranked #4 in another dubious category due to the high cost of living and its unfriendly business climate. Bloomberg Business reports that Honolulu has one of the highest rates of local people leaving the city for other cities in the United States. The study describes that as the locals leave, foreigners seeking opportunity, move in to the city and make it work by packing multiple adults or families in a single apartment or house. It is an arrangement that most Americans are just not willing to pursue. Investors need to take this changing dynamic into account since Stott Property Management has already noticed and reported this trend to its clients. Ultimately, landlords may have to make the decision between offering a lower rent to attract the much sought after one family household or be more willing to consider renting to multiple unrelated adults. Screening tenants will become more of a challenge because many new foreign people do not have any credit history or landlord references. This trend will also raise the importance of assigned parking when owning a condo or the availability of off-street parking at a house. Two or three bedroom condos with two assigned parking will be able to command higher rent because multiple bread winners that own cars for their daily commute will gravitate toward these dwellings. Additionally, young singles often seek out homes that have off-street parking for three or more cars in order to stretch their rental dollars in areas where street parking is already difficult to find.

This summer has been unseasonable hot and sticky, reminding Tim Kelley of his summer days in New Orleans versus the mild summers typical of Hawaii. The hot and humid conditions have resulted in a flood of orders to repair, replace, or install air conditioning systems and the companies that provide those services have been overwhelmed. Stott Property Management has had to wait several weeks just to receive estimates and service for their rental properties. One tenant had to reschedule an appointment and now must wait two more weeks to have the repair completed. We have received information from a variety of sources that parts and systems are not available on Oahu and people must wait for new inventory to be shipped in. Even though the trade winds returned last week, the hot summer will likely make air conditioning a greater priority for tenants looking for a new home.

The Hawaii Board of Land and Natural Resources’ voted to approve an emergency rule prohibiting camping and restricting access to Mauna Kea’s summit between the hours of 10 p.m. to 4 a.m. in response to increasingly hostile protests. Attorney General Doug Chin stated that campers have blocked the road to the summit with boulders and cars, inadvertently introduced invasive species, and opened unauthorized toilets. Activity logs released by the Office of Mauna Kea Management cite hostile engagements with the protestors and threats to personnel. Water consumption, which must be trucked up the mountain, has been at a record high. A woman was arrested after the ruling for allegedly damaging a park ranger’s vehicle by hitting it with her own car. The Mauna Kea access road reopened on July 13th while the visitor center and its public bathrooms remain closed. The road had been closed for three weeks while the state repaired the damage to the road by some protestors. Governor David Ige signed the emergency rule on July 14th and it will expire in 120 days. 150 Hawaii National Guard soldiers have taken civil disturbance training in the event that protestors violate the emergency rule. 15 people have been arrested since the emergency rule went into effect. State officials recently removed a tent abandoned by protestors from the Mauna Kea summit. It appears that the protestors have caused more damage recently in “protecting the mountain.”

The Hawaii State Supreme Court heard arguments from attorneys representing the state, the University of Hawaii, and opponents of the planned Thirty Meter Telescope project in late August. This is the latest chapter in the drawn out saga concerning an international project to build a telescope that would search for answers regarding the beginning of the universe. In a classic case of judicial overreach, the Hawaii Supreme Court will decide if the state process for approving the project was proper.

The State of Hawaii appears to be falling under the weight of its bureaucracy and Hawaii taxpayers will end up eating some of the bill. In two articles published the week of September 28th, The Honolulu Star Advertiser reported that the EPA is withholding $8 million (all of 2015 fiscal year funding) for failure to efficiently spend federal funds to improve water mains and leaking pipes. There isn’t a week that goes by when Honolulu traffic is not disrupted by a broken water main. Three days later, the same paper reported that the Attorney General’s Office is asking for some of the $3.9 million paid to the state in fiscal years 2011 through 2013 to combat Medicare Fraud. The state only collected $337,000 for its efforts and the Inspector General found several deficiencies in the state’s efforts including the failure to hire sufficient full-time investigators, losing files, and failing to investigate 22 percent of the assigned cases. The state and Attorney General’s Office are currently negotiating a settlement.

It appears that the total amount that the Honolulu rail project’s total price tag will continue to grow and that the project will continue regardless of the cost and taxpayers will have to foot the bill. The estimated deficit recently grew from $900,000 to $1.1 billion. Mayor Kirk Caldwell has been quoted as saying, “I do not want to accept increased costs of $200 million, projected. We need to work hard to have that not happen.” Meanwhile, the Honolulu Star Advertiser reports that the city has spent hundreds of millions of dollars on useless construction plans that the hired contractors are unlikely to use.

The University of Hawaii at Manoa’s Army Reserve Officers’ Training Corps (ROTC) program was recently recognized as the best among 30 ROTC programs on the West Coast including Alaska and Guam. The professor of military science at UH Manoa credits the award with their successful partnership with The Hawaii Army National Guard and the 25th Infantry Division at Schofield Barracks with the University of Hawaii ROTC’s success. This is the fourth time in the last 15 years that the University of Hawaii has been recognized for their success in training young leaders. The ROTC programs are reviewed based on the Cadet National Order of Merit list, cadet retention ratio, quality and performance of military training and newly commissioned second lieutenants. Tim Kelley graduated from Tulane University’s Navy ROTC program and credits both the ROTC program and the U.S. Navy for making him “grow up,” and developing the leadership skills that he still leverages today in running a business.

The University of Hawaii has more reasons to cheer as the women’s volleyball team has started the season by winning 10 of their first 11 games. The UH Wahine Volleyball team is currently ranked #11 in the latest national poll. The UH Warriors football team has started out a respectable 2 – 2 with wins over Colorado and UC Davis. Both the volleyball and football team have started conference play.

The University of Hawaii Economic Research Organization has published a report highlighting concerns with Hawaiian Electric Company’s current net metering program. HECO’s current net metering currently allows consumers with photovoltaic systems to both buy and sell power at retail rates, effectively using the grid to store surplus power. UHERO argues that under the current system, customers with roof-top PV don’t pay any fixed costs for the grid and those costs get passed on to customers without rooftop solar. UHERO argues that as consumers continue to install PV systems, the electricity produced at mid-day becomes less valuable than evening or nighttime power. Researches noted that Hawaii’s high electricity rates coupled with an inefficient pricing system could encourage many consumers to install stand-alone systems and unplug from the grid. The report appears to be more concerned with rising costs for some versus embracing technology that can end a monopolists grip (HECO) on electricity production and enable consumer choice in the electricity market.

As ultra-luxury condos get built, Kakaako continues to struggle with a growing homeless problem. State Representative, Tom Brower, was hospitalized after being beaten while taking photos of a homeless encampment by at least two assailants. Later in August, the Honolulu Star Advertiser reported that assaults have risen dramatically around three homeless encampments in Kakaako. Authorities have not come up with a solution to the growing problem and are currently unwilling to force the homeless to move. Kakaako is just the latest area to struggle with a homeless population that has been growing as rents and home prices have reached record levels. Governor David Ige has announced that a team of county, state, and federal government officials will meet weekly to purchase land, secure funding to develop transitional and permanent housing, and provide health and outreach services for the homeless. Hawaii’s estimated homeless population has grown over 35% since 2009. The U.S. Department of Housing and Urban Development just awarded the state approximately $14.2 million to address homelessness and build affordable housing.

A solar powered aircraft, Solar Impulse 2, landed at Kalaeloa Airport in West Oahu on July 3rd setting records for the longest solar powered flight in both time and duration. It took pilot Andre’ Borschberg five days to fly from Nagoya, Japan to Oahu, the longest leg on the planned around-the-word flight that began on March 9th in Abu Dhabi. The pilot only slept for periods of 20 minutes at a time and used breathing exercises and yoga techniques to remain functioning in an unheated and unpressurized cockpit. The Solar Impulse 2 will remain on Oahu until April because repairs to the plane’s batteries won’t be completed for about a month and shorter days make the remainder of the trip too risky. We will never complain about flying coach (until we fly again).

Turtle Bay finally has some competition on the North Shore. Tourists can now stay at the Courtyard by Marriott Oahu North Shore in Laie. The 144-room property opened in late June and is located next to the Polynesian Cultural Center. The hotel is the final piece in the puzzle for making the Polynesian Cultural Center a more inviting destination for Hawaii visitors.

Everyone knows that pigs can’t fly. However, here in Hawaii, pigs can apparently surf. Waikiki’s premier ocean sports festival, Duke’s OceanFest, included the “Going to the Dogs SurFur Competition.” More than a dozen dogs and a pig competed for the best ride, the best tandem wave, and the best-dressed surfing pet.

Three nuclear engineers from Pearl Harbor are opening a brewpub, Beer Lab HI, in Manoa later this year. Both Tim Kelley and George Stott were nuclear trained engineers and look forward to seeing how this trio “nuke it out.” For those not indoctrinated in the nuclear navy’s geekdom, “nuking it out” is another phrase for figuring it out. In an unusual twist, the brewpub will have a bring-your-own-food policy for those who would like to dine while enjoying a few cold ones.

Tim and Tracey are officially empty nesters. Their youngest, Mark, is attending Santa Clara University.

Odds & Ends

Relaxed Loan Policies: Fannie Mae has lowered the bar for those homeowners looking to qualify for a new home purchase without selling their previous home. Previously, Fannie Mae required that an owner have 30% equity in their current home and provide a signed lease before they could use rental income from that property to qualify for a new home loan. Now, buyers just need to provide a lease agreement on the home in order to use that rental income to qualify for a new mortgage. If you were turned down for a mortgage in the recent past because you owned investment property and failed to meet the earlier requirements, then it may be worth trying to get pre-approved for a mortgage again.

Fannie Mae will also be rolling out another program aimed at households with extended families. The program will let lenders include income from nonborrowers within a household towards qualifying for a loan. The “nonborrowers” can be family members or boarders that pay rent at the property. The program will require credit counseling and will allow down payments as little as 3%. Critics of the program say that counting non-traditional income can lead borrowers into mortgages that they ultimately can’t afford.

In unrelated news, Freddie Mac recently launched a first time home-buyer program with reduced mortgage insurance requirements and as little as 3% down.

The two government sponsored mortgage giants, Fannie Mae and Freddie Mac, are relaxing their lending standards after receiving increased pressure from lawmakers to help the housing recovery along. Please contact us at home@stott.com if you would like more information about these changes and if we can help you with your real estate goals.

Property Tax Assessments: Oahu property owners should keep their eyes open in the next couple of months for their property tax assessment. The Real Property Assessment Division sends out their annual notice of assessment on or before December 15th and property owners have until January 15th to file an appeal if you think the assessed value is too high. If you don’t receive a letter or if you misplace your letter, you can review the assessed value of your property at www.honolulupropertytax.com. The most common grounds for appeal is if the assessed value of the property exceeds the property’s market value by more than 10%.

The assessment has additional consequences for owners of second homes or investment property with market values at or approaching $1 million. The City and County of Honolulu created the Residential A classification that applies to properties with an assessed value $1 million or more, does not have a home exemption, and is in an area zoned residential. Residential A property taxes will jump from 0.35 percent of the assessed value to 0.60 percent of the assessed value. Unfortunately, the city council and the mayor decided to try and evade responsibility for a tax increase by raising taxes on tax payers that can’t vote.

If you think that your tax assessment is too high, then you can contact us at home@stott.com and ask for a free market analysis. We can provide you recent comparable sales that you may be able to use as evidence that the assessed value is too high. Otherwise, you will just have to take solace in the fact that you own a very valuable piece of property.

The Big Picture

Decades of managing rental properties and 18 years of owning investment property have given us a decent grasp of and appreciation for keeping the big picture in mind when dealing with issues and making informed decisions. The purpose of the article is to help investors and homeowners take a step back from the details and ask more basic questions like, “Should I sell my home or convert it into a rental?” Failure to keep the big picture in mind can cost you tens of thousands of dollars in lost income or higher expenses and cause unnecessary stress.

Selling versus Renting: Many homeowners that are leaving the islands contemplate renting out their home versus selling without crunching numbers or even asking if their home would make an appropriate rental property. The first question a homeowner should as is: “Would I have purchased my home as a rental property?” In most cases, the answer will be “No.”

The first reason has to do with the low annual rental revenue of Oahu rental properties in relation to the market sales price. Some studio apartments have annual rents equal to about 7.5% of the sales price. The rent-to-sales price ratio gets rapidly worse as the property becomes larger and more expensive. The rent-to-sales price ratio for a $1,000,000 property is typically about 3%. If you hire a property manager to manage a property, then the rental income is reduced by another 14.5% when taking property management fees and General Excise Tax into account. In general, an investor will have to make a down payment on an Oahu investment property of at least 50% just to have their investment break even.

Homeowners, in general, don’t want to live in a property that would make a great rental. A great rental property maximizes rental revenue per square foot, uses moderately priced fixtures that will minimize the effects of wear and tear, and appeals to the largest percentage of available tenants by using neutral colors. Many homeowners tailor their homes according to their individual tastes over time. Luxury fixtures may not command an increase in rent to justify the cost and may require special care that tenants won’t provide. Emotionally speaking, people that convert their homes into a rental are less likely to make objective decisions based on economic fundamentals and more likely to make decisions based on emotional responses that hurt their bank accounts.

Lastly, homeowners currently enjoy one of the best capital gains tax breaks available. An individual receives a $250,000 capital gains tax exemption and a married couple receives a $500,000 capital gains tax exemption. I am unaware of a better source of tax-free income available to ordinary American citizens.

One of the times that it makes sense to rent out your home is if you have plans to return to Oahu in a couple years or less and move right back in. Stott Property Management has successfully helped many clients accomplish this goal. In fact, we are currently renting out a condo for one family who is currently on a sabbatical in Europe. They will return at the end of the year while pocketing about six months of rental income while they were gone.

Your Tenant is The Customer: Keeping in mind that your tenant is the customer can help maintain perspective when it comes to making decisions about your rental property and your interacting with your tenants. There are a small percentage of owners that feel that they can access their property at any time and treat their tenants as wayward children. In exchange for rent, a tenant expects quite enjoyment of the property. In Hawaii, a landlord must give a tenant 48-hours written notice before accessing the property unless it is an emergency. The landlord-tenant code also states that an owner may periodically inspect a property so long as the periodicity is not considered harassment.

Stott Property Management has spoken to several owners that were upset because they felt that their tenants were “slobs,” or “hoarders.” We try to explain that in exchange for rent, a tenant can live as he or she chooses as long as the tenant returns the property back to the landlord in the same condition minus normal wear and tear, and as long as the tenant’s behavior does not violate local, state, or federal law. One owner even felt that it was appropriate to try and implement overly strict house rules because she “used cheap building materials in her rental property” (her words). The tenants actually called the cops several times to escort the owner off the property because she would show up unannounced at the property to enforce the house rules.

Property Maintenance: One of the biggest mistakes that we routinely see is an owner’s failure to quickly address cosmetic and functional repairs on a vacant property. The cost of many cosmetic repairs can be much more expensive in Hawaii than the very same repairs in other parts of the country. Owners will either refuse to do repairs or request multiple estimates even if the delay will result in weeks of additional vacancy time. For every $1,000 of rent that a property brings in, one week of vacancy results in a loss of $250 in rental revenue. About six years ago, Stott Property Management, provided an estimate to a client from a contractor that could get to work immediately. The client thought that the estimate was too high and thought he could save about $1,000 by hiring a contractor on his own. In the end, the repairs took five months to complete (4 months longer than accepting the original estimate), costing our client at least $4,000 in lost rental revenue.

Allowing deferred maintenance to accumulate can result in even costlier issues. Stott Property Management inspects their rental properties at least once per year to make sure that the tenant is taking care of the rental property and to look for repair items that should be addressed immediately. Stott Property Management has taken over properties where spending a few thousand dollars resulted in an estimated $10,000 of additional rental revenue through higher rent over a years time. Ironically, these properties would also have fewer tenant related problems in the past because a well maintained property attracts more responsible tenants.

Saving the PM Fees: We have spoken to several people that try to manage their Hawaii property from thousands of miles away with the help of friends, or rent to “friends” in order to save monthly property management fees. In one extreme case, Stott Property Management determined that an owner had been renting his property for approximately $2,000 under market per month for about ten years. Saving about $24,000 in property management fees over that ten year time span ultimately cost the owner approximately $240,000 in lost revenue. When learning the news, the owner continued to manage the property himself because he could not justify paying someone thousands of dollars per year to just “collect the rent”… Really? Stott Property Management conducts a rental market analysis of every property that has a lease that is about to expire to evaluate if a rent increase is justifiable. Stott Property Management will recommend a rent increase if a tenant is unlikely to move because similar vacant properties have higher asking rents. Stott Property Management helps their owners maximize their investments following this methodology.

Failing to hire a professional carries many other risks as well. Properly screening tenants is one of the most critical steps when considering a new tenant. Ordering a credit check, checking with previous landlords, and verifying a prospects employment can save thousands in lost rental revenue, cleanup costs, and legal fees. Stott Property Management does get hired from time to time to deal with problem tenants that would have been avoided if the owner had screened the tenant prospects before turning over the keys.

Many owners that manage Hawaii property from the continental U.S. often rely on their tenants to make repair requests when problems come up. An owner who has had the same tenant for ages, may not have seen their property for seven to ten years. When the tenant does move, the owner is shocked that the property is a wreck. We started managing one property for a client who allowed the tenant to rent his house for $900 per month as long as he took care of the house. The tenant lived there for ten years. When the tenant vacated, the owner spent about a month fixing all the problems that the tenant failed to address. Once the house was ready, Stott Property Management rented the house for $3,000 per month. Once again, an owner lost hundreds of thousands in revenue by trying to manage the house himself.

Negative Cash Flow: Many owners of Hawaii rental property tolerate negative cash flow for years in the hopes that rents will increase enough to provide positive cash flow or sales prices will rise so that they can sell for a greater profit. Since rents typically increase at the same rate of inflation over time, an owner may have to wait 10 years or more for rents to increase enough to cover the mortgage and operating expenses. If you own an investment property that is producing negative cash flow and you can sell for a profit, consider conducting a 1031 exchange into a property in another part of the country that will generate better cash flow. Why work harder and longer to make up for a negative cash flow situation when you could possibly invest in a property that will give you cash every month?

Leverage Your Time: In order to retire comfortably, a person’s investments must generate enough passive income to pay their living expenses with some margin for error. Owning investment real estate is a great way to generate passive income, however, many investors stop buying investment property because it is such a hassle to manage. Who wants to work a day job, only to answer tenants’ phone calls in the middle of the night and show vacant property on weekends? By hiring a property manager, all you have to do is review monthly statements and verify that the money has been deposited into your account.

Tim and Tracey started investing in 1998 with the purchase of their first duplex. They had “romantic visions” of fixing up the place themselves and saving a ton of money in labor costs. After several weekends working at the duplex while trying to keep their toddlers amused, and several late nights painting, the duplex was ready to rent. While some of the cosmetic repairs were successful, others had to be reworked a few years later resulting in little net savings. The experience turned out to be a valuable lesson in knowing their limitations and leveraging their time by hiring the appropriate expertise. Tim and Tracey have since expanded their investments to include three duplexes and a four-plex over the span of 15 years. By factoring in property management fees when purchasing new acquisitions, Tim and Tracey were able to generate positive cash flow while paying someone else to deal with the headaches. These investments now help to ease the sting of college tuition for their two grown children, Ashley and Mark.

While some companies specialize in either residential real estate sales or property management and imply specialization provides an operational advantage, Stott Real Estate, Inc. offers both services. Tracey Stott Kelley is one of a few agents on Oahu that has been in the top 100 in sales for nine straight years and Stott Property Management is a leader in units under management on Oahu. Tim and Tracey believe in educating their clients, giving their clients the necessary information to evaluate their options, and then executing according to their clients’ decisions. Stott Real Estate, Inc. has the depth of knowledge necessary to provide their clients useful, timely information and provide objective advice when requested. Please call Stott Real Estate, Inc. at 1-800-922-6811 or e-mail home@stott.com if you would like our help with your property.

Oahu’s June median sales prices in March were $700,000 for single family homes (same as June 2014) and $338,500 for condos (6.0% lower than June 2015).  Sales price increases remain relatively tame even though inventory remains tight and demand was strong.  There is currently 3.2 months of remaining inventory for single family homes and 3.5 months of remaining inventory for condos.

While sales prices continue to hover near all-time highs for most neighborhoods on Oahu, Stott Property Management has witnessed a softening in rents for some areas, particularly West Oahu.  Stott Property Management first noticed a trend starting in October as a larger than normal number of tenants gave notice to vacate and moved to other parts of the country.  Rent increases over the past few years appear to have outpaced the median per capita income.  Rents have increased approximately 15% to 20% since 2010 (based on a sample of rents from properties that we manage) while the paychecks of Hawaii residents have only increased about 7% to 8% over the same period (based on data from The University of Hawaii Economic Research Organization).  Stott Property Management recently wrote a letter to all of its clients advising them of the current pause in the rental market since landlords were growing accustomed to consistent rent increases.

The University of Hawaii Economic Research Organization (UHERO) predicts that the construction industry will help propel the economy over the next couple of years after lagging behind the recovery in tourism.  Low unemployment rates coupled with moderate job growth should translate into income growth of two to three percent in 2015.  Risks to UHERO’s economic forecast include potential policy errors by the Fed, heightened fiscal austerity by national governments, and continued slowing of China’s economy.

 

A Mixed Plate of Talk Story

The USNS Mercy, or one of the tugs assisting in the hospital ship’s Pearl Harbor departure collided with the floating dock at the USS Arizona Memorial damaging the docks handrails and infrastructure.  The USS Arizona Memorial was closed to visitors from May 27th to June 5th while repairs were completed.  U.S. Navy divers, the Seabees, Air Force civil engineers, crane operators, and safety inspectors worked night and day since the damage occurred so that tourists could once again visit the memorial and pay their respects.  The sunken battleship and the hospital ship were not damaged.  The USS Arizona Memorial is Hawaii’s #1 tourist attraction with about 1.8 million people visiting annually.

Planning a trip to Hawaii?  Hawaiian Airlines was recently ranked second in an airline quality report released by Embry-Riddle Aeronautical University and Wichita State University.  The report compares the performance of U.S. airlines using a weighted average in several categories like on-time arrivals, involuntary denied boarding, mishandled baggage, and a combination of 12 customer complaint categories.  Hawaiian Airlines placed second to Virgin America, which has announced that it will start launching flights from San Francisco to Hawaii in November.

If you visit Oahu, Dr. Beach recommends that you visit Waimanalo Beach.  Stephen Leatherman, aka Dr. Beach, is a coastal science professor at Florida International University who recently ranked Waimanalo beach as the #1 beach in the United States.

Pacific Business News published Hawaii’s top ten golf courses as determined by a poll of Hawaii golfers that responded to a recent survey.  The golf courses ranked from #1 through #10:  Ko Olina Golf Club (Oahu), Waialae Country Club (Oahu), Manele Golf Course (Lanai), Ewa Beach Golf Club (Oahu), Hawaii Prince Golf Club (Oahu), Turtle Bay Arnold Palmer Course (Oahu), Mauna Lani Resort (Big Island), Kapolei Golf Course (Oahu), Koolau Golf Club (Oahu), Mid Pacific Country Club (Oahu).

Hawaii has recently ranked as the worst state to do business according to CNBC for the second time in the past three years.  Hawaii was ranked 49th last year before falling to the bottom once again.  Major factors in earning the dubious ranking included the high cost of doing business, the high cost of living, poor infrastructure, poor performing public schools, and a business unfriendly regulatory environment.

The Big Island’s famous Ironman Triathalon was notified by the Department of Justice regarding its practice of allowing athletes that failed to qualify an opportunity to buy a chance to enter the race at $50 per chance.  The Department of Justice has ruled a practice that has been in place since 1983 as an illegal form of gambling.  It appears that the “no fun police” of the federal government has eliminated the opportunity for lesser-qualified athletes to participate in a world-class event.  The organization that runs the Ironman Triathalon decided not to fight the Department of Justice’s findings and has ended the lottery for future events.

Plenty of drama has unfolded around the planned construction of The Thirty Meter Telescope (TMT) on Mauna Kea’s summit.  The $1.3 billion internationally backed project held a groundbreaking ceremony in October 2014 after completing a seven-year public and agency review.  TMT halted construction at the site when Native Hawaiian protestors were arrested for blocking construction equipment and crews.  More than 120 people showed up to testify at a University of Hawaii Board of Regents’ meeting in Hilo, Hawaii on April 16, 2015.  Several of the board’s new members were not present when the board approved the project over five years ago and agreed to hear testimony to learn more about the management of the mountain and the opposition’s arguments.  In an ironic twist, the protestors have introduced an invasive species of ants at Mauna Kea’s summit.  In a compromise with the protest movement, Governor Ige required that some existing telescopes be removed from the summit earlier than originally planned and that the University of Hawaii return 10,000 acres of the Mauna Kea summit not currently being used to the State Department of Land and Natural Resources.  Governor Ige stated that TMT is legally entitled to use its discretion to proceed and TMT tried to resume construction on June 24, 2015.  Protestors blocked access to the summit by placing rocks, rock walls, and stone altars in the road leading to multiple arrests.  Governor David Ige has called for another halt in construction and the state is currently working on restoring access to the summit once a safety assessment has been completed.  TMT will pay $1 million per year in rent with 20 percent going to the Office of Hawaiian Affairs.

Hawaii had a number of extremely competitive college teams this spring.  The UH Men’s Volleyball team lost to Penn State in four sets in the NCAA tournament and finished the season with a 24-7 record.  The Warriors were ranked #1 in the country before losing in the Big West’s postseason tournament and the NCAAs.  The previously #1 ranked UH Women’s sand volleyball team lost in the double elimination national championship tournament to finish the year 18-3.  Previously undefeated and #1 ranked Hawaii Pacific University’s (HPU) men’s tennis team lost its first match of the season in the finals of the NCAA Division II tournament.  Tim Kelley recently had the pleasure of taking part of a tennis clinic put on by the HPU men featuring tennis drills that they routinely use to hone their skills during the competitive season.

Elected officials at the City and County of Honolulu appear to be getting desperate in their attempts to deflect criticism of the traffic mess in Waipahu, Pearl City, and Aiea.  The headline in the local section of the Star Advertiser exclaims, “Firms can cut traffic, official says.”  City Councilman Brandon Elefante introduced a resolution to urge public and private employers to sponsor van pools, subsidize bus passes, and provide flexible schedules.  The Star Advertiser acknowledged that the measures were not feasible for most small businesses just striving to stay in business.  Tim Kelley had the pleasure of driving along Kamehameha Highway in Pearl City at lunchtime on a June weekday and experienced the lane closures due to rail and other city projects.  He was happy that he had an all-wheel drive Subaru to navigate the “off-road” conditions on one of Honolulu’s major roadways.  Hawaii ranked among the bottom four states with the worst rural roads in the country.  Only 15 percent of the rural roads in Hawaii were rated as “good.”  The pain and suffering for West Oahu commuters has just started and will continue for the foreseeable future.

Oahu’s road problems are essentially self-inflicted and the state can’t blame their woes on a lack of funding.  The federal government has warned the state that federal funding for highway projects may get pulled if the state does not start construction within 180 days from the time the federal government commits funds for each project.  It currently takes the state of Hawaii about 270 days on average to start construction once funding approval is received while nine other states start construction in 80 to 100 days on average.

Even though medical marijuana has been legal in Hawaii for the past 15 years, patients that receive prescriptions had to grow marijuana themselves since there was no legal mechanism to purchase it.  A bill allowing medical marijuana dispensaries will become law no later than July 14th.

 

Odds & Ends

Paul Brewbaker’s Talk:  We had an opportunity to listen to Paul Brewbaker, a leading Hawaii economist, describe his view of Hawaii’s economy today and his short-term expectations for the next few years.  As per usual, he was able to make the topic of economics entertaining by mixing in personal stories and a little Pidgin.

Paul’s near-term forecast mirrors some recent comments from the University of Hawaii Economic Research Organization (UHERO) and builds on some topics that Paul has touched on previously.  Similar to last year, Paul emphasized that the lack of new hotel development has choked off any further growth in Hawaii’s #1 export industry, tourism.  Hawaii’s inability to meet increasing demand for rooms has resulted in rising hotel room rates cannibalizing other tourism related business and shorter visits.  Paul updated his graphs to show that Federal dollars into Hawaii continue to shrink and he added that military cuts impacting Hawaii really means military cuts impacting Oahu.  The one area for possible growth is construction.  By stripping out permits associated with photovoltaic installations (PV), Paul estimates that new building construction continued to decline as the economy recovered and that we may be finally seeing some growth in the construction industry.  Permit values for new construction are still significantly lower than permit values for new construction in 2005.  If construction does not pick up, then Hawaii’s economy growth will lag the nation’s more than it already is.

Paul has thrown out his previous predictions for Oahu’s housing market by stating that “boring is the new normal,” and that he is “resigned to this.”  Low inventory has not resulted in the same price appreciation that Hawaii witnessed 10 years ago.  The strengthening dollar and weak oil prices have made Hawaii real estate prices 50% more expensive for Japanese buyers and caused Canadian money to dry up.  Paul does not see any major source of demand driving real estate price appreciation above four to five percent annually.  However, this new boring has resulted in real price appreciation, after stripping out inflation, of about two percent.  Additionally, homeowners benefit from the dividend of ownership:  “you get to live in the home.”  Paul did point to one ominous sign.  “Reduced military on Oahu in the 90’s was not good for real estate and they are planning it again.”

Paul was amused by the change in governors since the same party won the election.  He distilled Abercrombie’s loss in economic terms down to:  “the last governor woke up and there was no more money.”

New Mortgage Rules Coming in August:  Buyers and Sellers may experience more delays when trying to buy or sell a home as a result of new regulations put forth by the Consumer Financial Protection Bureau (CFPB).  The upside to the new regulations is that it reduces the number of documents that must be reviewed and signed.  The current good faith estimate and truth in lending disclosure will be combined into one disclosure that will be given at the loan application.  At closing, the development settlement statement and final truth in lending disclosure will be combined into the closing disclosure.

The downside has to do with the required review periods that the CFPB has put in place if certain figures on the closing disclosure end up differing from the disclosure signed during the loan application.  In many cases, the changes in the figures will be due to negotiations during the sale of the property in which the lender has no control.  Both Buyers and Sellers will have fewer negotiating options available to them as the closing date approaches unless they are willing to put up with additional delays.

Remote Out Of Control:  Remote controls for some home electronics and fixtures make sense because they provide convenience for the use.  Other remote controls just make things more complicated and ultimately frustrating for a homeowner, landlord, and/or tenant.  Examples of helpful remote controls include television remotes and garage door remotes.

Ceiling fan remotes fall into the category of bad ideas when old school switches and chain pulls provide the same level of convenience and are not as prone to failing in Hawaii’s humid climate.  The first thing that comes to mind when I think of a ceiling fan remote is the amount of time I sometimes spend searching for a wayward TV remote or cordless phone.  Remote controls have an annoying habit of wandering around the house for no apparent reason.  The second issue involves the additional electronic circuitry involved with both the remote control itself and within the ceiling fan and light kit.  Stott Property Management recently had to replace a fan that was just over a year old because the tenant could no longer shut off the ceiling fan even after following the manufacturer’s instructions for resetting the remote and fan.

Save yourself a major potential hazard by carefully reading the contents of a ceiling fan box at the big box stores and choose a ceiling fan and light kit that is operated by switches and pull chains.

Home Equity Lines of Credit:  The Wall Street Journal recently wrote an article about increasing default rates by homeowners who have taken out home equity lines of credit.  Banks like to entice homeowners with lines like, “tap your home equity,” and gloss over the fact that what a homeowner is really doing is simply taking out another loan that will have to be paid off in the future.  Yes, the interest rate is lower.  The reason is that the homeowner signs off his or her house as collateral for the loan and the lender can file for foreclosure if the loan is not paid.  Teaser rates for the first year or 18 months combined with interest only financing for the first 10 years make the monthly payments extremely low.  The downside to this financing has hit some homeowners at the 10 year and one month point when the loan switches from an interest only loan to an amortized loan and the resulting monthly payments jump accordingly.

Homeowners beware before “tapping your equity,” to remodel your house.  Please consider that if you don’t pay off any principal on the loan taken out for the remodel over 10 years, you just end up with what is essentially a higher mortgage on a house with a 10-year old interior.

If you find yourself in the position of owning a considerable sum of money on a home equity line of credit that will change into an amortized loan resulting in a serious cash crunch, then consider consolidating your current mortgage and home equity line of credit into a new fixed mortgage while interest rates are still near all-time lows.  This strategy won’t work if your house value has not recovered from the latest downturn, but will work for people in many areas of the United States including Hawaii.  It is best to negotiate with lenders before a potential cash flow scenario evolves into a full-blown financial crisis.

One strategy that has worked for us involves using a home equity line of credit to buy investment property.  We put 50% down on a duplex and financed the remainder using our home equity line of credit.  We enjoyed lower origination fees and enjoyed 1.5% interest over 18 months.  We stuck to a plan that enabled us to pay off the loan in less than 3 years.  We now have the line of credit ready to use if another great investment opportunity surfaces and own a income producing property free and clear.

 

Property Management Guidance

Background:  Stott Real Estate, Inc. conducts business as The Stott Team for real estate listings and sales and 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 don’t typically result in more profits.

Pets:  Allowing pets will increase the number of prospective tenants and often enables an owner to get a higher rent while retaining carpeting that otherwise would need to be replaced.  If your carpeting is not in good condition, consider allowing pets.  Tenants with pets will often agree to pay the higher rent and live with the old carpeting if the owner will allow pets.

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.

Recently, the U.S. Department of Housing and Urban Development has extended protections to handicapped people with assistance animals.  “Conditions and restrictions that housing providers apply to pets may not be applied to assistance animals.”  A landlord must allow a service animal if a disabled tenant applies and qualifies for rental that does not allow pets.