January to March 2019 Quarterly Newsletter

The March median price for single-family homes was $782,500 (3.0% higher than March 2018) and for condos was $429,000 (1.4% lower than March 2018). Demand continues to drop but shows signs of moderating since the percentages are single-digit reductions versus the double-digit reductions over the past few months. Closed sales of single-family homes dropped 9.5% and of condos dropped 3.7% compared to last year and pending sales (property under contract but not sold) of single-family homes dropped 9.6% and condos dropped 6.9%. Supply continues to creep up with 3.4 months of inventory of single-family homes and 3.6 months of condos even though the supply of available homes continues to be relatively tight.

A recent report by the state Department of Business, Economic Development and Tourism (DBEDT) helps explain why Hawaii’s population has shrunk over the past two years. Hawaii’s economic growth has trailed the Mainland by 18% and growth is predicted to lag in the future. Hawaii has experienced an annual growth rate of 1.8% since 2009 while the average growth rate for the U.S. was 2.2%. A recent poll reported that 45% of Hawaii voters live in homes where someone is considering or has already left the islands primarily due to the cost of living. The people thinking of leaving tend to be between the ages of 18 & 34 (66%), have kids in private school (56%), attended private school (54%), are college graduates (51%), have household incomes above $60,000 (51%), and rent (50%).

We offer a monthly e-mail newsletter that contains additional local news and often includes photos, videos, and useful links. Please e-mail us at home@stott.com if you would like to be added to the distribution. You will continue to receive this mailed newsletter.

A Mixed Plate of Talk Story

9.95 million people visited Hawaii in 2018, a new record. An eight percent rise in available airline seats helped bring 6% more visitors compared to the previous year. Visitor spending grew 7% generating more than $2 billion in tax revenue for the state. Headwinds in the second half of the year including the volcanic activity at fissure eight and the disruptive Waikiki hotel strike resulted in a weaker second half of the year and that appears to be carrying into the first quarter of 2019. Hawaii’s hotels experienced their greatest drop in occupancy in about a decade this past February. Statewide occupancy dropped 3% compared to February 2018 and total revenue dropped 6%. The soft numbers are causing some concern in the industry that has witnessed softening since last June.

Three of the state’s most visited tourist attractions, The USS Arizona Memorial, Hawai’I Volcanoes National Park, and Haleakala National Park have seen declining attendance in 2018 compared to 2017. While the memorial’s dock problems and Kiluaea’s eruption obviously impacted attendance, there was no smoking gun to Haleakala’s attendance decline. The USS Arizona Memorial had 168,000 fewer visitors in 2018, Hawai’i Volcanoes National Park had 900,000 fewer visitors, and Haleakala National Park had 68,000 fewer visitors on top of a 2017 decline of 151,000 visitors. It appears to be another sign that Hawaii’s tourism market may have peaked for this latest business cycle.

Scientists at the U.S. Geological Survey’s Hawaiian Volcano Observatory have called the end of the 35-year Puu OO eruption on Kilauea Volcano after a quiet seven months. The latest report mentioned that volcanic activity at Puu OO was extremely unlikely resulting in a concluding milestone for the volcanic event. Scientists believe the collapse of the Halemaumau crater at Kilauea’s summit was connected to the eruptions of two dozen fissures in Kilauea’s lower East Rift Zone and the spectacular lava flows from Fissure Eight that covered 13.7 square miles of land and destroyed 716 homes. The Puu OO eruption was continuously active with the exception of a few pauses lasting from a few hours to two months. Scientists are warning that Kilauea is still a very active volcano and deformation data is showing evidence of magma refilling the Middle East Rift Zone. The question is not if Kilauea will erupt again but when and where. In March, The U.S. Geological Survey changed Kiluaea Volcanoe’s alert level to “normal,” marking the end to one of the most voluminous eruptions in Hawaii’s recorded history. Data from the past eight months show relatively low rates of seismicity, deformation, and gas emissions at the volcanoes summit and at the East Rift Zone. Residents can also breathe easier as lower sulfur dioxide emissions mean less vog than experienced over the last decade.

Hawaii was ranked the happiest state once again in 2018 placing in the top five in every category: Career, Social, Financial, Community, and Physical. Hawaii topped the U.S. in wellbeing for a record 7th time. The data is based on more than 115,000 surveys with adults across all fifty states and conducted in all 12 months. Hawaii placed #1 in career (liking what you do each day), social (having supporting relationships), and financial (managing economic life to reduce stress). It is a little surprising that Hawaii came out on top for financial with all the news and polls showing Hawaii’s high cost of living and affordable housing issues. Hawaii placed #4 in community (liking where you live) and physical (having good health and energy). Tim and Tracey are just as happy living in paradise.

A state circuit judge denied the state’s attempt to subpoena rental records from rental booking site Airbnb. The state wanted Airbnb to provide access to its Hawaii booking invoices, receipts, statements and confirmations from 2008. It also wanted the personal host information including names, user IDs, taxpayer IDs, Social Security Numbers, and addresses. Airbnb sought to quash the subpoena stating that it was an “unprecedented attempt to amass a decade’s worth of detailed private data on about 16,000 people. The judge ruled that the state failed to show that Airbnb hosts were not paying their taxes and the information that the state was seeking was not readily available from other sources.

The state of Hawaii’s pension deficit reached a record $13.41 billion last year and is expected to keep rising over the next five years. The state currently does not project to having fully funding the state’s pension commitments until 2043. While taxpayers are going to take a major hit, state employees are also going to feel their wallets get lighter. Employee contributions from firefighters and police will be increased from 28% of their current pay to 31% next year, 36% in 2020, and a staggering 41% in fiscal year 2021. All other employees will see their contributions climb from 18% to 19% next year, 22% in 2020, and 24% in fiscal year 2021. The contribution rates will then stay the same until the pension fund is fully funded. State and city employees may think twice about their overly generous pensions if they can’t afford to make ends meet until they retire. It appears that the current employees are also stuck paying the tab for currently retired employees who were not required to contribute more towards their pensions. It will be interesting to see what future contract negotiations hold since the pension bill has now come due. Taxpayers can be forgiven for thinking that ultimately they will get stuck with paying the majority of the retiree pensions.

Lee Cataluna, a columnist for the Honolulu Advertiser, summed up the latest “developments” with the Honolulu Authority for Rapid Transit’s (HART) rail project in a Sunday commentary titled “Rail Problems Big Enough to Impress the Big Guys.” Her quote describes the public on the rail spectrum, “And some people, maybe even most people, are in the middle – accepting the excise tax surcharge to help fund the project, gritting teeth through the construction delays, sticking it out in solidarity with those west-side commuters – but increasingly feeling like chumps as the stream of disheartening news about project management and financing continues.” The Honolulu Star Advertiser seems to be writing articles almost daily concerning the poor management and apparently outright incompetence throughout the rail project. Some of the latest articles describe the train cars built and designed by Hitachi Rail Italy failed the initial roof and floor fire testing conducted in Texas in February. A recently released report describes how a subcontractor for Ansaldo derailed a train car twice on the same day by leaving the train switch in the wrong position twice on the same day. Train #3 was damaged when workers pushed the train on a section of track where the energized third rail had been disassembled and breaking off one of the trains “shoes.” Ansaldo was ordered to stand down until they created written safety rules and safety enforcement associated with operating and testing the trains. The U.S. Transportation Department Inspector General is looking into claims by a former quality manager who claims he was fired and harassed for raising attention to construction flaws with rail columns that support the airport section of the rail line. The U.S. Justice Department and the Federal Bureau of Investigations (FBI) has issued three separate subpoena’s involved with different aspects of HART’s operations and management oversight. Lee Cataluna summed up the article appropriately, “But that rush to start, that shameful lack of realistic planning, stuck us with a nightmare in which there are great reasons to keep going and even more great reasons to quit, and there is no one we trust to help make the right decision.”

The corruption probe concerning the Kealohas continues to spread and the City of Honolulu’s Corporate Counsel, Donna Leong, was placed on paid leave in January once she received a target letter from the U.S. Department of Justice. The FBI is looking into Leong’s role in an agreement that allowed Police Chief Louis Kealoha to retire with full benefits and a $250,000 severance check. This is the first time a member of Mayor Kirk Caldwell’s cabinet has become the target of a federal grand jury investigation. She joins several city prosecutors who are also under investigation. Honolulu Prosecutor Keith Kaneshiro finally agreed to take a voluntary paid leave of absence on March 7th. His announcement came on the last of the twenty days that the Hawaii Supreme Court gave him to respond to the state attorney general’s petition that he be suspended until a federal investigation is completed. Kaneshiro will continue to earn his $170,000 annual salary during the federal investigation into government corruption related to Katherine Kealoha’s indictment for public corruption and drug dealing.

Constant rains over the past few months have triggered landslides that has closed the Pali Highway until the state fortifies unstable slopes near the highway and remove portions of the damaged Old Pali Road above the Pali Highway. Tracey and Mary Lou were actually on the Pali when police raced by to stop traffic due one of the rockslides. Sections of the Old Pali Road have shifted and pose a danger. State officials have started contra flowing traffic to Honolulu in the morning from 5:00 am to 9:00 am and back to Kailua from 3:00 pm to 7:00 pm during weekdays to help ease the rush hour traffic. The state hopes to open the Pali Highway by August. Two projects aim to prevent future rockslides from threatening commuters. Crews will install a mesh barrier on the slope between the Old Pali Road and the Pali Highway to catch falling debris and then crews will extend the entrance of the Honolulu-bound tunnel about 80 feet to further shield. Currently nothing on the Kaneohe-bound side of the highway appears to pose a threat to traffic.

Maui Brewing Company has joined the renewable energy movement by investing over $9 million in a one-megawatt rooftop PV system with three Tesla battery storage systems and two biofuel generators. The company plans on operating independent of the grid in the third quarter of 2019. The initiative will make the company more cost competitive because the new system will produce the brewery’s electricity at a much cheaper rate than buying electricity from Maui Electric Company. Tim celebrated his birthday with Tracey last week at the new Kailua restaurant that Maui Brewing Company opened in January. Both the food and beer were excellent and Tim added to his collection of microbrewery t-shirts.

The Ka’upulehu Marine Reserve is off to a good start that may provide hope for Hawaiian reefs and the tropical fish that live there. Under the 10-year harvest rules, the public may not fish or take any marine life from the reserve’s established rest area that consists of 3.6 miles of coastline and extends to a depth of 120 feet. Fishers are allowed to use Kona crab nets from depths of 120 feet to 600 feet and use hook-and-line methods to catch 18 species of fish. Two years into the period, dive surveys have found that some species of fish have increased between 30% and 60%. The dive surveys have seen a 62% increase in some types of wrasses, a 46% increase in some types of surgeon-fish, and a 30% increase in some types of parrot-fish. The Nature Conservancy does caution that it is too early to draw any conclusions from the conservation efforts but they are hopeful that rest periods could hold the key to turning around declining reef fish populations.

A landslide that took out a bridge on one of Kalaupapa Trail’s switchbacks has closed the trail indefinitely. The three-mile trail consisting of 26 switchbacks is the only way to get to the isolated peninsula on Molakai’s north coast. Kalaupapa is where Hawaii banished leprosy patients (known as Hansen’s disease) for about a century. The state stopped exiling patients in Kalaupapa in 1969. Only a few former patients still live in Kalaupapa even though they have been cured and are free to leave. The state Department of Health employs about 40 people at the site and they will be flown in until the trail is reopened. Supply deliveries come by barge and weekly flights, so those deliveries won’t be impacted by the trails closure.

The University of Hawaii men’s volleyball team is having a record-breaking year. They won a NCAA record 74 straight sets over their opponents before losing a set to 3rd ranked University of California Santa Barbara this past weekend and have a perfect record, 25-0. Hawaii finishes the regular season next weekend against the #2 team in the country, Long Beach State.

Overcoming Inertia

I recently read an article in the Wall Street Journal about financial inertia and how it could be costing you some significant money in lost returns simply by not looking at where you were parking your money. I have mentioned previously that Tracey and Tim have both read The Total Money Makeover by Dave Ramsey and one of the themes that he stresses is having a safety fund in place to cover the unexpected expenses that happen due to “Murphy’s Law.” Since we own our own business, we maintain the equivalent of six months of expenses plus our estimated quarterly tax payments in a liquid account just in case things go south. Up until recently, we had just been parking it in a regular savings account making about 0.1%. The article mentioned that by simply moving those funds into a money market fund, we could improve our returns to over 2.5% without taking on any significant risk. All of the sudden, we increased our returns on this rainy day fund 25 times with a couple clicks of a mouse. It seems crazy, but we got so used to the miserable returns when during the poor economic years following the Great Recession of 2008, that we failed to pay attention to a simple way to earn a few more dollars with essentially no effort.

Inertia can come in all types of forms and that goes the same with second homes and investment real estate. Since real estate, particularly on Oahu, requires a significant investment plus carrying costs, failing to act when things aren’t going well can cost the owner tens of thousands of dollars, even hundreds of thousands of dollars if the owner fails to act over a decade or more. This article touches on the some forms of inertia concerning second homes and investment real estate. These forms include but are not limited to owning a second home that is no longer being used and keeping it vacant, holding onto an investment property with equity that provides negative cash flow, letting an investment property sit vacant while they wait for time off to make the cosmetic repairs themselves, or even sticking with a poorly performing property manager that fails to return calls and e-mails.

Tracey and Tim have spoken to hundreds of clients over the past fifteen years that own second homes that they either failed to visit as much as they envisioned or life changed and they no longer visited as often as they used to. The carrying costs of a second home between property taxes, insurance, association fees, maintenance, and repairs typically run more than $10,000 per year. Some second homeowners will rent out their properties when they aren’t here to help offset some of those costs, but then must contend with the additional wear and tear that tenants bring. Many of these homes have hundreds of thousands of dollars in equity in them if owned for a long period of time and provide none of the enjoyment that comes with the envisioned frequent visits to paradise. Some owners delay selling because they think that they must come out and do a bunch of work to make the property ready to sell while others don’t want to pay capital gains taxes. Many clients have learned that Tracey will handle the details concerning make ready repairs and the repairs themselves are often much less extensive than the seller thinks necessary. In the latter, many owners will end up paying more than the capital gains bill by simply holding onto the property and paying the costs associated with owning a second home. For example, assume that a seller will have a $200,000 gain when the home sells. The capital gains bill will be roughly $45,000 assuming a federal capital gains rate of 15% and a state rate of 7.25%. That is often less than three years of carrying costs, especially when you consider that the City and County of Honolulu continues to jack up property taxes on properties that don’t have a Homeowners Exemption. Why not sell and pocket the $155,000 and invest it or spend it as you see fit?

Tim and Tracey have helped several clients who could not afford to sell during the last downturn because they owed more money on the property than it was worth. In many cases, the client had to suffer through years of negative cash flow before the market recovered, but they did eventually get to sell for a small profit and stem the bleeding. There are other investors that have continued to experience negative cash flow as the market has expanded over the past seven years in the hopes of eventually generating positive cash flow. The money that they are spending on their investment every year could be invested more productively in the stock market or real estate in other parts of the country. Even putting the money in a mattress would provide better results. Once these people sold, they enjoyed more financial freedom and enjoyed greater options on choosing how to spend their money.

Tim has talked to several people over the years that were fixing up their rental property themselves in order to save money on repairs. Almost all of these people lived elsewhere in the country and also worked a full-time job. These properties would literally sit vacant for a year or more. In most cases, all the property needed was a fresh coat of paint, new flooring, and replacing some fixtures. With an average rent of roughly $2,000, these people were forfeiting $24,000 in order to save a few thousand dollars. The simple thought of having to spend valuable vacation time and fly thousands of miles made many of these people continue to procrastinate. The ones that finally allowed Stott Property Management, LLC to manage the property and hire contractors to do the work started seeing cash deposited into their accounts after paying for the necessary repairs and waiting for the work to be completed. Again, in many cases, the work that was required was less than the investor originally envisioned. The only time that the investor had to spend was the time needed to fill out and sign the contract.

Tim has also talked to investors, in some instances several times over the years, where the investor could not stand his or her property manager. They would not promptly respond or fail to respond at all. In the most extreme cases, the property managers would fail to send rental proceeds to the owners when a property had a tenant and failed to provide statements or an explanation. Not only were these people suffering financial harm, they were also suffering mental stress. Tracey even made Tim agree to change one of their own property managers on the mainland recently after she got tired of listening to Tim fix the property manager’s accounting errors and see large repair expenses without notice or approval. Changing property managers is as simple as signing a new contract and giving the old property manager written notice to cancel. A good property manager will then take it from there and handle all the details involved with the management transition. All the investor needs to do is read the e-mail updates.

Do you fall into one of these categories or another not mentioned in this article. If you do, why not e-mail us at home@stott.com or call us at 1-800-922-6811. We may have a simple, profitable solution for you.

Clutter

Tracey often watches the show “Hoarders: Buried Alive” on weekends and Tim 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 individual’s 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, LLC 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 were destroyed by the elements and Stott Property Management, LLC ended 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.

Tim and Tracey have helped out many people clean out homes and condos when they did not have the time to spare or could not emotionally deal with sorting through a family members belongings. If you are in a similar situation, e-mail or call us and we can at least take a look at the property. Tracey has emptied her parents’ home and can quickly determine items that may hold sentimental value versus items that should be simply thrown away.

Heirs and Hawaii Real Estate

Many absentee owners hold on to Oahu real estate so that they can pass the property to their heirs and be able to avoid capital gains taxes. The acquisition basis for the heirs is the value of the property at time of death of the decedent. Many heirs sell the inherited property shortly after acquisition; therefore, there is little if any gain that will be subject to capital gains taxes.

While it is desirable to avoid unnecessary taxes, problems frequently arise when there are several heirs that have an equal interest in an inherited property. Our experience indicates that when there are three or more heirs, about half the time a conflict will exist concerning what to do with the inherited property. The most common problem is a lack of agreement as to whether the heirs should continue to hold on to the property as an investment or sell it and use their tax-free proceeds elsewhere. Most of the time, the heirs are siblings with very different opinions. Often, one or more of them is cash-short and wants to sell the property immediately while others may want to hold on to it.

It is not unusual for there also to be disagreements between the heirs that are completely separate from holding the property as a long-term investment. Three common examples are:

  1. One or more of the heirs may want to hold on to the home so they can use it on a future Hawaiian vacation. This particularly applies if the home has been used in this regard in the past by some but not all of the heirs.
  2. If the property is a former family home, there may be widespread emotional differences between the heirs when it comes to selling. One or more of the heirs may want to hold on to the property so they can have future access to it for themselves and/or their children.
  3. One or more of the heirs may be living in the property, often either rent-free or at a rent that is well under market rent.

There are legal steps that heirs can take to force a sale; however, legal actions between family members usually create major discord. Most of the time, the heirs decide on a compromise that usually involves continuing to hold the property for a period of time. On several occasions, we have waited for several years to be able to sell such a property. Our experience indicates that one strong-willed family member usually blocks what the majority of heirs favor.

An emotional public auction in Kauai for four landlocked parcels in Mark Zuckerberg’s 700-acre estate provides a cautionary tale in passing real estate to multiple heirs. A quiet title lawsuit was initiated in 2016 because the land passed over time to as many as 300 partial owners. Typically land sold at auction fetches less money than if the land is sold through a standard real estate transaction. In this case, the lands were sold for $1.76 million and the proceeds will be divided up amongst the heirs. The entire process caused many of the heirs’ mental anguish through the forced sale. While an extreme case, the story should provide caution to those who want to pass real estate to multiple heirs when they pass away. As the number of heirs grows, the chance for a peaceful resolution towards managing and ultimately selling the property diminishes greatly.

Many absentee owners opt to avoid the likelihood of such an intra-family problem by selling their Oahu property, paying the applicable capital gains taxes and then leaving easily divided cash or securities to their heirs. When asked why they are selling, the absentee owner normally will say that they are “settling their estate.” One past client mentioned, “I love all my children, but they would have difficulty agreeing on almost anything.”