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April to June 2015 Quarterly Newsletter

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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.

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