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April to June 2018 Quarterly Newsletter

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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 [email protected] 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 [email protected] 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:

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 [email protected], visiting our website at, 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.

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