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July to September 2015 Quarterly Newsletter

P r i n t  |  R e p l i c a

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 [email protected] 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  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 [email protected] 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 [email protected] if you would like our help with your property.

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