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Quarterly Newsletter April - June 2022

| P r i n t  H e r e |  The June median price for single-family homes was $1,100,000 (12.4% higher than June 2021) and for condos was a record $534,000 (16.1% higher than June 2021).  The rapid rise in mortgage interest rates has already had a profound impact on demand.  There were 20.8% fewer single-family home sales last month compared to June 2021 and 14.2% fewer condo sales last month compared to June 2021.  Pending sales of single-family homes dropped 27.7% last month compared to June 2021 and pending sales of condos dropped 24.8% compared to June 2021.  The difficult interest rate environment may be discouraging some homeowners from selling since there were 18.9% fewer new listings of single-family homes last month compared to June 2021 and 12.5% fewer new listings of condos last month compared to June 2021.  Buyers do not have many choices yet since inventory is very tight.  There are only 1.5 months of single-family home inventory and 1.6 months of condo inventory.

Tim and Tracey listened to the mid-year update for Oahu’s housing market by Hawaii economist, Paul Brewbaker, last week.  Paul predicts that the demand for homes will fall 30% to 45% due to the recent rise in mortgage interest rates if earlier patterns hold (15% drop for every 1% increase in mortgage rates), but he does not forecast a drop in prices due to limited supply.  Mortgage rates have reached about 5.75% due to the Federal Reserve’s interest rate hikes and lenders placing a greater risk premium on mortgages.  Despite the rate hike, Brewbaker argues in economist speak that mortgage rates have turned negative due to inflation’s surge.  

A major area of concern centers on the recent lack of gross domestic product growth in Hawaii’s economy compared to the rest of the nation.  Hawaii has lagged the country by several percentage points recently and he estimates growth will be 15% lower in the future.  Lower productivity spells trouble for a government that continues to add to its liabilities to fund government operations.

A Mixed Plate of Talk Story

Pay-to-play politics is front and center as the issue in Hawaii politics with the indictment of Hawaii’s political class and private contractors who fill the politician’s re-election campaign coffers.  The most recently indicted executives donated a combined $830,000 to candidates in critical state and county offices and received $12.72 million in state contracts including three to provide consulting, engineering, and other construction services “as-needed.”  The three candidates seeking the Democratic nomination for Governor emphasized their opponents’ fundraising efforts and tried to either isolate themselves from the fallout or paint their opponents as cogs in the pay-to-play system.  The lack of contributions and press coverage also highlighted the Republican party’s irrelevance in Hawaiian politics today.

Former Honolulu Prosecuting Attorney, Keith Kaneshiro, was arrested by the Federal Bureau of Investigations (FBI) on Friday, June 17, 2022.  The indictment alleges that a Honolulu businessman paid more than $45,000 in campaign contributions to prosecute a former employee.  The employee was fired in November 2011 and her unemployment benefits were contested by the employer and was ruled eligible to receive benefits a year later.  Kaneshiro was persuaded to investigate and prosecute the employee for working other jobs on company time.  The businessman and family later donated $45,000 to Kaneshiro’s campaign.  Though unrelated, Kaneshiro’s attitude and behavior mirrored that of his employee, assistant prosecutor Katherine Kealoha, who tried to frame her uncle in the theft of a mailbox.  She was successfully prosecuted last year.

Mayor Rick Blangiardi signed currently the most restrictive short-term rental law in the country, Ordinance 22-6, on March 26, 2022.  The new law raises the length of the minimum allowed lease term from thirty days to three months and prohibits all short-term rentals outside the resort-zoned areas of Waikiki, Ko Olina, Turtle Bay, and Makaha.  Apartment-zoned areas close to these neighborhoods may receive approval for renting entire units and bed-and-breakfast (B&B) operations where the operator lives on the property.  Vacation Rentals must provide off-street parking in communities zoned rural, residential, or apartment-use.  Owners in Ko’olina Hillside Villas and Ko Olina Fairways must carefully check the new map showing where short-term rental activity is legal because it cuts off portions of the two complexes.  The law goes into effect October 23, 2022.

The University of Hawaii Economic Research Organization (UHERO) published “Measuring the Burden of Housing Regulation in Hawaii,” on April 14th and promised further research into how much Hawaii’s regulatory environment contributes to Hawaii’s high home prices.  UHERO conducted a survey to apply the Warton Index, a methodology of quantifying local regulation’s impact on new housing production, to compare Hawaii’s regulatory climate to other counties in the nation.  Economists released the first Warton Index in 2006 which only included Honolulu County and the index completely omitted Hawaii in 2018.  UHERO asked each county to complete the same survey used in the 2018 Warton Index update to compare Hawaii’s regulatory environment to other counties in the United States.  The index has a mean of zero meaning that a county with a positive value has more regulatory barriers to development than the average county and a county with a negative value has fewer regulatory barriers.  Hawaii County (The Big Island) had the highest barriers in the country and all Hawaii counties fell in to the top third of index values.  The state of Hawaii had significantly higher housing regulatory burdens than any other state in the union.  The study further breaks down the index with subcategories that highlight Hawaii’s affordable housing requirements and permit approval delays as the main contributor to suppressed development.  The Wharton Index correlates with an 8% increase of home prices with every one-point index increase implying that regulations add 8% to Oahu’s home prices and roughly 20% to the Big Island home prices.  

A KHON2 article highlighting the shrinking supply of rental housing confirms that landlords will sell when government makes renting a difficult and money losing business.  It was a little shocking that the news organization failed to make any effort in finding out the causes of the shrinking rental market by interviewing landlords that were selling, property managers, or real estate agents.  David Ige and the state legislature put the burden of pandemic related government shutdowns on landlords by prohibiting evictions during the first sixteen months of the pandemic and then adding extra steps to an already tenant friendly eviction process.  Government officials consistently touted they were helping the situation by providing rental assistance yet failed to mention that rental assistance did not always cover the rent and failed to allow landlords to apply for rental assistance without the cooperation of the tenants.  One of Stott Property Management, LLC’s clients will remove another rental property from the market when the owner will finally be free of a non-rent-paying tenant and will sell the condo.  An owner-occupant will most likely buy the property since high sales prices and rising interest rates make real estate investing on Oahu a poor option. 

The Honolulu City Council passed the recovery plan proposed by the Honolulu Authority on Rapid Transportation 6-3. The recovery plan ends the rail line in Kakaako versus the planned station at Ala Moana and eliminates a 1,600-space parking garage at Pearl Highlands.  Councilmember Heidi Tsuneyoshi voted against the recovery plan because elimination of the parking garage designed to accommodate passengers from Central Oahu and the North Shore.  The price tag for the parking garage was $330 million or $200,000 for each parking stall.  Only the government officials and contractors can justify construction costs that exceed the cost of privately built studio apartments.

The U.S. Navy agreed to the state Department of Health’s (DOH) emergency order to drain the Red Hill underground fuel tanks by June 30, 2022, and to close the facility by November 1, 2022.  The U.S. Navy will end years of tension with environmentalists who argued that the U.S. Navy was failing to operate the tanks safely and could not quickly detect fuel leaks nor prevent major fuel leaks in the future.  The military quickly built the Red Hill underground fuel tanks during World War II addressing concerns that the military’s above-ground fuel tanks were vulnerable to attack.  The U.S. Navy has already missed the June 30th deadline and is seeking an additional $1.1 to make repairs to Red Hill’s fuel facility so that the underground fuel tanks can be safely drained.  The budget request follows a report released last month stating that major repairs were required to prevent another fuel spill that could further pollute the nearby ground water.  The defueling plan must be approved by the state Department of Health by the end of the month.  Meanwhile, the Navy has been pumping 4.5 million gallons of water into the Halawa Stream even though there has been no indication of further contamination.  The tremendous waste of water is exacerbating a water shortage on West Oahu.

Ocean Defenders Alliance removed 110 tires from Kaneohe Bay weighing 7,200 lbs. on June 26th.  The team of divers using lift bags have removed 219 tires from the bay during three dives over two years at Heeia Small Boat Harbor.  The $25 fee to have a tire dumped encourages the illegal activity.  Of the 110 tires pulled out of the bay, eight were dumped from the pier Saturday evening according to the harbor master.  It makes one wonder why the harbor master does not intervene and prevent the illegal activity occurring right in front of him.  The tires leach chemicals into the bay harmful to rare coral species.  The tires are taken to H-Power for incineration after they are pulled up from the bay.

The Department of Defense has awarded the University of Hawaii $25 million to build a hybrid reef off the coast of Oahu to dissipate wave energy and protect Oahu’s shoreline.  The base of the reef will be built with thin-walled concrete structures that scientists will attach heat tolerant coral fragments that will eventually cover the base material.  The finished product will function like a typical fringe reef with a fore reef, a reef crest that absorbs most of the wave energy, and a protected back reef that supports more delicate species.  The goal is to have the man-made structure completely covered with life in five years with an increased biodiversity of fish.

The Hawaiian monk seal population has recently passed 1,500.  Conservation efforts appear to be working for one of the most endangered species and the number of Hawaiian monk seals will have to double before removing them from the list of endangered species.  A high rate of pup deaths in the Northwestern Hawaiian Islands is still a concern.

Kilauea volcano has continuously erupted for the past 1 ½ months in the Halemaumau crater raising the depth of the lava lake 325 feet since the current eruption started on September 29, 2021.  Initially, the eruption paused temporarily for a few days here and there.  Scientists cannot predict how long the eruption will last, but the volcano did previously erupt for decades in the 1800s.  

The University of Hawaii Rainbow Warriors volleyball team repeated as national champions by sweeping arch-rival Long Beach State in the NCAA Men’s Collegiate Volleyball Championship final Saturday, May 5, 2022.  UH’s successful defense involve a sweep of North Greenville, a come from behind five-set victory against Ball State, and then the sweep of Long Beach State.  The Rainbow Warriors definitively answered the question of the superior Big West team by sweeping Long Beach State in the finals of the Big West tournament and the NCAA tournament.  Long Beach State won the national championship in 2018 and 2019 and UH won the national championship in 2021 and 2022.  There was no 2020 champion due to the pandemic.

Former Campbell High School phenom Jocelyn Alo led the #1 Oklahoma Sooners to the College World Series again this year.  Alo, credited with having one of the most beautiful swings in softball and baseball, holds the record for most home runs over a college career while batting an astonishing .497 this season as of June 1, 2022.  Jocelyn Alo finished her illustrious college softball career with 122 home runs and was awarded the Most Outstanding Player of the 2022 College World Series by leading the Oklahoma Sooners to their second consecutive national championship.

The Hawaii Food & Wine Festival announced its schedule of events from October 20, 2022, through November 6, 2022, that takes place on Maui, Oahu, and The Big Island over three weekends.  World recognized chefs, Alan Wong, and Roy Yamaguchi, started the festival 12 years ago to highlight local talent and Hawaii’s local ingredients.  

Tim and Tracey visited Washington D.C. from April 24th through April 27th to attend a wedding, visit family and friends, and take in the sites at the National Monument and Smithsonian museums.  Tim and Tracey learned a fun fact about Hawaii after visiting the Lincoln Memorial interior.  Prior to entering, they had noticed the state's artists engraved the states at the top of the four exterior sides of the Lincoln Memorial and planned on finding Hawaii.  As they circled the building, they overheard a guide speaking to a tour group of veterans from Indiana explaining that Alaska and Hawaii are missing because builders completed the memorial in 1922 and there was no more room for Alaska and Hawaii when they became states in 1959.  What Tim and Tracey did not learn until they returned home was of a plaque on the steps of the Lincoln Memorial dedicated to the two states.  

Tim and Tracey have participated in the first two races of the 2022 North Shore Swim Series.  Tim has achieved his goal of not being pulled out of the ocean by lifeguards and Tracey aims to complete her 6th series of races.  Ocean activities have become a larger focus over the past two years since COVID-19 restrictions placed limits on other types of outdoor activities.

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

 How does marketing apply to real estate?  Many people have heard the real estate phrase, “location, location, location.” The largest component of real estate marketing actually occurs when a buyer purchases a home or investment property. Location makes up the largest component of positioning the product, in this case, a home.  Architecture, interior design, amenities, and condition of the home play an important but smaller role.  You can have the best of all worlds when it comes to the features of a home, however, if the property is located in a poor location, then the homeowner or investor has simply over-improved the property.  That is the reason that regardless of size and condition, a house will sell within a certain range in a specific location and a condo will sell within a certain range in a specific complex regardless of what the interior and exterior look like.  For example, the same exact house located in Kahala will be worth more and cater to a different clientele than the house located in Mililani.  Is there anything right or wrong with Kahala over Mililani.  The answer lies in the eyes of the beholder.  That being said, a homeowner is unlikely to sell a luxury home in Mililani for several million dollars to a movie star or mogul regardless of how much money is spent on the construction, decorations, and advertising.

 Who is your target market?  Are you offering workforce housing?  Do you want to rent to traveling professionals?  Or, to visitors on vacation?  The answer to this question will determine if you need to furnish the property.  Long-term renters typically have their own furniture while traveling professionals and visitors just bring a suitcase.

 Maintaining a rental property is critical in attracting qualified tenants.  Most of the tenant issues that Stott Property Management has to deal (late rent, tenant damage, etc.) occur in rental properties located in less desireable neighborhoods and in properties that suffer from deferred maintenance.

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

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

 Property Management Guidance

 Background:  Stott Real Estate, Inc. sells residential real estate and its subsidiary, Stott Property Management, LLC (Stott PM), 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 PM.  Stott PM currently manages approximately 420 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 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 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 PM requires every adult applicant to fill out an application and then checks the following:  Credit Score, Employment, and Previous Landlord References.  By carefully screening tenants, Stott PM 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 have a signed Property Inventory and Condition Form from the tenant at the time of check-in 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 PM 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 PM has taken over many rental properties that were not inspected because a “great tenant” was living there.  It appears 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 owners make is charging below market rent to friends and family.  A 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 MM 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 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, and they are less likely to move since they will have to take their furnishings with them.  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 the “pet” is an Emotional Support Animal.

 Stott PM 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, expensive cabinetry, hard wood floors, high-end appliances and bathroom fixtures do not provide a sufficient return on investment unless the property is in a high-end neighborhood.  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 do not want to replace the carpet every five to seven years, then consider installing ceramic tile or vinyl planks.  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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