Quarterly Newsletter January - March 2022

P R I N T  |  R E P L I C A  The March median price for single-family homes was a record $1,150,000 (21.1% higher than March 2021) and for condos was a record $515,500 (14.3% higher than March 2021).  The lack of available single-family home inventory continues to constrain sales with the numbers dropping 11.5% compared to March 2021.  The number of condo sales rose 7.3%.  Buyers continue to struggle finding a home with only 1.0 months of single-family home inventory and 1.5 months of condo inventory available.  The nationwide shortage of available homes is likely contributing to the lack of inventory here on the islands.  Tim and Tracey have spoken to potential clients and property management clients about selling and conducting a 1031 Exchange to defer capital gains taxes only to find out about the lack of available properties in the desired area to invest their funds.

The 10-year Treasury bond yield has risen for six straight days ending April 8, 2022, to settle at a three-year high of 2.713%.  The Wall Street Journal noted that Treasury yields have risen the fastest over the last three months than 97% of three-month periods since 1950 according to the chief strategist at the Leuthold Group, an independent investment research firm.  30-year mortgage interest rates closely track the 10-year Treasury bond yield and Fannie Mae set the rate at 4.375% effective April 14, 2022, about 1.4% higher than rates 3 months ago and 2.25% higher than 6 months ago.  Tim and Tracey remotely attended a business development seminar in January and the main speaker predicted that there will be a tug-of-war between the lack of available housing inventory and rising interest rates in 2022.  The extremely low inventory levels on Oahu held the greatest weight in the market during the first quarter since median prices for both single-family homes and condos continued their march higher.

Hawaii continues to suffer from net migration losses and its population continues to shrink.  The U.S. Census Bureau estimates that Hawaii’s population dropped 0.7% from the July 2021 figure to 1,441,573.  Oahu alone lost 13,686 residents as people continue to leave the island in search of better opportunities.

A Mixed Plate of Talk Story

Governor David Ige let the latest emergency proclamation addressing the COVID-19 pandemic to expire on March 25^th.  The state’s Safe Travels program and the state’s requirement to wear a face mask in indoor public spaces have ended for the time being.  The state is unlikely to revive the Safe Travels program in the event of another surge because federal funds to the states to address the pandemic have ended.  The governor did not rule out a future mask requirement should a new outbreak threaten Hawaii’s vulnerable hospital system.

The special attorney for the U.S. attorney general continues an investigation into allegations of law enforcement, elected officials, and their business supporters of conspiring to abuse their positions and punish their opponents.  A federal grand jury probed campaign donations in late January and questioned a past city council member and U.S. congress member under oath about donations received by a Honolulu engineering executive and his family.  The special attorney successfully prosecuted former Honolulu Police Department (HPD) police chief Louis Kealoha and his then wife, former Deputy Prosecuting Attorney Katherine Kealoha.  Federal prosecutors delivered target letters notifying former city Prosecutor Keith Kaneshiro and two of his deputies that they were under investigation.

In January, the special attorney indicted three top officials in ex-Mayor Kirk Caldwell’s organization allegedly conspiring to divert $250,000 in government funds to pay then-indicted Honolulu Police Chief Louis Kealoha in a retirement settlement.  Federal prosecutors allege that the three convinced the Honolulu Police Department (HPD) to pay for the settlement out of funds to pay police salaries and then lie about the source of the deficit to use funds from a program using federal funding to fill the shortfall without involving the Honolulu City Council.  One of the accused officials allegedly explained to HPD that they must conceal the source of the budget shortfall to avoid bringing the issue in front of the “nine bananas” (city council members).  The decision to pay a settlement to the indicted police chief raised eyebrows at the time and the court eventually sentenced Kealoha to seven years in prison for conspiracy, fraud, and obstruction of justice.

Prosecutors charged former state Senator Majority Leader J. Kalani English, and state Representative Ty J.K. Cullen and they pled guilty in February to honest services wire fraud for taking bribes and in return for pushing for legislation considered favorable to, and killing legislation considered unfavorable to, H2O Process, a wastewater treatment and industrial machinery company.  English has retired in early 2021 citing symptoms of long COVID and Cullen resigned 28 minutes prior to the press conference by the U.S. Department of Justice and the FBI.  Milton Choy, owner of H2O Process Systems LLC and Fluid Systems, his son Jarret, two other family members and two business managers donated $268,046 to politicians of the Democrat Party since 2014 including Governor Neil Abercrombie, Governor David Ige, Mayor Kirk Caldwell, and Mayor Rick Blangiardi.  The companies received $6 million in state government contracts for sanitization operations related to COVID-19, wastewater treatment and filtration, and operation of temporary emergency shelters.  Two of the largest contracts totaling $4 million were sole-sourced, meaning that Choy’s companies were the only ones that could meet the bid requirements.  The Honolulu Authority for Rapid Transportation (HART) tried the same tactic when they offered current Chairwoman, Colleen Hanabusa, a lucrative consulting contract with the organization before she turned down the offer after many in the state objected.

The Red Hill housing water crisis has turned the corner as state health officials announced that residents in Red Hill Housing could resume drinking and cooking with tap water on February 14, 2022, and the remaining impacted neighborhoods were told their tap water was safe to drink in March. President Biden signed a bill into law on February 18^th, designating $100 million in funding to drain the tanks in accordance with the state Department of Health’s order.  Faced with the task of draining the tanks resulted in the next shoe to drop.  Navy documents, or more descriptively, the lack of documents raise concerns of deferred maintenance on the fuel facilities pipeline to the Pearl Harbor fueling piers. A 2016 assessment identified 350 required repairs to address corrosion and dents with 230 of those categorized as “urgent.”  The Navy only budgeted money for twenty-three of the repairs and the Navy did not complete an additional twenty-six until 2018.  The documents suggest that defense officials papered over the problem by shifting to more lenient criteria.  As more groups and officials call for draining and shutting down the facility, state officials caution that the pipeline system must be capable of conducting the operation safely.  In what amounts to shutting the barn door after the horses escaped, the Environmental Protection Agency (EPA) is launching an investigation into the Red Hill fuel facility.  Secretary of Defense, Lloyd Austin ordered the permanent closure of the facility on March 7^th.  Hawaii Rent-All’s sign on McCully sums up the mess by announcing, “When gas prices are high, tap into Redhill’s water supply.”  Taxpayers can only hope the investigation does not result in a circular firing squad where one federal agency fines another federal agency and either the taxpayers get holding the bag or the wasted funds further degrade the country’s ability to defend itself.

Honolulu Star Advertiser columnist, David Shapiro, takes HART to task in its latest attempt to resist transparency in a February article.  HART, in a brazen attempt to squelch criticism of its operations by board members, has attempted to force legislature appointed members of the board to sign a new confidentiality agreement that calls for criminal penalties for violating the agreement.  Two board members appointed by the legislature have refused to sign the agreements since their responsibilities should include reporting back to the state legislature.  The HART board was preparing to discuss the performance evaluation of new executive director, Lori Kahikina, when the board told the two members they could not attend because they had not signed the agreements.  Critics of Board Chairwoman, Colleen Hanabusa, were not surprised by the developments and attempts to restrict transparency concerning the board’s operation and decision making.  One of the appointed board members is a certified public accountant (CPA) and certified fraud examiner and her refusal is based on concerns that she could not report any wrongdoing that she discovered during her participation on the board to the state legislature.  Her concern appears valid since the project’s costs have ballooned to $11.4 billion and there remains a budget gap of $1.9 billion.

Mayor Rick Blangiardi pointedly addressed two significant issues in his state of the city speech on March 15^th.  The first announcement described the city’s new plan to shorten the disastrous rail project and end it near Circuit Court at the corner of South Street and Halekauwila Street in Kakaako, eliminating two stations.  The Federal Transit Administration (FTA) must still approve the plan for the city to qualify for the remainder of the federal funding.  In another notable development, the mayor acknowledged the Department of Planning and Permitting’s (DPP) abysmal performance over the past few decades. He highlighted the city’s new electronic permitting system for residential and commercial projects and push to hire more staff as part of the administration’s plan to eliminate the delays.  Unfortunately, he did not mention any initiatives to streamline the process or eliminate any unnecessary red tape contributing to the delays.

Stopping the rail project 1.25 miles short of the original goal could end a costly Kakaako land dispute.  Negotiations to obtain two acres of land through eminent domain could cost taxpayers up to $200 million.  HART has already paid over $23 million in legal fees on the dispute with Howard Hughes Corp., the developer of Ward Village.  City council members are questioning the practicality of ending the project near Halekauwila Street since there are currently no convenient bus routes from the last proposed station.  A lack of convenient mass transit options near the last Honolulu stop will result in even fewer riders and result in taxpayers picking up the tab for even greater subsidies.

Erosion from North Shore swells claimed a home near Sunset Beach on February 28^th as a home’s compromised foundation failed and the house slid down the sand dune to the beach.  Homes on the ocean side of Ke Nui Road have seen their back yards disappear over the decades.  Heavy tarps, sandbags, and boulders from homeowners trying to save their homes from the ocean waves litter the beach by the fallen structure.  The state Department of Land and Natural Resources (DLNR) has allowed “emergency measures” to remain for decades as the state dithers and hopes the problem will solve itself.  The DLNR Chair viewed the wreckage and “hopes that homeowners will take the time to find alternatives.”  Unless the state finds a way to help homeowners move or remove endangered structures, then more houses will end up toppling into the surf.

The University of Hawaii (UH) Rainbow Wahine earned an automatic bid to the NCAA women’s basketball tournament by following up its regular season Big West Championship with winning the Big West Conference tournament.  The Wahine overcame a 26-21 deficit to the University of California Irvine Anteaters and delivered in the second half to run away with a 59-48 victory.  UH received the 15^th seed in the Wichita Region against 2^nd seeded Baylor University.  Baylor thumped the Rainbow Wahine 89-49 on March 29^th, ending a successful season.  The UH men’s basketball team finished 3^rd in the Big West Conference regular season and lost in the semifinals of the Big West Conference tournament.  2022 turned out to be a great year for UH basketball overall.

In a bit of hopeful news, Hawaii’s most common corals show more resiliency to warming waters and rising ocean acidity from rising carbon dioxide levels.  A 22-month study observed three types of Hawaii coral in four tanks.  The researchers maintained one tank at current ocean temperature and acidity, one tank with warming conditions, one tank with rising acidity levels, and one tank combining warming and acidification.  46% percent of the most vulnerable coral species survived the most difficult conditions and 71% of Hawaii’s most populous coral species survived.  The two Porites species were able to maintain normal growth rates and metabolism throughout the study offering hope since these coral species are the most common types of coral found worldwide and are key to reef building.

Humpback whale activity has been very active this winter with 278 whale sightings across the state from 9:00 to 9:15 am on Saturday, 1/29/2022.  Cooler artic water temperatures have resulted in a larger number of whales making the trip to Hawaii’s breeding grounds.  Tim and Tracey have spoken to friends who saw humpback whales outside of Kailua Bay as they were paddling in their one-man canoes.  One individual quickly paddled away when spotting a calf without the mother to avoid separating the two and spooking the mother.  To Tim and Tracey’s disappointment, they did not spot any whales when paddling outside Kailua Bay, but they do think they heard whale spouts while enjoying their time on the water.

A bill to establish a pilot program to eradicate feral chickens across the state has received passionate opposition from a group, Save Hawaii Chickens.  The group is arguing that feral chickens could be an important food source and the eggs are “cage free.”  Do you know how to cook a feral Hawaii chicken?  Boil the chicken in a pot with a rock and the chicken is ready when the rock softens.  Some people complain that the feral chickens are messy and noisy while feral chicken advocates emphasize that chickens eat centipedes and other pesty insects.  Tim witnessed one law-abiding chicken use the crosswalk to “cross the road.”  The chicken had no comment when Tim asked why the chicken did it.  Environmentalists have valid concerns about the unforeseen consequences of using a proposed bird contraceptive, OvoControl feed, daily. The feed can contaminate soil, vertebrates, and water sources.

Odds & Ends

Recent Real Estate News:  The pandemic has not been kind to real estate investors on Oahu as government restrictions pummeled property owners by taking away the livelihood of many residents and then preventing landlords from evicting tenants who were not paying rent.  Governor David Ige did not lift the eviction moratorium until after the legislature made it much more difficult to evict tenants by:

• Defining when a tenant could be evicted based on how many months past due rent the tenant owed.
• Stretching the demand period from five days to fifteen days.
• Requiring mediation prior to an eviction hearing if the tenant requested it.

The governor’s stated goal was to prevent eviction efforts from overwhelming the courts and the new measures apparently have failed.  One of Stott Property Management, LLC’s (Stott PM) clients must wait until May 19^th before the court will consider evicting a tenant who currently owes $12,000 in rent and who has refused to move even after receiving legal written notice to vacate over three months ago.  The judge ordered a second round of mediation even though a first one failed to produce an agreement.  A second tenant who abused the eviction moratorium owes over $48,000 in past due rent and damages and the court has still not issued a financial judgement against the tenant despite months of effort.  The lawyer Stott PM partners with summed up the current environment by saying, “the system is broken.”

The Honolulu City Council is again considering a bill that would alter the rules for short-term rentals by increasing the minimum stay from 30 days to three months unless the city issues a special permit.  An amendment reduced the bill’s originally six-month minimum stay because temporary workers like traveling nurses stay for less than six months and might have trouble finding a place to live as a result.  The proposed bill will only allow short-term rental operations in resort zoned areas like Ko Olina, Turtle Bay, Makaha, and parts of Waikiki.  One individual Tim met late last year asked why Oahu residents just lay down and accept ever increasing restrictions and Tim responded stating the city council decides what they think is best regardless of the feedback given.  True to form, most of the public testimony was against the measure, yet the city council voted to move the bill forward.  Not surprising, the hotel industry supported the measure.  A representative from Expedia asked why the city council considers the bill when the Department of Planning and Permitting never fully implemented the 2019 law regulating short-term rentals.  

The Honolulu City Council voted to give condominiums more time to comply with a 2018 law requiring automatic fire sprinkler installation or passing a fire safety evaluation.  The measure changes the deadline to complete the fire safety inspection to August 31, 2022, versus May 3, 2022, and gives the associations until 2030 to receive a passing score, versus the 2025 deadline.  The Honolulu Fire Department (HFD) reported only twelve of the 178 buildings deciding to take the fire safety evaluation have passed.  One member of the council proposed to loosen the criteria since so many buildings are failing the evaluations.

The city council continues to target the hotel and visitor industry for tax increases.  The property tax rate for hotel and resort property is 1.39%, the residential property tax rate is 0.35%, and the Residential A (property that does not have a homeowner’s exemption) property tax rate is 0.45% up to $1 million and then 1.05% above one million.  If you live in a property that has a hotel and resort classification, and you either live in the property or rent it long term, then you can petition the City and County of Honolulu to reclass your property by filling out form BFS-RP-P41-E.  You can find the form using the link below.

https://www.realpropertyhonolulu.com/forms/

Fannie Mae and Freddie Mac have given lenders new questionnaires in response to the Champlain Towers South collapse in Surfside FL that killed ninety-eight people last June.  The companies that buy mortgages and package them for investors will no longer purchase mortgages for condos with significant deferred maintenance or safety issues.  Many condominium boards do not have the expertise to answer questions related to the structural integrity of their buildings.  As a result, the condo boards are not filling out the questionnaires for loan companies.  Bank of Hawaii announced on February 22^nd that they will consider all loans on condominiums with five or more units as portfolio loans.  Portfolio loans carry a slightly higher interest rate because Bank of Hawaii keeps the mortgages on their books and assumes the full credit risk of the borrower for the duration of the mortgage.

Market Pricing:  What is the market price?  The market price of any item is the price a willing and able buyer and a willing and authorized seller agree to in a transaction.  Trading platforms constantly adjust the market price of liquid assets like stocks or government bonds during the trading session each time ownership of a stock or bonds change hands. Determining the market price of an illiquid like real estate is more difficult and requires a bit of research before settling on a number.

Residential real estate consists of sales transactions and rental contracts (leases).  The additional challenge with real estate involves the substantial number of features a single-family home or condominium offer versus the consistency of a stock share.  One Microsoft share is identical to another Microsoft share.  A single-family home or condo can differ from another single-family home or condo in location, the number of bedrooms, number of bathrooms, type and availability of parking, views, amenities like swimming pool, and structural integrity.  Real estate platforms like Zillow still struggle to automate the process resulting in “Zestimates” that can be very misleading.  Zillow’s pricing estimates do work well in tract neighborhoods with associations because there is a limited variety of floor plans, lot sizes, and conditions when associations enforce minimum standards.  Zillow’s pricing model struggles with neighborhoods consisting of custom homes, older neighborhoods without associations, and neighborhoods near water, hills, or mountains.

Zillow recently exited the iBuyer market, an attempt to automate the home buying process using computer pricing algorithms, resulting in billions of dollars in losses last year when the algorithms failed to accurately predict the pandemic related surge in inflation, both real estate prices and make-ready repair costs.  A couple of iBuyer companies still exist and those companies still rely on investor capital infusions to support their current operations that have yet to generate a profit.

Stott Real Estate, Inc. and Stott Property Management, LLC follow a similar process when determining the market price or market rent of a single-family home or condo.  We pull up the advertised properties for either sale or rent and pull up all properties that either sold or rented in the past six months.  We compare the evaluated subject property to either sales or rents of property that is comparable to the subject property in both location and floor plan.  We will then give a range of either sales prices or rents accounting for uncertainties in condition and terms.  The market price range or rent range acknowledges the exercise determines a reasonable estimate of the market value.  The only way to determine the actual market price is by placing the property up for sale or for rent and let a willing and able buyer or tenant help determine the value.

Stott Real Estate, Inc. offers a service through its website that provides market activity updates every three months.  We set up the market update to show property currently available to buy, property under contract to sell, and property sold in the last six months.  This can give you an idea of what your property is worth during the snapshot in time.  Please keep in mind that you will inject bias into your value determinations since you own the property.  A third party (appraiser or real estate agent) will be more objective about the market value of your property.  A notable example of bias involves people’s belongings, more specifically, furniture.  A client every year or so will ask us to sell their furniture and occasionally we oblige to do so or ask a third-party contractor to do so.  We often hear that their furniture is worth much more because that is what the furniture cost.  However, a potential buyer typically offers much less because someone’s “grime,” not theirs, is on used furniture.  Factor in the potential of introducing bed bugs into a home, and the price buyer is willing to pay drops significantly due to the risk involved.  The same goes for fully furnished rental properties.  Stott Property Management, LLC sometimes begs their clients to dispose of their furniture because potential renters take one quick look at the beat-up furnishings from years of wear and tear and immediately leave.

Market pricing for selling or for renting is not an exact science due to the real estate market’s complexity and emotions involved when buying, selling, or renting a home.  Stott Real Estate, Inc. and Stott Property Management, LLC offer a complementary market analysis and/or rental analysis if you would like an independent, unbiased, market value of your home or investment property.  Simply email us at [email protected] or visit our website and fill out a request.

A Bird Broke Our Septic Tank:  Hedge funds, professional investors, and investment gurus often talk about “black swan” events in the context that you must anticipate the unexpected to make your portfolio resilient.  The most recent black swan event was the global government response to the COVID-19 pandemic in early 2020.  The uncertainty created by a lack of testing, lack of treatments, and absence of vaccines caused the federal and state governments in the United States to lock down their residents in their homes for weeks and arbitrarily decide the types of businesses that could continue operating and the steps that they must take to operate.  The stock market plunged during this time of uncertainty and some leveraged investors and panicked individuals suffered large losses to their portfolios.

Tim and Tracey experienced a personal black swan event with one of their Austin rental properties this past November.  The tenants reported that they could no longer flush toilets and the drains backed up.  Plumbers discovered that tree roots punctured the fiberglass septic tank and disrupted proper operation.  The property manager texted a picture of the culprit, a tree in the middle of the back yard that did not exist when Tim and Tracey purchased the duplex.  Tim asked the property manager why the tenants planted trees without permission and the property manager responded the tree in question was a hackberry tree, a trash tree in local speak.  Hackberry trees rely on birds to eat the berries, fly away, and poop out the seeds elsewhere to propagate the species.  The most likely scenario involves a bird sitting on the back yard fence.  The tree grew over a span of ten to fifteen years and the roots eventually reached and punctured the septic tank.  In other words, a bird broke the septic tank.

Part of Tim and Tracey’s financial strategy is to continually add new investment property to their portfolio and eventually generate enough passive cash flow to retire (See Investment Property Business Life Cycle).  The positive cash flow from their seventeen doors not only paid for the septic tank replacement, but it also paid for remodeling one of the units when tenants broke the lease due to mess created by the backed up septic tank.  The business, Buddy’s Buildings LLC, paid the money to recover from the black swan event.  Tim and Tracey did not have to use any money from their personal savings.

Positive cash flow and emergency funds exist for surviving the unexpected.  Is your investment real estate portfolio resilient enough to manage a black swan event?  Would you like help building such a portfolio?  Contact us at [email protected] if you are, have questions, or would like to explore available options.

Truth In Advertising:  Many headlines have been written in the paper over the years when a large company is fined by the government or sued by customers for exaggerating the benefits of their products or services. Both landlords and sellers should carefully consider this concept when it comes to renting or selling a property.

How does “truth in advertising” apply to rental properties? The state of Hawaii codifies the concept in the Residential Landlord-Tenant Code and failure to abide by the law can be costly to owners of investment property in Hawaii.  One chapter of the code requires that, “landlord to supply and maintain fit premises.” The state goes further by specifying that the landlord shall “maintain all electrical, plumbing, and other facilities and appliances supplied by the landlord in good working order and condition, subject to reasonable wear and tear.” In practical terms, if a landlord does not want the responsibility of repairing a fixture in their rental property, then the fixture should be removed before showing the property to prospective tenants and signing a lease. Otherwise, the state allows the tenant to repair a fixture and reimburse themselves by reducing future rent payments by the cost of the repair subject to certain limits. Therefore, landlords may not refuse a repair request to repair or replace an air conditioner, for example, even if the landlord writes a clause in the lease specifying that the air conditioner will not be repaired or replaced. Please note that wear and tear applies to the appearance of a fixture and not its functionality. The landlord is obligated to address function problems with any fixture or appliance if the fixture or appliance was present at the time the tenant checked in.

The concept applies to Sellers in the form of the Seller’s Real Property Disclosure Statement. The document is five pages long and may only be filled out and signed by the seller or sellers of a residential property. There are over 100 items pertaining to the condition of a property that the seller must consider and respond to. While the disclosure statement is not a warranty of any kind by the seller, it can be an effective defense if the buyer claims that the seller misled them regarding some perceived defect in the home and the seller can show that he or she documented it in the Seller’s Real Property Disclosure Statement.

1031 Exchange – Kailua to Sacramento:  This is a case study explaining the how and why Stott Real Estate, Inc. helped Stott Property Management, LLC clients successfully complete a 1031 Exchange.  The clients hired Stott Property Management, LLC to manage their fully furnished Kailua house in 2012 and their plan was to stay in the house for part of the year and rent it out the rest of the time.  Life took over and it turned out to be impractical for the clients and their family to visit Oahu on a regular basis and ended up renting it full-time.  They started looking at other investment opportunities and realized that they could sell the Kailua house and buy property close by in Sacramento with the proceeds.

The Kailua house rented for $3,200 when they decided to sell and sold for $870,000.  They bought three two-bedroom condos located near an Amazon fulfillment center for about $810,000.  The three condos combined rents totaled more than $5,500 after completing some make-ready repairs in two of the condos.  The Kailua house was built in 1955 and all three condos were built after 2000.  Sacramento held additional advantages over Kailua in the form of lower expenses including lower labor rates, lower insurance rates, and lower utilities.  Because the cost of land in Sacramento is much cheaper than Kailua, our clients were able to generate more tax-free income in the form of higher depreciation rates.  In summary, our clients sold a property that rented for $3,200 per month and bought investment property that rents for $5,500 per month and nets them $3,000 per month.  They significantly improved their positive cash flow and tax-free cash flow by completing a 1031 Exchange.