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Quarterly Newsletter January - March 2023

|  P R I N T   R E P L I C A  |  The March median sales price for single-family homes was $1,083,750 (5.8% lower than March 2022) and for condos was $536,000 (4.0% higher than March 2022).  Demand continues to crater with 26.5% fewer single-family homes and 33.9% fewer condos sold compared to the same month last year and pending sales are more than 30% lower for both categories.  Inventory continues to grow with 2.1 months of single-family homes available and 2.4 months of condos available despite fewer new properties coming on the market. Rising interest rates are rippling through the national rental market and causing investors to pause the rapid deal-making of the past two years.  Multi-family building prices have dropped 8.7% nationally and further declines could force some owners to sell when their short-term, floating rate debt comes due.  Flat and in some areas, decreasing rents have removed another popular strategy of would-be buyers since they can no longer raise rents to support the higher purchase prices.  

 

An estimated 29,684 Hawaii residents left for the mainland from 2020 to 2022 for economic reasons.  The state experienced a greater that average impact from the COVID-19 government restrictions and has recovered only 95% of its 2019 GDP and only 83% of the revenue generated by visitors.  Oahu experienced an even greater out migration.  31,682 residents left Oahu leaving its population below 1 million residents.  The loss in population loss has been a drag on the county’s economic recovery in the form of lower household consumption and a growing labor shortage.  The rest of the nation has fully recovered economically from the pandemic while Hawaii continues to struggle.  Hawaii’s Chief State Economist sees the population shrinking even further due to Hawaii’s high cost of living and rapidly aging population. Tracey just returned from a trip on the East Coast and was reminded how much cheaper it is to live on the mainland with a trip to the grocery store serving as a serious eye opener.

 

A Mixed Plate of Talk Story

 

The city has hired a bill collector to pursue 20 owners of vacation rentals for violations of Ordinance 22-7.  The city first gives a violator 30-days to correct the deficiency, then has two months to pay the fine issued, and then the city sends a demand letter giving the violator three more months to pay.  71 of the 512 violations issued have reached the level of sending a demand letter.  A U.S. District Judge placed issued an order enjoining the city from enforcing the law claiming the new ordinance violates the U.S. Constitution.  The plaintiffs in the case claim in a January 20 letter that the city’s enforcement actions violate the preliminary injunction.  The city has not responded to the January 20 letter and a conference call to resolve the issue has been scheduled.

 

Just another reminder of the state taxes that Hawaii landlords must pay.  Most landlords are aware of general excise tax, and transient accommodation tax (if applicable), yet are unaware of state income tax, particularly when they live in a state that does not have an income tax.  When an out of state individual sells a property, they will often be due a refund for capital gains tax withheld through the Hawaii Real Property Tax Law (HARPTA).  When an individual files for a refund using form N288c, the state asks for their GET license number and may check to make sure the individual has filed and paid state income tax.

 

The Hawaii Department of Natural Resources (DLNR) continues to try and reverse course against shoreline hardening along the North Shore after years of giving emergency relief to owners whose houses are threatened by beachside erosion.  The latest involves an owner who was allowed to install rocks and “beach burritos” to protect his property starting in 2002.  The emergency barriers expired in 2020 and the state has found that the owner installed new material and contractors poured concrete to secure the rocks previously installed.  The state has fined the owner $188,000 over 18 months and the owner has appealed a rejection of his seawall permit.  The owner has operated the property as a vacation rental starting in 2015.

 

Erosion is once again a concern for Hauula residents as a sink hole forces emergency repairs on a 30-foot stretch of Kamehameha Highway’s shoulder.  The road’s collapse temporarily trapped a sewage truck until neighbors helped free the front wheel from the hole.  A $500,000 project to shore up the road is expected to last five to ten years will start next month.

 

The Board of Water Supply (BOWS) sent a letter to all customers arguing against the latest Environmental Protection Agency regulatory agreement with the U.S. Navy over the Red Hill Bulk Fuel Storage Tank defueling.  Stott Property Management, LLC’s mailbox was filled with more than 80 letters during the week of 1/09/2023, While arguing that neither the EPA nor the U.S Navy could be trusted, a reasonable argument, BOWS objected to the state Department of Health (DOH) becoming the lead agency in the defueling oversight.  The letter encouraged neighbors to attend a contentious town January 18 town hall meeting where the BOWS, community activists, and residents lambasted the agreement as toothless.  The major complaints included the lack of deadlines and lack of fines if the U.S. Navy failed to meet the deadlines.  In order to prevent future spills, the work should be event driven, not deadline driven.  The letter spells out the BOWS’s objections.

 

  • Does not contain clear deadlines for completing the work.
  • Does not contain strict penalties for noncompliance.
  • Lacks opportunities for stakeholder and public participation.
  • Does not contain actions to address the latest release of aqueous film forming foam (AFFF) concentrate containing per- and polyfluoroalkyl substances (PFAS).
  • May conflict with existing Hawaii Department of Health’s (DOH) Emergency Order and enforcement actions and the existing Administrative Order on Consent from 2015.  DOH is not part of this proposed Consent Order.
  • Is premature given that the full extent of the damages to the environment including our water resources are unknown, and the Red Hill Bulk Fuel Storage Facility still stores 104 million gallons of jet fuel and diesel over the aquifer.

 

The four Hawaii members of the U.S. Congress wrote a letter to the Internal Revenue Service (IRS) asking the IRS to exempt reimbursements by the military to displaced families forced to shelter in hotels because of the Red Hill Fuel Storage Facility.  The IRS notified displaced family members of steep income tax increases resulting from reimbursement payments in 2021 and 2022.  The Hawaii delegation argues that “assistance provided to individuals provided by the Federal Emergency Management Agency (FEMA) under the Stafford Act is exempted under article 139 of the Internal Revenue Code.”

 

Tensions between the University of Hawaii (UH) leadership and state legislature has intensified over the past few years as legislators agitate to weaken the state constitutional change to provide greater autonomy in handling its affairs.  Both the head of the Senate Ways and Means and Higher Education committees have gone on record stating that UH President David Lassner should resign.  Critics of the senators claim they are micromanaging and bullying the UH staff, thus interfering with the leadership’s ability to serve their students.  Opinion columnist David Shapiro highlights the obvious by pointing out that Senator Dela Cruz stated Lassner has served 10 years as President and it should be time to step down while the senator has served for 13 years and opposes term limits for the legislature.

 

The city has allocated $43.6 million to begin a project to refurbish the Neil S. Blaisdell Center temporarily closing parts of the entertainment venue from July 2023 through June 2024.  The project will upgrade the center’s failing fire suppression system, replace air conditioning cooling towers, exterior roofing, above-stage grid structure, and repair concrete spalling.  The mayor announced the project stating that the upgrades of the 60-year complex are long overdue.  Will the state notice and focus its attention on the convention center’s roof?

 

Hawaii Convention Center Attendees have a new activity to explore between seminars.  Guests can go spelunking in the stairwells due to the legislatures failures to provide funds to fix the roof.  Stalactites have formed in a stairwell and the unmitigated water damage threatens the structural integrity of the convention center.  Last year, the legislature only approved $15 million towards a $64 million repair project and the bill expects to grow to $88 million by 2027.

 

A football field sized space object was discovered by a Hawaii observatory as it passed through the solar system.  The comet, Oumuamua, became the center of wild theories due to its odd shape and the strange gasses it expelled.  Oumuamua means from afar arriving first which is appropriate since it is the first known object to enter our solar system from interstellar space.  The water rich comet traveled about $196,000 miles per hour and took a hook turn past the sun to continue its journey into the Milky Way.  Theories involving interstellar space craft originated from the comet’s gaseous propelled trajectory that defied gravity.

 

The University of Hawaii (UH) Wahine basketball team repeated as the Big West Conference tournament champions and earned a automatic berth the to the NCAA tournament.  The Wahine came back from a 15-point halftime deficit to beat UC Santa Barbara in the final seconds of the final.  The Wahine are seeded 14th in their region and are scheduled to played 3rd seeded Louisiana State University in Baton Rouge losing 73-50.  LSU’s depth and talent resulted in only two losses in the regular season, one to #1 ranked South Carolina and a second in an upset to #24 ranked Tennessee in the SEC final.

 

The Waikiki Beach Special Improvement District Association started a 3-hour daily closure of the Royal Hawaiian Beach from 2:00 am to 5:00 am to address safety and sanitation issues from overnight camping at the beach effective March 1, 2023.  Some campers were witnessed digging through the trash at a beachfront hotel and piling up recyclables in the middle of the beach.  Sanitation crews have had to clean up trash and human feces from about 6:00 am to make the beach ready for visitors.  The public will be able to still walk the beach and go to the ocean while the beach is closed.  They just won’t be able to loiter or camp.

 

Honolulu Lifeguard Luke Shepardson won the 2023 Eddie Aikau Invitational Big Wave Contest at Waimea Bay riding the top of the largest wave of the day, dropping in the steep face, and completing the ride after a series of maneuvers.  He defeated 2nd place finisher, John John Florence, who won the last “Eddie” in 2016.  The wave faces averaged 50 feet during the contest and Shepardson started the day as a lifeguard during the early rounds.  

 

A recent two-month drone deployment identified a second group of humpback whales breeding in the northwest end of the Papahanaumokuakea Monument.  The Hawaiian distinct population feeds off Alaska and breeds among the main island chains of the Big Island, Maui, Oahu, and Kauai.  A second group, suspected to be the West Pacific segment feeds in the Bearing Sea and the Aleutians but scientists have been unable to find out where they breed.  They now suspect that this segment breeds in the northwest end of the monument but further investigation is needed.

 

The state cited a Maui man for harassing a young humpback whale and a pod of spinner dolphins at Kealakekua Bay State Historical Park.  The man snorkeled after the adolescent humpback whale almost touching its fin and could be heard laughing in the background of a video recording.  The man also led a group of snorkelers who chased after the pod of spinner dolphins.  Federal law prohibits swimming with and approaching a humpback whale or spinner dolphin within 50 yards.

 

Hawaii loves to count wildlife and March 16th was the “Every Kolea Counts” event that occurred in Hawaii.  A webinar talked about the Pacific Golden-Plovers, their habitats, and their behaviors.  The National Marine Sanctuaries hosted the event whose aim is to educate the community about marine wildlife in both formal and informal settings.  While golfing late in March, Tim and a friend noticed the Koleas’ feathers changing in advance of their annual migration to Alaska starting in April.

 

House Bill 72 proposes a $500 fine for feeding feral chickens.  The bill proposed by an elementary school principal claims the chickens, "who are as large as some of the students," have become aggressive.  Apparently encouraging highly active 6th grade boys to chase the chickens is too dangerous.  Ironically, a photo of grade school kids practicing for a national flag football tournament showed them chasing each other around a park.  One neighbor is apparently afraid of walking his dog due to the number of chickens.  Tim and Tracey’s dog, Buddy, would love the opportunity of a chicken approaching within the range of his leash.  

 

Tim and seven teammates traveled to San Diego and represented Hawaii in the Tom Fey USTA Tri-Level National Invitational on March 17th, 18th, and 19th.  Tim has attended about 15 national tournaments over the past decade and the teams usually finish somewhere near the middle of the pack.  March turned out to be different with the men’s Hawaii team taking the national crown finishing first out of 17 teams.

Odds & Ends

 

Options to Saving on Your Mortgage Payments:  We recently heard the following frame from a lender.  “Marry the house and date the interest rate.”  The article discusses four options available in the order of popularity, not in savings.

 

The most popular method of reducing monthly mortgage payments is refinancing an existing mortgage when interest rates drop.  Mortgage lenders feasted off the Federal Reserve’s quantitative easing for 14 years as homeowners refinanced every couple of years when rates continued to fall to all-time lows.  One rule of thumb in paying off a mortgage is to refinance from a 30-year mortgage to a 15-year mortgage when you can obtain a mortgage rate 2% lower than your existing rate.  Tim and Tracey did exactly that in 2014 and moved to a 15-year mortgage with essentially the same monthly payment.

 

Recasting a mortgage is little known option available to some homeowners that want lower monthly mortgage payments, have a large lump sum of cash available, and do not want to refinance their mortgage.  Normally, if you pay off extra principal on a mortgage, the monthly payment remains the same and you simply end up paying off the mortgage sooner. While this strategy will save you interest paid over the life of the loan, it will not shrink your monthly payments.

 

Recasting, or re-amortization, involves reducing your monthly payment by paying off a sizeable chunk of the principal on the loan, and then requesting the lender to recalculate the principal and interest owed using the same interest rate and time remaining to pay off the loan.  The result is that you pay a lower monthly amount, make your final loan payment on the date specified in the loan documentation, and save some interest over the life of the loan.  The added principal could have been paid off over time or the borrower could have a large lump sum available from savings, a recent bonus, or asset sale.  We recommend contacting your lender first before paying off a large chunk of your mortgage if your goal is to recast your loan.  Not all lenders will offer the option and some lenders may charge an administrative fee.  Bank of Hawaii for instance, will allow a borrower to recast their mortgage once for certain mortgages over the life of the loan.

 

A third alternative is to make one extra mortgage payment every year to accelerate principal repayment.  This practice will pay off a 30-year mortgage in 17 years.  The advantage of making the extra payments is that you don’t have to wait for a change in interest rates to take advantage of the technique.

 

Finally, improving your credit score can lead to lower mortgage rates.  Lenders penalize borrowers with credit scores below 680 in the form of interest rates currently 1.5% higher than borrowers with credit scores above 780.  Previous penalties have been as high as 2.75%.  You must refinance a mortgage once your credit score improves to obtain a lower rate.  Refinancing in a lowering interest rate environment can add to the savings.  One great feature is that your credit score will rise if you make your monthly mortgage payments and other payments on time.

 

Pet Friendly Lease Terms:  Recent events have inspired an article describing the benefits to residential investment property owners of pet friendly policies.  Stott Property Management, LLC has been encouraging its clients to adopt pet friendly policies when feasible ever since the state of Hawaii allowed landlords to collect a refundable pet deposit in addition to a refundable security deposit and the expansion of the Americans Disability Act to cover Emotional Support Animals (ESA).

 

Stott Property Management, LLC manages roughly 380 rental properties and has been we have been in the business for over forty years.  Properties that allow pets, all other amenities and lease terms being equal, experience lower vacancy rates (shorter vacancies and longer leases) and higher rents than those properties that have no pet policies.  

 

The experience of Stott Property Management, LLC highlights that many landlords don’t allow pets because they over-estimate the perceived risks associated with the damage that pets cause.  In all but a very few cases, the security deposit and pet deposit have covered all charges associated with making a property ready to rent after a tenant failed to prevent or address pet related damage.  In some of those cases, part or all of the security deposit was used to cover unpaid rent and other charges in addition to pet related damage.  In fact, some of the most messy and expensive cleanups have involved tenants that did not have pets.  The latest case involved an evicted tenant that left behind an apartment completely filled with urine-soaked belongings and debris.  Removing the debris and sanitizing the unit cost more than $5,000 alone.  The figure did not include the cost of painting, replacing the flooring, and replacing the refrigerator.

 

There are some very good reasons for not allowing a pet.  Some owners or their family members are highly allergic to pets and plan on visiting or returning to the home.  High end fully furnished homes don’t allow pets since pets can ruin expensive furnishings.  And some condo and homeowner associations don’t allow pets.  In the absence of these or other unique circumstances, landlords that don’t allow pets may want to reconsider their policy.

 

Hidden Fees:  A Wall Street Journal article titled “The Sinister Logic of Hidden Online Fees” by Michael Luca describes the attempts by Airbnb and StubHub to post more transparent pricing and end the practice of tacking on fees as a customer completes an order online.  StubHub’s revenue dropped when the true cost of a ticket was initially displayed as customers either chose less expensive options or decided against buying a ticket altogether.  UberEats, eBay, Lyft, Instacart, Etsy, and Ticketmaster also tack on hidden fees during the transaction.

 

By focusing the customer’s attention to the base price, researchers found out they were able to convince shoppers they were getting a better deal than they received.  While working with StubHub, researchers found that customers were 13% more likely to buy tickets using drip pricing.  The customers ended up spending 5% more than customers who were shown the total cost up front.

 

Tim has discovered that many property managers engage in the same practice by burying additional fees in their contracts.  Stott Property Management, LLC charges two fees.  A fee as a percentage of the rent revenue capped at $300 per unit for unfurnished units and a one-time fee when a new tenant checks in.  Some property managers charge additional fees for advertising, running credit checks, coordinating maintenance and repairs, and having tenants sign lease extensions in addition to the two fees that Stott Property Management, LLC charges.  Those fees can add up and become a significant source of revenue for the property management firm at the cost of the client.

 

Property Rights and Rental Markets:  Savvy real estate investors find communities that offer a return on their investment by fulfilling a need or desire of individuals in that community.   Government regulations and restrictions at the local, state, and federal level have raised the cost of maintaining older rental properties and in some areas, all rental properties.  There are a wide variety of rules, regulations, and taxes that impact a landlord’s ability to earn a return on a significant investment.  The purpose of this article is to help identify rules, regulations, and taxes that an investor should research before investing in a certain location and to determine when to exit a real estate market due to recently passed legislation.

 

Taxes:  States have differing ways to charge and collect taxes and real estate investors need to know what taxes apply to their rental activity.  On Oahu, real estate investors must file and pay state income taxes on their real estate income even if they are not Hawaii residents, must file and pay the state General Excise Tax on gross rents, property taxes to the City and County of Honolulu, and possibly the state Transient Accommodation Tax if the tenant has a primary resident in a different location and the rental period is less than six months.  The City and County of Honolulu City Council passed a bill a few years ago raising the property tax rates on property owners that don’t have a homeowners exemption, essentially raising taxes on investment property and on many taxpayers that are unable to vote in local elections.  Some states (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) do not charge income tax and those states have lower than average tax burdens resulting in residents keeping more of their money for living expenses and disposable income.

 

Regulations:  The EPA placed additional requirements and certification requirements on painters and contractors when the repair and maintenance activities disturb lead-based paint in older homes.  The 2008 rule changes require certified renovators trained by EPA-accredited trainers to work on homes built prior to 1978 unless the homeowner certifies that there are no children in the household and no pregnant women.  The certified renovators must install protective barriers, and follow cleaning and testing protocols to minimize the hazards associated with lead-based paint, lead contaminated dust, and lead contaminated soil.  Stott Property Management, LLC noticed the cost to prep and paint older homes rise by thousands when the new rules were fully implemented in 2010.

 

Water remediation has become increasingly disruptive and expensive over the years and many water remediation companies point to the Occupational Safety and Health Administration (OSHA) requirements to justify expensive testing and repair requirements when water penetrates a home or condo.  Years ago, many mold issues could be quickly resolved by cleaning the impacted area with a bleach solution.  Now heated fans must routinely be used in rooms with water leaks and holes drilled into drywall to make sure walls and flooring are quickly dried.  We have seen remediation companies insist on removing and destroying perfectly good cabinets, drywall, and other building materials to the tune of thousands and tens of thousands of dollars.  

 

Local Rules and Red Tape:  Numerous articles have been published by the Honolulu Star Advertiser and other publications about the increasingly restrictive permitting requirements and associated delays.  It routinely takes more than six months to obtain the necessary permits to start construction on a major renovation or a new home.  It takes decades for developers to jump through the necessary regulatory hoops to commence work on new developments and neighborhoods.  One of Stott Property Management, LLC’s clients had to wait six months to receive a permit to replace the main power line to the house because a trench had to be dug to route the underline cable.  One of the departments had to verify that the temporary trench would not cause excessive erosion in a neighborhood that has existed for more than 50 years.  The house was fortunately vacant at the time the main power line failed.

 

Overly restrictive zoning limits land usage and drives up the cost of workforce housing by making land currently zoned for residential or business development more valuable by artificially suppressing the supply of land zoned for development.  The impact on affordability can be readily observed in the housing prices and rents in Honolulu, San Francisco, Los Angeles, and Seattle versus the housing costs of a Texas, Georgia, Utah, or Florida suburb.  The myriad of zoning rules in Honolulu has created the proliferation of non-conforming structures and “monster houses” as landowners and developers try to dodge zoning restrictionss.

 

The state requires that a homeowner hire a licensed contractor any time the maintenance or repair will exceed $1,500 in both materials and labor.  The statute severely limits the work a handyman can perform when one considers that painting the interior or exterior of a house can cost several thousands of dollars and appliances can run several hundreds of dollars to well over $1,000 each.  As a result, the supply of readily affordable handymen has dropped over the years due to inflation and landlords must pay higher labor rates to hire contractors for relatively simple maintenance and repair items.

 

Tenant friendly legislation such as rent control, eviction hurdles, and restrictions to tenant screening can place an undue burden on landlords resulting in fewer available rentals because the laws drive mom and pop establishments out of business and encourage more mobile capital to invest elsewhere.  Countless studies have shown that rent control eventually results in fewer available rentals and more substandard housing because rent control prohibits landlords from charging rents to cover maintenance costs and are not rewarded to make their rentals attractive to more tenants.  Until recently, the state of Hawaii actually had a predictable eviction process where a landlord could regain possession of his property within about two months of filing suit provided the landlord proved the tenant did not pay the rent specified in the lease.  There are some other states that allow deadbeat tenants to remain in a property up to six months while the landlord struggles to overcome the hurdles put in place.  Some states prohibit landlords from asking prospective tenants about the source of their income.  How can a landlord determine if a tenant can pay the rent through the duration of the lease if employer references are prevented?

 

Analysis and Decisions:  Real estate investors should seriously consider the neighborhood’s regulatory environment before deciding to invest in an area and whether to remain invested in an area over time.  Charging a market rent that exceeds the costs associated with financing, managing, and maintaining a property (including paying taxes) is a requirement for building a successful investment real estate portfolio.  A great way to start locating investment opportunities is using a search engine and typing in states with no income tax, state tax burdens ranked, and state landlord tenant law.  Once you have narrowed down your criteria by state, then check for economic growth rates and start interviewing property managers for customer service, operational competence, and local regulatory knowledge.  Identifying and hiring a good property manager is an important step in building a profitable real estate portfolio because not all areas offer acceptable returns all the time and you may not live in a state or county that provides those opportunities.  Also keep in mind that there are limits to your time, energy, experience, and knowledge.  Therefore, leveraging the time and expertise of others will improve your odds.

 

Once you are invested, consistently review the cash flow of each investment and if you are not happy with your returns, then start asking questions.  You may have to find the answers yourself if you are managing your properties.  If you have a property manager, then ask why your rent and expenses are not leaving you with sufficient income.  The issue may be short-term, but make sure that it is.  Relying on things going perfectly to generate positive cash flow rarely result in satisfactory long-term performance.  If the trends look unfavorable, then it is likely time to sell and find a better place to invest your money.

 

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