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Quarterly Newsletter July-September 2022

P R I N T  |  R E P L I C A  The September median sales price for single-family homes was $1,100,000 (4.8% higher than September 2021) and for condos was $502,500 (5.1% higher than September 2021).  Rapidly rising mortgage rates are dampening demand.  There were 34.4% fewer single-family homes sold in September compared to September 2021 and 19.3% fewer condos.  The higher interest caused sellers to hesitate with 26.2% fewer single-family home listings and 18.6% fewer condo sales compared to the same month last year.  Inventory is creeping up in the slowing market with 43.9% more single-family homes available and 10.8% more condos available.  There is 1.9 months of single-family home inventory and 2.0 months of condos.

 The S & P CoreLogic Case-Shiller National Home Price Index showed the first drop in average home prices across the nation since January 2019, indicating that the pandemic-fueled home price surge has peaked.  The index reflects a three-month rolling average with a two-month delay and experts expect continued average price reductions over the coming months.  The July average of $389,500 is 0.3% lower than June yet 15.8% higher than July 2021.  The average mortgage rate jumped from 6.29% to 6.70% during the week ending September 30th as turmoil in the bond market drove up interest rates, and Bank of Hawaii is offering fixed mortgage rates of 6.375% the week ending September 30th.  

Median asking rents, a leading indicator, have peaked according to three rental property companies in July.  CoStar Group reported a 0.1% drop in the September median rent, Rent.com showed a 2.8% drop in September median rent for one-bedroom apartments, and Realtor.com showed a modest drop in September median rent.  While asking rents are falling, tenants signing one-year leases will still pay monthly rent increases of 7.1% since most leases renew every twelve to 24 months.  Median rents have increased nationally 23% since August 2023. 

 Stott Real Estate, Inc. has heard some promising anecdotal evidence that the market may be loosening up.  Some parts of the country are cooling faster than Oahu presenting investment opportunities for some Oahu investors to conduct an exchange to a mainland property.  Tracey recently put an Ewa Beach house on the market after their client finally found a replacement property near him in California.  The client plans on conducting a 1031 Exchange to defer his capital gains taxes and generate higher cash flow.

 ACT 57, Hawaii’s modified eviction law, expired on August 6, 2022, providing a relief for landlords who have received the brunt of pandemic related burdens imposed by Governor Ige and the state legislature.  The law was passed to prevent the courts from becoming overwhelmed by landlords seeking relief and failed to do so.  The courts and legislature essentially delayed the landlord’s ability to regain possession of a home where a tenant has failed to pay rent.  This law in tandem with Governor Ige’s eviction moratorium cost one of Stott Property Management, LLC’s clients close to $50,000 in damages.  The judge involved with the case has still refused to rule on a financial judgement over nine months and jeopardizing the landlord’s ability to mitigate the financial damage.  The time the landlord can demand payment has been reduced to five days from fifteen days and mediation is no longer required.  Mediation may still be appropriate in some cases since the mediators have direct contact with the rental relief organizations and can help landlords receive past due rent.  Landlords can request mediation after mailing the five-day demand letterby visiting https://www.mediatehawaii.org/semp.  Mediation sessions are currently conducted using Zoom so landlords and tenants do not have to be on Oahu to participate.

 The Honolulu City Council is considering increased shoreline setbacks that potential buyers should pay attention to before purchasing an oceanfront lot for future development.  The new rule would raise the 40-foot setback to a minimum of 60 feet and up to 130 feet should the erosion and sea-level rise impact the property.  The rate of the setback increase would equal 70 times the annual erosion rate of the property and is based on the average 70-year house lifetime.

 New drone footage shows increasingly desperate homeowners erecting illegal coast hardening structures to keep their homes from falling onto the beach as the state struggles to develop a long-term solution.  One homeowner recently constructed a moss rock retaining wall along the beach and covered it with a lanai.  Another homeowner is constructing a cement retaining wall fronting the same beach.  The Department of Permitting and Planning has not responded to requests for comment.

 Homeowners building plans will suffer continued delays as the Department of Planning and Permitting (DPP) reported a backlog of 8,000 permits in the initial processing phase or department review despite announcements by Mayor Rick Blangiardi that he would make addressing the backlog a priority.  City councilors promise to streamline the process instead of removing DPP from the review process and holding contractors accountable for their work.  Residential and commercial permits currently take six months to two years to get approved.

 A fire code violation contributed to releasing over 19,000 gallons of fuel oil making its way into the Navy’s Red Hill drinking water system.  The contractor installed PVC piping instead of steel piping throughout the fire suppression system and replaced only a small portion of the piping in 2017 when the error was discovered to save money.  A worker crashed the passenger cart train into the pipe, cracking one of the PVC valves.  A report cited a long list of operational, maintenance, and management failures that contributed to the disaster.  The U.S. Navy has shortened the timeline to drain the Red Hill Fuel Tanks by 5 months after receiving pressure from the state and environmental groups to speed up the process.  The Navy has committed to shortening the repair timeline by two months and the defueling phase by three months.  The project reported that it expects to remove 1 million gallons of fuel from the tanks by July 2024 versus the initial report of completing the project by the end of 2024.  The Navy just admitted that hundreds of water samples taken in the first few weeks of the crisis were never tested for fuel contamination despite urging military residents to call a hotline if they thought their water was contaminated.  The Navy dumped the samples one month after collection resulting in valuable lost time to identifying the contaminants and finding the source of the leak.

 The Federal Transit Authority (FTA) approved the Honolulu Authority for Rapid Transportation’s (HART’s) shortened route for the remaining $744 million in funding.  The FTA released $125 million of that funding and will release an additional $250 million of funding when HART awards the contract for the final leg of the construction.  HART must award the contract for Kakaako’s Civic Center station by 2024.  The Honolulu Authority for Rapid Transportation (HART) started extensive operational testing on Monday, 8/29/2022 with much shorter delays than previous efforts.  The first test run started 10 minutes late because one of the stations was not ready to receive the train.  The next day’s test run started 5 minutes late due to delayed train maintenance.  The testing is expected to run at least 90 days and the system must pass 98.5% of the time over 30 days.  HART still has construction hurdles to resolve before the first leg of the project can be turned over to the city.  The Federal Transit Authority has not approved the shortened 18.75 mile, 19 station route and engineers must review the severity of cracks discovered in station supports.

 The National Science review launched a full environmental review of the Thirty Meter Telescope project that could bring hundreds of millions of dollars in funding to the islands.  The leading funder of scientific research will hold a series of meetings from August 9th through August 12th to engage the public regarding the effects of TMT.  The opponents are not moved by the gesture and will oppose any efforts to add another telescope on the summit of Mauna Kea.  While the review appears to be a positive step forward, the fund could cut off U.S. involvement in the project at any time.  However, the Environmental Protection Agency (EPA) urged relocation of the Thirty Meter Telescope (TMT) to a different location and suggests a smaller facility.  The EPA comments state local indigenous people are most negatively impacted by the project even though the project yields net economic benefits to the Big Island and the state.  TMT opponents were both surprised and pleased by the report.

 The Navy has towed the USS Bowfin to dry dock for six weeks of maintenance, repairs, and a new coat of paint.  The submarine was christened on December 7th, 1942, and earned the nickname, the Pearl Harbor Avenger.  The submarine has been a mainstay of Pearl Harbor tours.

 Bellows Air Force Base is erecting fencing along the perimeter of the base as required by the federal government’s anti-terrorism efforts.  The contractors are trying to keep the fence on the Bellow’s side of the ridge, but the terrain does require fencing on some parts of the ridgeline.

 David Ige has returned to form by scrapping the latest plan for Aloha Stadium in favor of a government run facility.  True to form, Governor Ige has stated that a government run facility is superior to a private partnership.  Given the state’s failure to build large projects on time and within budget, no one currently knows when the project will start and finish and how expensive it will be for taxpayers.  Two senior stadium officials are questioning the move since it will simply cause further delays.  One official was quoted by the Honolulu Star-Advertiser stating, “I don’t know what his plan is, but I can tell you that we are so far along in our procurement that we are ready to move and proceed, and we actually have been for quite some time.  We’ve been waiting for that green light.  So I think my concern is any change at this point will cause a delay or will cause us to have to start over, and that’s what I would hate to see is to start this process over and kick this project out even further.”  The official also disputes that $350,000 will be sufficient to cover the costs of the stadium’s build since it is based on a 2017 estimate.  The stadium was once projected to be built by 2023 and that has now been pushed back to at least 2027.  Maybe Ige can save money by having HART manage the project and both the rail system and stadium can be delayed indefinitely.  The University of Hawaii was clairvoyant in starting construction on the Warriors expanded on campus facility.

 Oceanit, a local tech company, has partnered with Hawaii Gas to pilot a pipe surface treatment to remove the risk of hydrogen embrittlement failure and to decrease operating costs.  Moving hydrogen through existing high-pressure systems has risks.  Hawaii Gas operates at lower pressures and is the only utility to blend hydrogen with natural gas in the United States.  In addition to creating a barrier to hydrogen penetration, the treatment provides an ultra-slick surface that minimizes drag.  The United States has over 3 million miles of pipeline and the use of hydrogen could further reduce the carbonization of fossil fuels.

 Rocky the seal returned to Waikiki and gave birth to her 14th pup on Saturday, 7/9/2022.  The new boy seal was found playing in the sand near his mother at Kaimana Beach.  Rocky was born on Kauai and has given birth to all her offspring on Kauai until she gave birth to Kaimana on Kaimana Beach in Waikiki in 2017.  The pup, named Koalani, entertained visitors for weeks.  Koalani was weaned on August 18th and relocated by the state Department of Land and Natural Resources to a remote Oahu beach where he can grow up in the company of other monk seals.  He received his flipper tags and a morbillivirus vaccine before being set free.  A pup’s naivete’ and curiosity helps reduce stress during the relocation process.  While Rocky was nursing Koalani, Rocky’s granddaughter, Imikai, gave birth to Rocky’s great-granddaughter, RQ88.  RQ88 is the fifth known monk seal to be born on Lanai since 2014.  Hawaii monk seals are one of the most endangered seals species and receive both federal and state protection.  Beachgoers were reminded of the dangers of sharing space with a nursing Hawaiian monk seal when a swimmer was attacked by Rocky.  The victim gave Rocky and her son plenty of space, yet the mother swam up behind the unsuspecting woman and attacked her causing surface lacerations on her cheek and shoulder.  The swimmer will not be fined because she stayed 150 yards away from the pair of seals until Rocky initiated the contact.  Lifeguards have increased the buffer around Rocky and her pup after she chased a man carrying a toddler out of the surf on July 9th.

 Seabird fallout season has begun on Hawaii and the Hawaii Wildlife Center is again asking residents to drop off grounded fledglings to centers like Kailua’s Feather and Fur Animal Hospital and other vets on the Leeward Side and North Shore.  Young seabirds leave their burrows out to sea guided by moonlight, and many become disoriented by urban lights and circle around them until they land exhausted or collide with structures.  The grounded fledglings are vulnerable to predators, starvation, or getting hit by cars.  Hundreds of seabirds are downed each year in need of rescue.  560 seabirds were rescued last year with a 96% release rate.

 For more than 40 years, Hawaiian botanists have risked life and limb to find endangered plants and collect cuttings, flowers, or seeds.  The ordeal involves rappelling down cliff faces of 1,000 feet, hanging from helicopters, or hiking for days to remote locations.  Botanists can now rely on drones equipped with a fishing pole like appendage to collect the material necessary to replenish the endangered plants.

 

Creating a Buffer During Inflationary Times

 The United States Federal Reserve (Fed) has raised interest rates 0.75 percent three times in the last three months to combat inflation, resulting in mortgage rates above 6%.  The rising interest rates have also taken a toll in the stock market with the Dow Industrial Average reaching bear market lows.  The financial section of newspapers is full of articles about the lack of options in a stagflation environment.

 One option to hedge against inflation is to purchase I-Bonds from the United States Treasury using the Treasury Direct Website, https://www.treasurydirect.gov/.  I-Bonds are currently paying an interest rate of 9.62% through December 31, 2022.

 Another option to hedge your personal finances is to make principal payments against your home equity line of credit (HELOC) or business line of credit if you have one.  These financing vehicles typically charge interest only for the first few years and then the lender will amortize the remaining balance over the life of the loan.  By paying down the balance using excess cash or the positive cash flow from your real estate investment, you will lower the monthly interest payments.  The resulting savings will boost your monthly cash flow and hedge against rising expenses due to inflation.  Tim and Tracey have shifted their payment strategy from paying off a mortgage on a duplex to paying principal against their business line of credit that now has a higher interest rate.  The goal is to either eliminate the interest payments or pay down the balance for future real estate investments if a good opportunity shows up.

 Hawaii real estate investors often have another option.  Since Oahu investment real estate offers lower cash flow than most other areas of the country, an investor can conduct a 1031 Exchange and put the money into a property that generates higher cash flow.

 If you are approaching retirement, then a great way to eliminate a likely large monthly expense, is to sell your investment property and use the proceeds to pay off the mortgage on your home.  This option does result in a capital gains taxes, so you do want to make sure you put enough away for the upcoming tax bill.  If the proceeds are insufficient, yet will result in a large principal payment, then you can contact your lender and request that your mortgage be recast.  A lender will amortize the mortgage payments the lower balance over the remaining life of the loan resulting in lower monthly payments when recasting a mortgage.  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.

 Please email Tim and Tracey at [email protected] or call the office at 808-254-1515 if you would like to receive a rental and market analysis to see if selling would improve your finances.  If you are currently charging below market rent, then simply raising the rent to market values can provide you the buffer you are looking for.  Monthly rents have increased 23% since December 2020.  Please email Tim at [email protected] if you would like more information about our property management services.

 If you would like more details regarding a 1031 Exchange, then email or call and we can send you the 1031 Exchange Overview that explains the process in question and answer format.

 

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 375 rental units on the island of Oahu.

 There are many superb property managers (PMs) on Oahu.  Any negative comments made in this article are not directed at PMs as a group.  That being said, many of our clients had previously used another PM before hiring us.  The article discusses common errors made by owners and/or their PMs.  The article is designed to help owners increase their rental income by learning from the mistakes of others.

 Absentee Owner Managing Property:  By far the biggest mistake that we witness on a regular basis is an owner trying to manage a rental property while living thousands of miles away.  The owner does not typically have a good understanding of the Landlord-Tenant Code (Hawaii’s laws governing residential real estate), must rely solely on the tenant to maintain the property, and does not have the time and resources to address problem tenants.  The attorney that we use for evictions states that most of the difficult and expensive legal problems that he is hired to help solve involve owners acting as a PM that are not familiar with the Landlord-Tenant Code and proper check-in/check-out procedures.  Tim Kelley and Tracey Stott Kelley do not even attempt to manage their mainland rental properties despite their years of experience.  They have two PMs managing their investment real estate portfolio.

 Additionally, The State of Hawaii requires an absentee owner to obtain an on-island representative to manage the property.  We have witnessed a number of knowledgeable tenants create expensive headaches for owners that have tried to manage a property themselves.

 Poor or Inadequate Tenant Screening:  The best way to deal with problem tenants is refusing to allow problem tenants to move into a property.  Stott 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 that 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 PM 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 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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