There has been a lot of news about the Fed’s concern about Inflation in recent months and years, esp with the rapid rise in fuel costs.  Fuel costs effect the price of almost everything.   I read Travel Price Inflation Outpaces CPI and I automatically think this may hurt Hawaii more than other places since we rely heavily on tourist from an economic standpoint.  It also costs much more to come and visit Hawaii due to the higher cost by plane and the higher costs of goods.  I also read Deflation at the Wholesale Level, which describes it’s effect on tourism and is a lagging indicator of things to come. 

Reports released Tuesday painted a picture of an economy that is emerging from last winter’s severe slowdown despite the continued weakness in housing. And in what will be welcome news at the Federal Reserve, the recent acceleration in inflation caused by a surge in energy and food costs appears to be abating. 

Several Business highlights I read could possibly show the US economy has hit the end of it’s bad patch and may progress forward to a more level outcome.  If the Hawaii economy is anything like the Hawaii real estate market, then the effects from the recent bad news could effect Hawaii 6 months to a year later.  The tough economic news that hit the nation several months ago, may not be felt here in Hawaii for a few more months or a year. We don’t seem to be having nearly as rough of a time as other areas of the country. Not yet?

Seems to be more and more bad news in the US housing market and in the lending arena.  The National Association of Home Builders Index fell to the lowest reading since 1991.  The NAHB Index tracks builder’s perceptions of current market conditions and expectations for home sales over the next six months. 

It is amazing that Hawaii has done so well compared to the rest of the country, and the wonder has to be, with the mounting bad housing news around the rest of the country, when will it effect Hawaii’s real estate market, or will it?  There are a lot of reasons Hawaii has done well, but the market in Hawaii does have a large number of out-of-state buyers, so if other markets suffer declining prices then the buyer pool in Hawaii should be effected, thus effecting home demand and home prices.  Hawaii’s home prices just hit record highs for both SFH’s and condos, so you would think the bad news in other markets would eventually effect the Hawaii market.  Any thoughts?

Mortgage interest rates improved as an across the board sell-off in stocks helped improve bond rates.  This helped home loan rates improve from levels hit earlier in the week, and end up about .125% better for the week overall.

Keep up with Hawaii’s mortgage rates with Keri Shepherd’s Mortgage Market Update.

This is a little late, but my hard drive crashed and I had no clue what to do with myself without my computer, email and the Internet.  I never realized how attached to technology I was until that happened.  How did I survive as a kid without all this? Anyway.. Read Keri Shepherd’s mortgage market updatefor the latest on mortgage interest rates.

I received information from Old Republic’s 1031 Exchange Department  and felt it was beneficial to pass on.  I recommend getting a tax attorney who handles 1031 exchanges to help handle your exchange.  Someone needs to oversee the entire process from A to Z.  There are way too many small details that can cause you serious financial stress should your exchange be deemed invalid.  If you have already purchased your replacement property and have completed your 1031 exchange, it may take two years or more for the exchange to be deemed invalid.  That means, penalties and interest for the time frame from the completion of the exchange up to the time it was deemed invalid.  When the IRS knocks on your door and wants payment, that property you now have is not as liquid of an assest as you would like, and the penalties will kill you. Below is Old Republics info (please cunsult your tax attorney or accountant for advice on exchanges.  Info is deemed reliable but not guaranteed):

“Identification” refers to the IRS requirement that taxpayers must identify in writing property they intend to acquire as replacement property in a 1031 tax-deferred exchange. 
What is a proper identification? The Treasury Regulations state that replacement property is “identified” only if it is designated in a writing, signed by the taxpayer and sent before the end of the 45-day identification period to either the seller of the replacement property or another person involved in the exchange who is not disqualified¹-e.g. seller’s broker, escrow officer, or qualified intermediary (“QI”). 
When must the identification notice be given?  The identification notice must be sent to one of the parties noted above on or before midnight of the 45th day of the exchange period. 
Who must sign the identification notice?  The identification notice must be signed by the taxpayer. For example, if the taxpayer is a corporation or partnership, a person authorized under the corporate bylaws or partnership agreement must sign the identification notice.  The Treasury Regulations do not permit an agent – for example, the taxpayer’s real estate agent  – to sign the identification notice. 
What constitutes a “writing”?  Any kind of writing – a form, a letter, etc.  The contract for the replacement property will satisfy the requirement of a writing, so long as the contract is signed by both the taxpayer and the seller within the 45 day identification period. 
Can the identification notice be revoked?  Yes, if it is in writing and in the same manner as originally made and it is sent on or before midnight of the 45th day of the exchange period.  For example, if the identification notice was a writing given to the QI it must be revoked in a writing given to the QI by the 45th day of the exchange.  Likewise, if the identification was made in a written contract, the contract must be amended by the 45th day of the exchange to provide for the revocation.
If multiple identification notices are made by the taxpayer without any revocation, those notices will be treated as supplements to the first identification.
How should the identification notice describe the replacement property?  Unambiguously.  A legal description, street address, or distinguishable name (e.g. Mayfair Apartment Building) along with the city and state will satisfy this requirement.
How many properties can an exchanger identify?  Three properties of any value or any number of properties as long as the combined value does not exceed 200% of the value of the relinquished property.  If the exchanger identifies more properties than allowed, they will be treated as if they identified nothing and the exchange will fail, unless they actually complete the acquisition of 95% of the value of all identified properties.
Since failure to properly identify replacement property is fatal to an exchange, this area is subject to fraud.  For example, in Dobrich v. Commissoner (9th Cir 1999) 188 F3d 512, the taxpayer, Mr. Dobrich, backdated his identification notice. The IRS imposed a fraud penalty equal to 75 percent of the underpayment of tax that was due. Mr. Dobrich paid over $1,000,000 in back taxes, plus a $774,307 fraud penalty.

I just read:

China’s sizzling economy grew even faster in 2006 than previously reported, bringing it closer to overtaking Germany as the world’s third-biggest, and its export-fueled foreign reserves have risen to a new high of $1.33 trillion, according to official figures released yesterday. The National Bureau of Statistics raised its estimate of China’s 2006 growth rate from 10.7 percent to 11.1 percent. the central bank’s research bureau said last month the economy was expected to expand by 10.8 percent this year. That was in line with projections by the World Bank and other economists, and would be China’s fifth straight year of growth in excess of 10 percent.

Wow!  Compare that to the US economic growth of 2.5-3% growth, and this will be China’s 5th straight year of 10% or more economic growth. 

The article does bring up a key point about runaway spending:

Chinese leaders want to maintain fast growth to reduce poverty but are trying to slow investment in auto manufacturing, real estate and other areas where supply outstrips demand. They worry that runaway spending could ignite inflation or leave banks and borrowers with dangerously high debt levels.

Remind you a little of the US stock market and Internet stocks?

So the headline in the Honolulu Star Bulletin is, “Isle Business Optimism Lowest In 8 Years. Oh no!  What does that mean? It must be time to jump ship.

Fewer than a quarter of Hawaii companies are optimistic that the economy will improve this year, although only 18 percent expect it to get worse.

Ok?  Lets get this straight. The stock market went nuts in the late 90’s, which people and businesses did far beyond well and made money, and lots of it.  If you have read “The Next Great Bubble Boom” Harry S Dent compares the Internet and the rapid growth of technology, creating a more global marketplace (The flattening of the World, as Thomas Friedman would call it) to the roaring twenties, which, with the creation of electricity brought about the assembly line and revolutionized how we did business. 

That’s a pretty bold comparison, but one that essentially says we have had one hell of a changing marketplace that has resulted in economic growth like we have almost never seen before, except for almost a century ago. 

8 years of extremely strong growth and, as everybody knows we are leveling off, and the response is,

The latest Business Banking Council survey of more than 400 local companies showed that more than half expect no change in the economy, while 18 percent feel it will get worse this year.

Well, no kidding.  It is no surprise that we are leveling off after some unbelievable growth.  It isn’t realistic to expect this same impressive growth to be sustainable over the long haul, but the headline doesn’t accurately paint the right picture. 

Over 50% of Isle Businesses Expect No Change In the Economy.

Doesn’t sound as catchy does it?

Now the key item to look at here is what I have mentioned before.  Inflation.  Increased business costs that essentially cause no economic growth.  Inflation is a little higher than expected this year, so lets keep an eye on it and see how it plays out.

Despite the drop in optimism, local economists expect Hawai’i’s economy will continue to expand over the next few years, though at a slower pace than recent years because of softening job and income growth, the home-building slowdown and near-flat visitor arrivals. The state Department of Business, Economic Development and Tourism projects that the local economy next year will grow 2.5 percent adjusted for inflation.

I read this:

Hours after Standard & Poor’s warned it may cut the credit rating of more than $12 billion in bonds backed by risky home loans, another agency downgraded its rating on hundreds of similar securities. Lower ratings for mortgage-backed bonds could cause a domino effect that might ultimately strangle what was a major propellent of home prices: easy access to money. Subprime borrowers collectively have missed a lot more payments on loans amid higher interest rates and a slowdown in the economy. The subprime mortgage industry has deteriorated more than expected, S&P said. Subprime lenders adopted more lenient lending standards during the housing run-up, S&P said, and many home buyers painted a false picture of their credit. The subprime mortgage market began collapsing in February. Dozens of subprime lenders have since gone bankrupt.

All of the subprime fallout that has occurred lately has made it much more difficult for borrowers to qualify for home loans. The US government is looking into the loan industry as a whole. In doing so, to correct itself and make sure these foreclosure trends don’t continue, the lending industry is tightening it’s lending guidelines for getting a loan. What this means is, borrowers that could qualify for a 100% financing, stated income loan, with 620 FICO scores a year ago, now don’t have that loan option. In fact, that loan option doesn’t exist. A stated income loan with 620 FICO scores is requiring a 15% downpayment. The requirements for qualifying for a loan are getting harder and the guidelines are changing every day. This tightening of loan guidelines causes there to be less buyers that qualify for loans, thus shrinking the buyer pool or demand for housing. This has been going on for a while already, so we have already seen a reduction in the number of buyers that qualify for loans. We will see if guidelines continue to tighten even more.

This is a day late in getting out, but after 18 hours of work yesterday, I was in no mood to write last night.  Boy, this is when I wish I had video of the meeting to be able to plug in for your enjoyment.

Overall,  from a residential real estate market standpoint, we shouldn’t expect more price appreciation.  We should conitinue to move sideways for a while.  The good news is that both Harvey Shapiro and Paul Brewbaker feel that “it appears” we hit our bottom for the residential real estate market at the end of last year.  it is too early to say definitively though.

There has been a clear reduction in demand since the 3rd quarter of 2005, which was our peak, but we may be stabilizing. We had been in a period of contraction in demand.

We saw a pretty nice drop off in the number of sales toward the end of last year and now the volume of sales have picked up to a consistent level for the first 6 months of this year. 

We hit the speed bump, came down, and now have gotten back to level ground.  In late 2006 we hit a soft patch and now have come back up. 

It was interesting to see that in the mid 1990’s, the bottom of the Japanese market bust, we sold 4,000 units annually, then we ran up to 13,000 units annually (2005).  Now we are below 10,000 units and Harvey Shapiro’s best estimate would be to stabilize at 8,000 units a year.

In the early 1990’s Honolulu became more expensive on a median home price level than San Francisco, and Orange County (typically the most expensive areas in CA).  What we saw in the mid to late 90’s was the inverse, where Honolulu became a good buy.  In fact, in the mid 90’s the percentage of a local family’s income that went towards the mortgage payment of a single family home was 30%.  In 1990, it was 60%.  We sit at 52% currently. When we compare our housing cost with CA now, we are still below Orange County and San Francisco/Silicon Valley.  When this happens, there won’t really be much downward price pressure. The other factors are that our new construction (supply) during the run up in prices, never outpaced demand so we haven’t seen large price drops. The supply on Oahu is still relatively low compared to demand and other areas of the country.

Economically, according to Paul Brewbaker, we are converging to a modest growth path.  the forecast for Hawaii economic growth is more flat right now due to high inflation as of late.  The risk is that our growth, should inflation rates stay high, would be at zero.  As long as we don’t sustain zero growth over several years we should be good. Operating expenses are increasing, much of it due to oil prices, and could put a drag on the economy.  Something, definitely to keep an eye on, but the thoughts are that as the economy cools from it’s torrid pace, so should inflation.  With growth at zero, though, we must keep an eye on Interest Rates. If they go up significantly and we don’t have any growth in our after inflation adjusted income, then this could cause downward pressure on home prices. (part of the mid 90’s effect)

The residential side of real estate construction (jobs) slowed already.  We are still seeing strong signs of construction in the industrial/commercial sectors, but this should level off and be a slow roll slightly sideways or a little slower (late 2008 or 2009). At this point construction costs should come down some.

The tourism market has peaked and is sideways (flat), and could drop of slightly.  Room rates are increasing and occupancy is still very good, but should subside some. When the total visitor expenditure amount is adjusted for inflation, we are actually down, and the funny thing is that 1988 was the peak.

The general thoughts on the US economy are that everything is on track.  We are on a slow steady cruise control.  What will be important will be the global economy activity and adjusting to it’s effects that it has on the US and Hawaii economy.

***The Hawaii Developers Council website will be one to visit often, once they get it revamped. They will have the slide presentations from the speakers posted on it.

Last Week the Fed stated that the inflation numbers were improving modestly and when the inflation numbers came out, they were more in line with an “acceptable range” for the Fed.   Home loan rates improved on this news, but only briefly.   Follow rates and the economic news that effects them with Keri Shepherd’s Mortgage Market Newsletter. Sign up in the upper right of her newsletter.  It is FREE!