Honolulu’s CO 19-18 (Bill 89) – Economic Impact And The Path Forward – North Shore, Waikiki Banyan & Waikiki Sunset

— Last week, a reporter from KITV Channel 4 News called to get some information for a story she was working on about homeowners that are economically impacted because they could no longer do short-term renting. She found the article Bill 89 – New Short-Term Rental Rules For Oahu and was not sure what my position was regarding the new law. She thought we might have some clients that were blindsided and are now stressed as a result.

She admitted she barely skimmed the article and did not actually read it, claiming “nobody has time to read long articles anymore.”  –  We hope that at least you still find our articles helpful. We will continue to write useful stuff.

I explained to the reporter what I expressed in the article:  “I’m neither for or against the law. However, I recommend following the law. We don’t have clients that are surprised about short-term rental restrictions. The rules had been the same for decades. The only immediate change is the imminent threat of enforcement. Hawaii Living has been educating property owners on real estate matters since day one. Anybody that claims they didn’t know simply didn’t ask the right questions. The information is readily available on our site.”

I sensed that the reporter was looking for a more dramatic story portraying immediate economic suffering by unsuspecting property owners. I was unable to assist and politely suggested she might need to ask someone else.  

The Tyranny Of Small Decisions

Changes can create unintended consequences. And a series of small rational decisions can sometimes lead to monumental and unpredictable negative results. It’s called the tyranny of small decisions.

That’s the same principle behind slow environmental pollution that becomes harder to reverse. It’s also the principle when governments try to fine-tune tax laws around the edges and end up with an unbelievably bloated and complex tax code.

It’s what can cause people to slowly gain weight, one innocent little sugary snack at a time. And why people can get into financial trouble with credit card impulse shopping that slowly mushrooms out of control.

The same principal created the proliferation of thousands of illegal short-term rentals. Hosting platforms like Airbnb and VRBO tweaked their service offerings, improving user experience, lowering the trust threshold, reaching critical mass, and transforming entire residential neighborhoods. Easy. Convenient. Practical. And lucrative. What could go wrong?

Regardless of what triggered short-term rental regulation, the threat of imminent enforcement indeed has economic consequences.

Economic Ripples From CO 19-18 (Bill 89)

It is impossible to accurately predict the long-term economic impact. There are too many unknown variables. It’s been 3 months and counting since CO 19-18 (Bill 89) was signed into law on 6/25/2019. Today we analyze what transpired so far.

Homeowners who had gotten spoiled with collecting short-term rental income are now exercising any of the following options:

1. Continuing as before and taking a chance until receiving a citation. Once a citation is received, the owner stops or modifies their advertising but continues with servicing the existing future bookings. As of the date of this writing, we are not aware that anybody paid a fine yet.
2. Some owners are selling their investment properties, and some are aggressively buying legal short-term rentals. Our Condotel Guide shows the entire list of legal condotels. Attractively priced Honolulu homes and condos are being bought by savvy buyers with a long-term vision.
3. Some are opting to use their property for personal enjoyment.
4. Some switch to long-term renting with 30+ day rental terms per tenant.
5. Some have found creative ways to continue circumventing the law. E.g., some batch multiple short-term bookings into extended 30+ day rental slots. Not legal, just harder to catch.

People are wondering if Oahu property values will drop. We are not privy to the future, but an investor stampede exiting Hawaii real estate is unlikely. In five years from now looking back, the effects of the law on Oahu’s property values in the aggregate might barely show as a blip on the chart.

However, here are the notable exceptions:

• North Shore

Reportedly 25% of all North Shore homes have been involved in illegal short-term renting prior to the new law. Sales inventory has increased recently. We expect that North Shore home prices will soften and create excellent buying opportunities for the foreseeable future.

Most other residential neighborhoods show a minimal effect as a direct result of the law so far.

The ‘Hawaii Vacation Rental Owners Association’ filed a lawsuit with the U.S. District Court on August 3, 2019. Their attorney Greg Kugle calls the ordinance “fatally flawed” and claims “its impact will be immediate and devastating on the owners and operators of legal rental properties on Oahu.” And, “the regulations violate the search and seizure, due process, property, privacy and free speech clauses of the United States and Hawaii Constitutions.”  The lawsuit seeks a TRO to prevent the DPP from enforcing the new law. We will report any updates here.

• Waikiki

The vast majority of legal condotels are in Waikiki. Some of these are selling faster with noticeable price increases. Waikiki NUC units have all been gobbled up including the most recent NUC unit sale at a whopping $750K at the Waikiki Banyan.

For the first time in decades, NUC units are now being valued at a premium for their scarcity. And non-NUC units are being discounted. Some of the more dramatic price differentials are developing at the Waikiki Banyan and Waikiki Sunset. Here is why:

• Waikiki Banyan & Waikiki Sunset

Our Guide to Condotels organizes all legal short-term rental condo buildings into five categories. The fourth category shows:

D)  Parcels zoned ‘Apartment’ – with hotel operation. But not grandfathered as a non-conforming hotel.  = The individual unit must have a NUC, otherwise no short-term renting.

This category includes only two buildings, the Waikiki Banyan, and the Waikiki Sunset.

Both buildings have been operating as a hotel outside of the ‘Resort Mixed Use’ zone with an ongoing 24-hour front desk easily meeting today’s LUO’s hotel definition for decades. But they did not meet the old definition at the time Waikiki was rezoned. Hence, they had not been grandfathered as a ‘non-conforming hotel’ and have not been exempt from the NUC requirement in 1989.

Up until the law took effect on August 1^st, 2019, Aqua-Aston managed a large number of the 876 Waikiki Banyan units and the 435 Waikiki Sunset units. Only 197 Waikiki Banyan units and 256 Waikiki Sunset units have NUCs. All others are not permitted as TVUs.

On 7.23.2019, Aqua-Aston mailed letters to about 100 Waikiki Sunset owners and more than 100 Waikiki Banyan owners of condos without NUCs alerting them that as of 8.1.2019, Aqua-Aston will cease renting their units to comply with the new law.

With one week notice to owners, the Aqua-Aston Waikiki Banyan hotel room inventory dropped by ~50% and the Aqua-Aston Waikiki Sunset hotel room inventory dropped by ~30%.

Reportedly, Aqua-Aston and a few other property management companies within the Waikiki Banyan are renegotiating their commercial rent with the AOAO because of decreased revenue and profitability. It is expected that the loss in revenue to the AOAO will translate into a future increase in maintenance fees. 

Recently before the law took effect, a typical Waikiki Banyan unit with a partial ocean view sold around $600K, regardless if the unit had a NUC or not. The perceived value spread between NUC units vs. non-NUC units had been negligible. But Waikiki Banyan units are mostly bought by investors and are often valued based on their income potential. We have seen Waikiki Banyan income statements with short-term rental income between $4,000 and $4,700/mo vs. long-term rental income between $2,000 and $2,300/mo.

With the imminent enforcement, non-NUC units could drop in value from $600K to the lower mid $400K range, comparable with other Waikiki 1-bedroom units with partial ocean view where short-term renting is not allowed, e.g. Four Paddle, Villa On Eaton Square, Chateau Waikiki, etc.

Waikiki Banyan inventory for sale has quadrupled since the law took effect. It might take six months for people to realize their unit is not worth the ~$600K they thought it was.

However, there are a couple of reasons why this price adjustment might take longer or why it might only partially unfold.

1. Loss aversion. The human brain is far more averse to losing versus winning. You get more displeasure from losing $100K then pleasure from gaining $100K. Some owners will rather take a chance and wait. They will hold on until prices recover to break even instead of selling at a loss.
2. Hysteresis. The value adjustment lags behind the changes that cause it. We have seen this gradual price adjustment with Trump Tower condos that had been notoriously cash-flow negative year over year. A typical city view Trump studio dropped in value from the $700K range to eventually bottoming around $350K. But it took many years to get to those levels. Sellers dropped their unit price only marginally below the most recent low sale to spark buyer interest and eventually become the next lower sale.
3. Emotional purchase. Some buyers might not care about the actual cash flow differential and just like the Waikiki Banyan for its layout, location, amenities, and views. For an emotional buyer, there are plenty Waikiki Banyan bargain priced units currently available to choose from.
4. Optimistic probability bias. The AOAO filed a lawsuit with high hopes for a windfall ruling as early as the upcoming November court date. Stay tuned.

Waikiki Banyan Lawsuit

The Waikiki Banyan AOAO filed a lawsuit on August 6.2019 against the acting director of the DPP. A court date is expected in November 2019. The attorney Chris Porter makes three basic arguments in seeking the Waikiki Banyan to be exempt from CO 19-18 (Bill 89): 

1. Economic hardship.
2. Lack of past enforcement by the DPP.
3. The Waikiki Banyan is within 3,500 ft proximity of the ‘Resort Mixed Use’ district. This is a reference to CO 19-18 (Bill 89), Sec 21-5 (a).

We are not attorneys. We are expert realtors committed to excellence in assisting buyers and sellers with their real estate needs. We agree with Chris Porter’s team and the AOAO that both the Waikiki Banyan and Waikiki Sunset are different and do deserve special consideration. But the arguments in the complaint seem weak and could have been made by half a dozen other Waikiki buildings as well.

Chris Porter’s team has a monetary incentive to pursue this. Their is still time to sharpen their tools and refine the arguments before the November court date. Instead, Kathy Sokugawa as the DPP’s acting director has no financial incentive. She will defend the existing laws she didn’t create but has been tasked to enforce.

Filing a complaint against the acting director that is enforcing the law because of ‘economic hardship’ and ‘lack of past enforcement’ is comparable to suing a traffic cop that is issuing you a speeding ticket. “I have been speeding for years without ever receiving a ticket. Operating within the speed limit will now cost me productive time and economic hardship.”

The 3^rd argument, ‘within 3,500 ft proximity of the Resort Mixed Use district’ simply does not apply to Waikiki. There is no A-1 and A-2 district in Waikiki.

We are in full agreement that the economic impact at the Waikiki Banyan and the Waikiki Sunset are substantial. But are the three arguments presented in the complaint the right approach to convince a judge to grant an exemption status? Expecting this to get resolved at the November court date appears to be wishful thinking at best.

Here is a copy of the Waikiki Banyan complaint. What do you think?

The Path Forward

Times have changed during the last 30 years. Social and economic needs will continue to evolve. CO 19-18 (Bill 89) creates a new path effective October 2020, but only for new B&Bs. For now, that’s all there is and it’s the best that City Council came up with. But CO 19-18 needs to be reevaluated and possibly modified as future needs change.  

For immediate consideration we suggest the following:

The Waikiki Banyan and Waikiki Sunset are different and deserve special consideration. Both buildings have been matching precisely the current LUO’s hotel definition for decades.

No other buildings can make that claim, unless they are already exempt, period.

The Waikiki Banyan and Waikiki Sunset should both be granted ‘grandfathered hotel use status’ and exempt from the NUC requirement today.

There is a reason why the LUO’s hotel definition has been updated since 1989 eliminating the outdated 50% lodging unit requirement. The old definition became irrelevant. No longer should it be used today for a building to be exempt from the NUC requirement. It’s an oversight. That’s all.

The Waikiki Banyan and Waikiki Sunset deserve to join the ranks of other grandfathered non-conforming hotels, e.g. Aloha Surf, Hawaiian Monarch, Island Colony, Palms At Waikiki, Royal Garden At Waikiki, and the Ala Moana Hotel Condo.

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But wait. What about the tyranny of small decisions? A favorable ruling for the Waikiki Banyan and Waikiki Sunset could create two possible unintended consequences:

• 1) Perverse incentive. –  Other residential buildings could easily install a 24-h front desk out of economic self-interest and argue for deserving exempt status too. Wouldn’t that negate the intent of CO 19-18 (Bill 89)?  Follow some recent developments at the Waikiki Lanais here.

That’s why we suggest that the ‘grandfathered hotel use status’ and exemption from the NUC requirement should only be granted to buildings that have met the current LUO hotel definition prior to August 1^st, 2019, the effective date of CO 19-18. This will eliminate perverse incentives and is consistent with the spirit of CO 19-18.

• 2) The Free Rider Problem. – Owners of NUC units at the Waikiki Banyan and Waikiki Sunset have been faithfully renewing their NUCs at a cost of $400 every two years since 1989. From their viewpoint, it seems unfair that owners of non-NUC units have been ‘free riders’ and getting away with penalty-free short-term renting, plus they would now gain a free pass and the reward to become legal.

I regret, we don’t know if there is a perfect solution that is fair in every way. However, consider that all Waikiki Banyan and Waikiki Sunset owners will benefit, including the NUC unit owners. There won’t be a need for a $400 NUC renewal fee. It will restore lost hotel room inventory levels and reverse economic hardship.

We don’t pretend to know all the answers.  But the proposed represents a simple and most practical win-win solution.

Obviously, this won’t help North Shore homeowners, Kuilima Estates’ owners, or the owners at the Waikiki Lanais that allegedly hired an attorney for $40K to figure out why they have never met the LUOs hotel definition and how to change that.

The Waikiki Banyan and the Waikiki Sunset should correctly be categorized as non-conforming hotels, because they simply are. Kuilima Estates and Waikiki Lanais don’t appear close to make the cut. – But who are we to say? Tell us what you think!

We leave it up to the attorneys and the judge to figure it out. In the meantime, we are committed to excellence in assisting buyers and sellers. Let us know how we may assist you best. We are here to help. ~ Mahalo & Aloha

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The information is deemed reliable, but not guaranteed, and should not be relied on in deciding to purchase or sell. Always verify any and all information before making a decision to purchase or sell. Rules, regulations, tax rates, tax laws, zoning laws, condo governing documents, etc. are subject to change.

Let us know what we might have missed. We are grateful and will humbly update. With your kind consideration, the information will remain current and help others too! We are here to help. ~ Mahalo for your input and comments.

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