Mark Bratton

Last week I was at a presentation by Bank of Hawaii, and they got me thinking. The military and Federal Government combined in our state is holding up the entire economy on the Island of Oahu. Military construction has not receded, it continues. They are in the process of building housing on Oahu, 10,000 homes by Actus and an additional 4,500 homes over the next few years as replacements for military personnel. There are 102,000 people with the military, mostly based on the Island of Oahu. The military has 18,000 direct jobs that we know of and spending approximately $1 billion/year.

In addition to this, the Department of Defense spends $6.1 billion per year. There is quite a bit of high-tech investment and spending at the Barking Sands project. The Pearl Harbor Naval Shipyards account for a massive amount of spending on Oahu. The Navy has increased the number of jets that it houses and continues to upgrade its fleet here in Hawaii.

Today I noticed eight additional submarines are being repositioned to bases here in Hawaii over the current 24-month period. Military spending is 23% of our overall economy, while tourism, which we all think of as the leader, is just a little bit higher at 30%.

In addition to military spending, Hawaii has one of the highest spending per capita ratios of any state. This is courtesy of our senior senators, the committees, and the chair in congress. In 2007, the federal government spent a total of $14 billion in Hawaii. The State of Hawaii is getting the equivalent of $235 per person in federal earmarks as a result of Congress’ recent special hearings. These projects benefit primarily large government spending projects on Oahu. They include transportation, the University of Hawaii, and the telescopes atop Mauna Kea.

All of this spending is adding up and is the reason Oahu is weathering this economic storm better than most. This is why spending and economic activity on Oahu has stayed relatively similar to that of the previous years, while spending in the visitor economy overall is down in the range of 15%-20%.

Last week, I attended the International Council of Shopping Centers (“ICSC”) Show in Las Vegas. As I expected, the general mood was down. Attendance has been cut in half over the past two years’ conventions. It has become clearer and clearer that cash is king in the shopping center investment world today. The dark clouds hanging over the industry are the billions of dollars of mortgages that will need to be refinanced over the next four years. Most investors at the conference believe that if they can stay in business, it will provide the opportunities of a lifetime.

In the middle of the conference, the government announced that it would start buying these commercial-backed mortgage securities that were issued over the past five years from the TALF funds, starting in late July. Many investors think this will provide some liquidity and deal flow to the marketplace.

The majority of investors I spoke with believe we are skidding across the bottom of this cycle. Shopping Center sales are definitely still getting done across the country, typically with motivated, debt-burdened sellers and at rates of return between 8.5% to 10% for the properties that need to trade at this moment.

I noticed this morning another lender-owned property coming to market here in Oahu. This makes the fourth lender-owned or foreclosure property that we have seen in the last 30 days.

I had previously thought that Hawaii might escape high levels of foreclosed properties, but is seems that the first wave of properties that were over leveraged are now coming back on the market.

We are in the process of developing a page on my website for commercial properties, until that is set up, here’s a link to information on a commercial foreclosure property in Kauai:

http://www.markbratton.com/PBN_Notice_of_Foreclosure_Sale.pdf

Also, the Kapolei Spectrum Business Park (II) on Oahu is going through a Lender REO sale. Offers are due on May 15th, you can contact me with any questions you have.

Hong Kong is an amazing place. It’s so clean, modern, busy and efficient. I am here this week visiting clients and potential customers with our Asia regional team. As we share information on common clients we service, it’s amazing to see how small this world is and how many Hong Kong based investors own commercial real estate in Hawaii.
The Hong Kong commercial real estate market has some similarities to our market. The global financial crisis has impacted their market, and investment sales are following the same downward trend as the Hawaii market. Cap rates are up and rents are expected to ease off in the coming months. That’s where the similarities end. Rates of return in the first year of ownership (Cap rates) have gone from 3.5% last year to 5.0% this year. Borrowing costs are hovering around 6%, so investors for these top quality properties are willing to accept negative leverage, which is different from our market. With the mighty China adjacent, they feel a strong future to come even if there is a slight blip on the immediate horizon. The discussions here this week have been centered on a GDP that has slowed to a 9% annual rate and the question is, will China loan its 1 trillion dollars in excess capital to the IMF or will they use it in another way to increase their worldwide economic position?

There are still projects under development and construction here. It seems that they build skyscrapers here faster than anywhere, even Las Vegas! In front of our hotel is a construction site that, six months ago, was a part of the harbor. Next to the JW Marriott, there is a new luxury hotel just coming out of the ground that will be open next summer. We have been riding the ultra clean rail system all over the city and even out of town to Disneyland.

Retail projects are most successful in the busiest rail stations. With 75 story modern glass and steel towers feeding customers into these stations, the retail is magnificent. All the major brands are here. The most noticeable store type is much smaller than in the states. What these stores might lack in depth of merchandise they make up for in service. If the smaller store does not have your item they call out for it and promise to have it delivered to you by that night.
It’s great to travel and see the world. It reminds me of something a good friend of mine always says, “Some people have more money and more vision than us”. Seeing the growth, prosperity and continued development (even now) of massive architectural icons being built on what was ocean six months ago is motivating.

All commercial real estate markets are based on supply and demand. Hawaii’s market has typically been limited in supply, and demand has outstripped the existing supply. General interest and demand for Hawaii commercial properties comes from people’s fascination with Hawaii and spending time in, and surrounded by, its natural beauty. In trying to protect that natural beauty, difficulties in rezoning are wide spread across Oahu, Maui, The Big Island and Kauai. A very small portion of our states land is zoned for urban and commercial or industrial purposes. Typically, a developer will need to spend seven years to take a property through rezoning and allow that property to be added to the supply side of our commercial real estate marketplace.

Being in the middle of the Pacific and a part of the United States provides many advantages to investors. Our clients are comforted and sure of laws and financial markets of the United States and have access to capital and resources from Asia. In many real estate cycles, parts of Asia remain strong while the United States goes through a down period. Asian investors can remain bullish for many reasons, the most prevalent being that their economy at home is strong. The second reason is a positive currency swing for the investor. This situation can play itself out in many countries, always allowing one to be strong and driving investment into Hawaii.

Hawaii’s economy is now more diversified than ever. Several years ago the people, the government and the business leaders of Hawaii, determined that it was necessary and desirable to create some diversity in the State’s economy. After tourism and military spending, real estate has become a major portion of Hawaii’s economy. From land subdivision to high-rise condominium development, it has been big business. High Tech companies, including movie productions, have created a small blip on the screen for the economy. One positive side effect we have observed is the influx of new residents and people who want to spend more time in the state. Many of these investors include families who are starting to plan for retirement by purchasing a piece of investment real estate for the future. Another type of real estate investor we are seeing is the young financer from Asia who spends several months a year in Hawaii and has purchased a high-end resort luxury property. These types of investors are starting to get involved in the community, give back to local charities and don’t use many city or county resources. They of course pay real estate taxes and are fantastic consumers when in Hawaii.

There are many reasons to invest in Hawaii and many different sizes of investments. From individual weeks of a time share, to major institutional commercial real estate projects you can join in.

Western Real Estate Business provides a look into the varying landscapes of western offi ce, industrial, retail and multifamily markets.

Hawaiian Hospitality
The record air passenger arrivals and the increasing popularity of timeshare and resort residential developments have boosted recent interest in building new resorts in Hawaii. New, exciting concepts from family-oriented to ultra-luxury resorts are entering this market with plans on widening the breadth of service offerings for the island’s visitors.

Topping this list is the recent announcement of Disney Resorts selecting Ko Olina on the island of Oahu for its first stand-alone hotel development not associated with a theme park. Its plans are to build an 800-unit hotel that encompasses the Disney Vacation Club timeshare concept that has more than 350,000 members. Disney paid $144 million to acquire the property, which is situated on 21 acres of oceanfront land.

This is a unique concept for Disney and a great opportunity for Hawaii to benefit from Disney’s marketing and brand name.

On the other side of the hotel development spectrum are the plans by Starwood Capital Group to build an upscale Baccarat Resort. Capitalizing on the Baccarat crystal and jewelry luxury brand, the planned resort will demolish the former Wailea Rennaissance Hotel on Maui and replace it with 193 one- to four-bedroom residences. All units will have ocean views and include access to personalized concierge services. Architectural design and interiors are being directed by HKS Hill Glazier Studio and by world-renown interior designer Yabu Pushelburg. The planned opening of the Wailea Baccarat is 2010.

Similarly, an affiliate of Montage Hotels and Resorts purchased 122 acres on the North Shore of the island of Kauai. Overlooking picturesque Hanalei Bay, Montage has no immediate plans, but intends on eventually building an ultra-luxury resort.

Timeshare Development
Most hotel and resort developments are focused on the luxury marketplace as rising construction costs and land prices dictate the need for higher hotel room rates. In fact, most resort developments have had to incorporate a timeshare/fractional ownership component as well as a resort residential component to subsidize the development of a hotel.

Timeshare sales continue to be healthy with projects in Waikiki, Ko Olina, Wailea, Kaanapali, Kapalua, Waikoloa and Poipu on the drawing boards. Developers are capitalizing on the Hawaii brand and its unique appeal. In fact, many timeshare operators realize the importance of a Hawaii location as a way to bolster their appeal to timeshare investors, many of whom are willing to pay a premium for a vacation resort in Hawaii.

Hotel Transactions Record Volume
Hotel revenue and operating success bred increased interest from institutional investors seeking prized resort properties for investment. Sales transaction volume for commercial real estate increased fivefold from $850 million to a 2005 record of $4.3 billion. For 2007, hotel properties constituted the majority of the total transaction volume by contributing nearly $1.4 billion in activity. Topping the list were two major properties — the Hyatt Regency Waikiki sold for $475 million and the Makena Resort on Maui sold for $575 million. On the market and projected to close in the near term are two Resort Quest Hotels and the Fairmont Orchid on the Big Island of Hawaii.

Hawaii Hotel Market Analytics
For year-to-date October 2007, the Hospitality Advisors LLC industry report noted that Hawaii’s hospitality industry continued to post solid RevPAR and ADR gains. Average hotel room rates rose from $186.17 to $198.82 as RevPAR grew from a statewide average of $150.24 to $151.33 in the past year. Overall, Hawaii’s hotels ranked second in RevPar growth only to New York City. Percentage increases in the past year in average daily room rates for mid-priced hotels surpassed luxury and upscale hotel brands by posting an 11 percent increase, compared to 5.5 percent and 7.7 percent, respectively.

Despite these financial gains, hotel occupancy rates fell from the prior year. As of October 2007, the year-to-date occupancy rate for Hawaii’s hotels decline from 80.7 percent to 76.1 percent. This decline coincides with increased economic concerns over the drop in residential home appreciation rates, rising fuel costs and decreased personal income being encountered in the United States.

After growing to 7.5 million air passenger arrivals for 2005, capacity constraints limited our growth in 2006 and 2007. Both Hawaii’s hotel inventory and airline seats reached a level near capacity. After 4 solid years of robust growth in air passenger arrival counts and visitor spending, Hawaii’s hospitality industry posted only marginal growth in the past year.

Forecast 2008
Investors continue to remain enamored with Hawaii’s hotels and resorts. Shortage of prime vacation resort properties worldwide attracted institutional investors throughout the world to Hawaii’s shores. Japanese, Korean, Chinese and Australian as well as North, Central and South American firms are scouring the islands for attractive resort investment opportunities. The recent purchases of resort land bode well for increasing Hawaii’s hotel inventory and allow for continued growth in air passenger arrivals and visitor spending.

Despite Hawaii’s isolated location, it is not immune to the subprime woes and credit crunch that stirred concerns of a possible U.S. recession. Many transactions are likely to be re-traded or be faced with increased scrutiny of financial statements and projections by lenders. Investment sales transaction volume will slow through 2008 as investors reappraise their asset allocations into real estate. Those institutional investors willing to capitalize on this lull in activity by conducting thorough due diligence will find that Hawaii hotels and resorts remain a lucrative investment opportunity.

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