By Keith DeGreen, J.D., CFP — Hawaii Yacht Club, Honolulu

Welcome to Paradise

The first thing to remember about Hawaii’s paradise economy is that, by mainland standards, it is relatively small.

According to Jeff Tollefson, President of The Hawaii Chamber of Commerce, Hawaii’s top industry – tourism – pumps about $12B per year into the economy; and the military, a close second, generates about $9B.

Then there’s agriculture, health care, and education. Finally, are all the private businesses inherent to any reasonably large community. Many of these businesses are subcontractors to the military. But there is also the usual assortment of businesses serving the general population.

But to put all this in perspective, remember that the entire population here of 1.3 million people is only about a third as many people as live in Maricopa County, Arizona (Greater Phoenix).

They Ain’t Making Any More of It!

But the real money here is – and probably always will be – in real estate.

I’ve attached (below) a very interesting excerpt regarding land ownership in Hawaii (and other information) from an article prepared by the U.S. Government’s International Information Program. What strikes me from the excerpt is the paucity of Hawaiian land available for smaller investors, including “average” affluent investors – or for the permanent residents of the state for that matter.

As explained in the excerpt, an incredibly high percentage of the privately owned land on Hawaii is owned by just 39 non-native private owners who generally acquired the land, upon often questionable terms, as Hawaii’s old monarchy collapsed in the 1800s.

One beneficial consequence of this concentration of ownership has been the absence of massive development upon many large tracts of land. This has helped maintain the pristine beauty of the islands while clustering the population in cities such as Oahu, in the extreme – the dream of many “green” urban planners. Thus, in Hawaii at least, it can be argued that concentrated land ownership has helped protect the island’s top industry – tourism – and has protected the environment and thus the quality of life of those who live here. I personally do not believe that this argument is sufficient justification for this sort of intergenerational ownership. But the argument can certainly be made.

The sheer power of the U.S. economy, and the appeal of the Hawaiian islands to Asians, particularly the Japanese, has more than compensated for a poor land ownership structure here.

However, this pattern of land ownership concentration is also prevalent in several Pacific Island and Pacific Rim countries – with much less desirable results. The Philippines is a notable example. Not only is land ownership there concentrated in the hands of the few, but legal title to the remaining land is murky. The result: The Philippines has simply been unable to develop the land-based consuming middle class so necessary for a successful free-market economy; and nearly half of all Philippinos live on less than $2 per day.

How to Build a Middle Class #101

A state – or any government – can end the monopolization of land ownership through tax policy, and can protect against the helter-skelter degradation of the land by smaller owners, through enlightened – and objectively enforced – zoning policy.

As this old political science major remembers from “Land Planning 101,” here are the steps:

1. Democratically and openly establish an area master plan, with input from all layers of the community.

2. In countries where “clear title” to land is elusive, establish, through legislation, and enforce through an independent judiciary, clear land ownership rules, including the objective enforcement of adverse possession laws designed to protect families that have worked and lived on land, but not technically owned it, for generations (while protecting those with arguable legal title if they reasonably asserted their rights during the period of adverse possession).

3. Establish a fair and objective zoning code. There are trained zoning professionals and associations these days that have lifted this process to a high skill, of great beneficial to the entire communities;

4. Tax land based on its zoned purpose. Impose higher taxes on, say, industrial land that the community wants to see placed into productive use (Jobs, anyone?), and assess much lower taxes on land zoned, say, agricultural. Land designated as “preserved” or “protected” can be exempted from tax.

a. Tax policy can thus compel certain land to be used for its zoned purpose, and can protect other land from development. Land that is zoned for, say, industrial, commercial or residential development can actually be taxed at a higher rate when empty, and at a lower rate once developed. This encourages owners to get their act together, or to at least sell their land to people who will place it into productive use. But even if tax rates are decreased after the property is placed into productive use, the improvements to the property will likely cause tax revenues to increase.

Once the average person owns land, good things start happening in a hurry. An owner improves their land, they borrow against it, they use the money to start businesses, and – most important – they protect what they own (when was the last time you washed a rental car?). The moral here is simple: An enlightened land policy offering clear title, and the master-planned zoning and taxation of land, could help launch many economies into the free-enterprise 21st Century. Whether, at this point, such a policy is wise in Hawaii, is an open question, but I see a lot of Hawaiians who don’t seem to have much of an ownership stake in their own community. That could change in a heartbeat.

Should You Buy That 20th Floor Honolulu Condo?

But what of the real estate investment opportunities in Hawaii? Should you buy that high-rise condo, or that golf-course villa?

Actually, if you are seriously shopping for Hawaii real estate, now is an excellent time to shop. While the Hawaiian real estate market has not been hit quite as hard as real estate on the mainland, it is also drifting, relatively speaking.

Much of the problem here is the weakness of the Japanese real estate market, which is just now beginning to recover after more than a decade of depression. Until the Japanese – historically huge investors in Hawaii real estate – start recovering equity in their real estate back home, their real estate purchases here in Hawaii will be muted.

And while, to our mainland sensibilities, Oahu may seem crowded (unless you’re from Miami Beach or New York), the density here is entirely acceptable to most Japanese buyers.

It seems to me that foreign investors may provide the primary market for the many vertical condominiums I see being built in Oahu. Personally and professionally, I have always regarded vertical (high rise) condominiums as a poor investment. While land appreciates, buildings depreciate. Exiting a deteriorating condominium project can be problematic; and reaching consensus on the repairs or capital improvements to be made can be virtually impossible, even with the benefit of the most carefully written condominium CC&Rs.

However, given potential foreign demand over the next ten years, perhaps condos here will do well. Personally, I would stick to that golf course property, or other free-standing property, where you – and perhaps no more than one or two other owners – own the dirt upon which your detached, or marginally adjacent, homes or sit.

Here’s the excerpt from the article by our government’s office of International Information (I believe their purpose here is to explain Hawaii to foreigners. I did the math for you and converted original references in the article from “hectares” to “acres”.):

Article from the Office of Foreign Information

“Roughly half of all land in Hawaii is government owned, with the state, not the federal government, controlling 80 percent of that land. Most of it is in the agriculturally less desirable portions of the islands, and the bulk is in forest reserves and conservation districts. Most federal lands are primarily in national parks on the Big Island and Maui, or in military holdings on Oahu and Kahoolawe.

“Seven-eighths of all privately owned land in Hawaii is in the hands of only 39 owners; each owns (about) 5,000 acres or more. Six different landowners each control more than 100,000 acres out of a state total of about 2,600,000 acres. Smaller unit ownership of private land is most extensive on Oahu, but even there the larger owners control more than two-thirds of all privately owned land. Two of the islands, Lanai and Niihau, are each nearly entirely controlled by a single owner, and on all of the other islands (except Oahu) major landowners control about 90 percent of all privately held property.

“Most of these large landholdings were created during the 19th century period of freewheeling exploitation on the islands. Land had previously been held entirely by the monarchies. This land passed into the hands of non-Hawaiian private owners during the political decline of the monarchy. With the deaths of the early owners, most estates have been given over to trusts to administer rather than passing directly to heirs. This has made it difficult to break up the ownership patterns, which has led to high land values and pockets of high population density.

“Sugar, and later pineapples, fueled the Hawaiian economy for many decades after the 1860s. The economy remained primarily agricultural until the late 1940s. In recent decades, agriculture has continued to show modest gains in income, but its relative importance has declined. Only one Hawaiian worker in 30 is currently employed in agriculture.

“However, Hawaii continues to provide a substantial share of the world’s sugar harvest, and its production of pineapples is about 650,000 tons annually, making it the world’s largest supplier of pineapples.

“Gross economic statistics overwhelmingly emphasize the position of Oahu, where more than 80 percent of the state’s economy is concentrated. The role of agriculture remains great on the other islands. Both Lanai and Molokai depend on pineapples for much of their employment and income. Livestock and sugar form the backbone of the economy on the Big Island, as do sugar and pineapples on Maui and Kauai.

“As agriculture declined and lost its dominance over the Hawaiian economy, its place was first taken by the federal government. Over the past several decades, governmental expenditures have increased at a rate roughly comparable to the growth of the total economy, maintaining about a one-third share of all expenditures. Most of this has come from the military, which controls almost 25 percent of Oahu, including the land around Pearl Harbor, one of the finest natural harbors in the Pacific. Nearly one Hawaiian worker in four is an employee of the military, and military personnel and their dependents together represent over 10 percent of Hawaii’s population. The armed forces are also the largest civilian employer in the state.

“Tourism is a major industry, with over 4.5 million people visiting the state each year. Tourism has become the principal growth sector of the economy, increasing its share of total island income from 4 percent in 1950 to over 30 percent today.”

–Keith

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