What You Need to Know Before Investing in Hawaii Commercial Real Estate

When billionaire tech titan Larry Ellison snatched up almost all of the real estate on the Hawaiian Island of Lanai nearly a decade ago for $300 million, it was one of the most notable commercial real estate transactions in the state’s history.

The purchase of 98% of the “Pineapple Isle” from longtime Castle & Cooke chief David Murdock also highlighted one of the challenges in acquiring commercial real estate in the 50th state.

Ellison — who co-founded Oracle Corp. and is the seventh richest person in the world according to Forbes — could be referred to as a “trophy buyer,” someone who collects property in a certain area because of the prestige and notoriety that accompanies the purchase.

The same could be said for other billionaires who own properties in Hawaii, such as Facebook CEO Mark Zuckerberg, who also recently purchased hundreds of acres of land on the Hawaiian island of Kauai. Big land grabs by billionaire investors contribute to the scarcity of real estate investment opportunities in the state, which is one of the most prominent issues in a long list of challenges that exist for prospective investors in Hawaii commercial real estate.

Which isn’t to say that intrepid investors should avoid the market. While there may be some unique barriers (or at least complications) to entry, those factors also make the market distinctly rewarding (potentially, anyway). Nonetheless, before diving into the clear blue waters of Hawaii real estate, investors should be aware of some of the obstacles they may confront, including:

• Finite land.
• The Hawaii land use commission.
• Ancestral remains.
• Activist culture.
• High development/renovation costs.
• Competition from international investors.

Obviously, every market has a finite amount of land (it's one of the reasons real estate is such a solid investment), but that issue is particularly pronounced in Hawaii. The huge swaths of land being consumed by trophy buyers is particularly problematic in a state where only about 5% of its 4 million acres is developable.

On top of that, a few large companies already own most of that land. The most prominent are Kamehameha Schools, the state’s largest private landowner, and publicly traded Alexander & Baldwin Inc., a legacy company in Hawaii that was part of the state’s original “Big Five” companies. The Big Five companies, which also included American Factors (Amfac), Castle & Cooke, C. Brewer & Co. and Theo H. Davies & Co., rose to prominence during the early 20th century with their control of the sugar and pineapple plantations, as well as the shipping, banking and insurance industries.

If you are looking to invest in commercial properties in Hawaii, it is fairly likely that you will have to deal with one of these organizations. What’s more is that these companies are known as long-term landholders, so it could prove difficult to pry away some dirt from these real estate giants.

Jamie Brown, president of Honolulu-based Hawaii Commercial Real Estate, has been involved in transactions worth in excess of $1 billion in the state. He says that investment in Hawaii real estate is extremely limited.

“Finding the right investment property in Hawaii takes more time and effort than on the mainland,” he said. “We’ve seen investors take years before finding the right deal, especially if it’s their first investment in the Islands.”

Brown also says that, typically, total investment returns on Hawaii commercial real estate are lower than mainland markets, and they are skewed more towards appreciation than cashflow returns.

Even long-established Hawaii businesses, such as Castle & Cooke, can experience difficulty navigating the state’s bureaucratic entitlement and approval process.

Consider the firm’s Koa Ridge master-planned community, for example, which is a sprawling mixed-use development in central Oahu that has been in the works for more than a decade, and has only just started breaking ground recently.

Many observers contend that the project’s delays could have been avoided were it not for the extra layer of entitlements developers and investors are required to go through in Hawaii.

That additional phase of the entitlement process has a name: the Hawaii Land Use Commission (LUC). This governmental agency was created decades ago to keep more agricultural lands from becoming developed into urban areas. However, the LUC has become a deterrent to developers and investors, and yet another challenge these groups have to contend with.

Before the LUC, each county set its own permitting/entitlement guidelines, which in most states represents sufficient regulation. Now, developers must first make it through the permitting process at the county level, which is already notoriously slow, and then contend with the additional bureaucratic layer of the LUC. It’s no surprise at all if a project takes years to get permitted; while in most municipalities on the mainland, a similar process will usually take months.

Part of the entitlement process in Hawaii involves the relocating of ancestral remains, which are also known as “‘iwi kupuna”. When an investor/developer uncovers ‘iwi kupuna, the local burial council is summoned, and an investigation ensues to find out what descendant line these ‘iwi kupuna belong to and to determine where they can be relocated — either elsewhere on the property or someplace else entirely. If this process is not handled correctly, the results can be potentially disastrous for investors.

One of the more notable recent cases involves Whole Foods Market, which was supposed to open a store location more than a decade ago at Honolulu’s Ward Village — owned at the time by General Growth Properties. The former owner of the state’s largest shopping mall — Ala Moana Center — eventually pulled out of the project before the building was completed. After finding more remains at the site than what was originally anticipated, cultural descendants protested and filed a lawsuit to halt construction. In the end, the delays from the protests and lawsuit were just too much for the developer to overcome.

Ironically, Whole Foods Market eventually opened in Ward Village. And, this time, the current owner of the development — The Howard Hughes Corp. — learned the valuable lesson of how to deal with complex and sensitive issues involving ‘iwi kupuna. The Texas-based developer prioritized fostering deep relationships with cultural descendants and involved them in the project’s development from the outset of the process and frequently thereafter. Understanding the personal and cultural significance these burial sites hold is extremely important for prospective investors in any kind of real estate in Hawaii, especially commercial real estate, as that sector usually involves larger parcels of land.

Any investor currently looking to purchase commercial real estate in Hawaii should be warned that even if you conduct the process unimpeachably, you’ll still probably have to grapple with state’s prominent anti-development activist culture.

To ameliorate this complication, many investors hire a local consultant to help them navigate such challenges. You don’t have to look very far to find examples of the complications that can arise when activists take an interest in your project. In fact, the ongoing battle between investors/stakeholders in the more than $2 billion 30-meter telescope at the Maunakea Observatory on the “Big Island” of Hawaii is a literal shining example.

Activists against the telescope assert that it further desecrates the sacred mountain. Even after the developers completed a lengthy entitlement and permitting process, activists were able to block the roadway to the construction site, and thus stopped the prominent project in its tracks.

If an investor is considering improving any property in Hawaii, either through development or renovation, they will surely encounter the state’s high construction and materials costs. Materials are more expensive than in most other markets, as the majority of them have to be shipped from the mainland. Labor is also more expensive, given that Hawaii’s workforce is relatively small and it’s more difficult to source employees from other states compared to the mainland.

Honolulu consistently ranks near the top of U.S. markets when it comes to construction costs, and that prohibits some investors from pursuing opportunities in the city. While the costs will sometimes diminish at times, particularly during economic downturns, they can still be high compared to most other national markets.

Brian Maeshiro, president of Honolulu-based Action Realty Corp., noted that, besides high construction and labor costs, the general prices of Hawaiian commercial real estate are elevated to begin with when compared to almost every other area in the mainland.

“Most of my buyers who I deal with are owner-users, so they are willing to take a chance,” he said. “They look at it as long-term investment and their fallback is that they are using the property.”

For those not looking to be an owner-user, Maeshiro says the key to maximizing their investment is finding an exit strategy.

“The kicker is that you can hold on to it, but what’s the plan to hold on to it,” he said.

Hawaii’s strategic location near Asia has fostered significant investor interest from the continent, which creates additional competition for investors from the U.S. mainland.

While Asian investors are largely focused on Hawaii’s hospitality sector, which is the state’s top economic driver, their interest does drive up the prices across sectors in the market. One example is the recent record-breaking acquisition by South Korean firm Mirae Asset, which purchased the 1,230-room Hyatt Regency Waikiki Beach Resort & Spa from The Blackstone Group for nearly $800 million in 2016. Three years before that, Blackstone purchased the same property for $450 million.

While investing in Hawaii real estate comes with its share of challenges, many still consider the “Aloha State” one of the best places to acquire commercial property. Ironically, some of the barriers to entry outlined in this article generate the very circumstances that make commercial real estate in Hawaii such a durable and compelling investment. In an upcoming article LoopNet will explore such factors as scarcity, appreciation, international interest and stability to uncover some of the benefits of investing in Hawaii commercial real estate.