Housing: Part 2 – Muni Buyers Beware

By Brad Thomason, CPA


There is a whole field of study in the investment management world that deals with the way Asset A reacts when Asset B goes up or down.  As the conversation about real estate continues and investors try to decide whether to wade back in or not, the smart ones are also looking at what impact changes in real estate prices might have on their holdings in other asset classes.

Municipal bonds may not seem like part of a conversation about real estate prices.  But I’ll assure you, they are.

A number of people over the past few years have voiced concerns about the safety of municipal bonds.  These concerns stem from the idea that local sources of tax revenue may be jeopardized by economic challenges.  If tax revenues fall too far, it could make it hard for municipalities to pay their debts.  What’s that got to do with real estate prices?  To the extent the tax base comes from property taxes, a lot.

Recently I attended a tax sale in a “collar-county” to a large southern city (hint: they had an unpleasant run-in with General Sherman a few years back…).  The county judicial complex was an impressive campus, with modern buildings, expensive landscaping, veterans monuments, green spaces and so forth.  Clearly, being in proximity of a fast growing metro area had driven local prosperity, and the county had responded by building a beautiful, state of the art facility.

But here’s the thing.  In doing our analysis work prior to the sale we discovered that the market values for properties in the area ran about 30% less than assessed values.  That fact has huge implications.  Do you see why?

Assessed values are the basis on which taxes are calculated.  In principle they are supposed to be reflective of market prices; and in practice they are usually less than market, to cut down on the likelihood that residents (i.e. voters) will gripe about the valuation.

If market is 30% under assessed, a revaluation is in order.  We already know what the result will be: a 30% reduction in tax revenues!

I did not look at that county’s budget.  But I’ll bet you they aren’t running a 30% surplus.  Those state of the art facilities cost a lot of money, after all.  So if they took a 30% cut, they would most likely be deep in the red.

This is a time bomb of a sort that is probably present all over the country.  Sooner or later, if values don’t come up, assessments in these areas are going to have to come down.  To the extent that county services can’t contract at the same rate as the drops in revenue (and in most places, they probably won’t be able to to), budgetary shortfalls are the inevitable, mathematical effect.

I should point out that in most places where we operate, assessed values have fallen in step with market values, at least more or less.  So this is not a universal problem, nor even necessarily a prevalent one.  But even if unusual, this example from our recent activities shows that not only is it quite possible, the disparity between the two measures can be a big one.  If a house is valued by the county at $100K and it is only actually worth $70K, those are significant differences.

So before you go invest in municipal bonds from a given county, you might want to spend half an hour comparing assessed values on the county’s website with sale prices from local realtors or external sources of data such as Zillow.  Looking at one or two properties is not enough to give you a legitimate sense of what is going on.  But if you look at 15 or 20 scattered all over the county you very well might find the beginnings of a trend that points in a clear direction.  There’s no way to know if your bond broker is doing similar detective work.  And since it’s your money anyway…

I don’t buy or deal in muni’s myself.  But I can assure you if I did I would spend some time looking at how fragile the local property tax base is before I bought any of their bonds (new issue, or secondary market).  For most jurisdictions, those revenues may play a big role in whether or not you get paid.

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