The municipal bond market as an asset class offers investors a diverse array of sectors that constitute the backbone of infrastructure development across the United States. Each state has its own unique regulations related to infrastructure development. In Colorado, Metro Districts have provided a cost-effective financing mechanism to facilitate residential, industrial, and commercial developments for over 40 years. Metro Districts embody the ideology of growth paying for itself. For investors, the sector offers unique exposure to real estate and population trends with an inherent deleveraging credit component as the district matures and debt gets paid down over time.
What is a Metropolitan District?
A ‘Metro District’ is a special-purpose district created to provide public infrastructure and services to a specific development area. Typically created by local governments through a legal process, they are independent taxing authorities with their own board of directors. After formation, the district can issue tax-exempt bonds to fund the construction and installation of public infrastructure and amenities within the development. The bonds are often backed by future property tax revenues and have defined repayment schedules. As the district matures, governance often will transition from the original developer to property owners and residents within the district boundaries.
Early Stage
Bonds issued to fund the earliest stages of development are the riskiest type of Metro District bond. They are often nick-named ‘Dirt Deals’ referencing the largely undeveloped land before any vertical construction has taken place. The bonds issued at this stage are typically non-rated and trade in large minimum denominations meant for institutional clients and accredited investors. Investing in these types of Metro District bonds exposes the investor to construction risk and timing. Early stage bonds are typically issued with a “Capitalized Interest” fund, designed to pay debt service for a certain amount of time until sufficient development of property tax value is achieved. If the development stalls or is delayed there is a tangible risk that property tax revenues are not sufficient to cover the debt service (interest and principal) on the bonds. However, as yields for these early-stage bonds tend to be substantially higher than investment grade met district bonds, the risk reward can be attractive for high risk tolerance investors.
Development Stage
As the district starts vertical construction, assessed values will begin to increase in a meaningful way. The early-stage construction risk is reduced, and investors are mainly focused on the momentum of new construction to see increases in assessed value and property tax revenue. During this stage, the capitalized interest balance has typically been consumed and the district should begin to support the outstanding debt balance on its own. While construction and timing risk is reduced, it is not eliminated as the district still carries a significant debt balance in relation to the overall assessed value. Close monitoring of development progress is key during this stage.
Mature Stage
As the development approaches full build-out, there is less capacity to grow assessed values through new construction. Price appreciation (or depreciation) is now the primary driver of changing assessed values. At this stage, the debt balance is starting to get paid down and there may be an opportunity for the district to refinance the bonds at a lower rate. Generally, the district will issue new bonds with insurance and a rating that attracts a new, more risk-averse buyer base. As property values increase and the debt balance shrinks, the credit quality improves. This credit improvement story can be underappreciated or misunderstood among market participants. An airport, for example, has continuous capital maintenance requirements and will generally maintain a certain leverage ratio over time. Whereas a Metro District generally experiences increasing assessed values (taxing ability) at the same time that debt balances are declining. After enough time has passed, the district will have paid off all outstanding debt and transition into a more operational stage maintaining existing infrastructure through annual tax revenues or dissolve completely.
In Colorado
There are over 1,000 Metro Districts across the state of various shapes, sizes, stages of development and development use. This creates a diverse opportunity set for investors with varying risk profiles to participate in the sector. The variety of credit structures, for example limited vs unlimited General Obligation debt, revenue bonds or even Tax Increment financing structures, is another dimension to consider that often necessitates studying the offering documents to gain clarity on credit quality. Knowledge of local market trends and trading acumen creates a competitive edge when investing in this sector.
Sources:
Background on Metro Districts; Colorado Association of Home Builders, 2023; {https://www.hbacolorado.com/colorado-metro-districts/ }
About Metro Districts; Metro District Education Coalition, 2023; {https://www.metrodistricteducation.com/about }
Disclosures:
This content has been prepared for informational purposes only and should not be considered as investment, tax, or legal advice. Opinions and forward-looking statements expressed are subject to change without notice. We recommend all investors to consult with a financial and/or tax advisor regarding their individual circumstances before taking investment decisions.
Investing in bonds exposes the investor to the risk of loss of principal. Lower and non-rated securities are more volatile and less liquid than investment grade bonds. Liquidity risk relates to the timing of converting a security into cash without affecting the market price. Municipal bonds and preferred stocks tend to be less liquid than government or corporate bonds. Higher-yielding, longer-maturity, lower-rated, non-rated, or certain bond restrictions (minimum denomination requirements) limit or reduce the liquidity of bond holdings.
Please visit our website for a complete list of disclosures and risks: www.maustininvestments.com.
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