When municipal finances collapse, they often make it into the national consciousness. New York City during the 1970s and Detroit in the early 2000s and its bankruptcy in 2013 are good examples and the effects were well-documented: employment falls, services deteriorate, and property values follow. Recently researchers studied the influence of a municipality’s financial health on commercial real estate investments. The findings: Municipal finances are robustly associated with significantly higher real estate returns to the tune of 1% additional annual appreciation in the healthiest cities.¹

This relationship, discussed in a working paper, was strongest for office and self-storage assets, was amplified in gateway markets, and overall the relationship strengthened nationally post-COVID. The excess returns from strengthening municipal finances were felt in the “current quarter and several quarters ahead,” but those excess returns gradually thinned over time as valuations started to broadly reflect investor’s expectations of stable fiscal health.

The study matters because it provides a new, transparent and validated approach to MSA evaluation, one of the most consequential decisions in real estate investing. Municipal health today is not a standard input in most investors’ underwriting process, but the research shows that in the aggregate, it is a real, “priced determinant of institutional commercial real estate returns.” The study also helps government officials make a case for fiscally smart decisions as they can expect faster growth and higher property taxes as one result.

Interestingly, the outperformance of commercial real estate in healthy cities is reflected in appreciation but not in income returns, meaning these cities see lower cap rates and higher forward-looking growth expectations. This result is consistent with other studies that show stronger municipal balance sheets reduce local risk premia, improve expectations about future public service provision, and enhance the stability of the operating environment for income-producing properties, the paper notes.

The authors looked at institutional asset valuations in 100 cities from 2016 to 2023, examining cities’ liquidity, reserves, debt burden, revenue growth and long-term obligations, among other metrics of fiscal health. Some of these metrics mattered more than others, especially “balance sheet strength and long-run fiscal sustainability.” This means investors are especially sensitive to city revenue growth, reserves and debt burdens, including pension obligations.

And the study found event-based evidence for this relationship between municipal financial health and real estate values: Cities that implement fiscal monitoring and oversight see increases in commercial real estate values as a result. These oversight policies require regular review of municipal financial reports to identify fiscal distress. Formal fiscal monitoring adoption happened in different states at different times during the study period, providing individual testable moments for the researchers. Because adoption was staggered across states and not driven by real estate market conditions, the researchers could isolate the fiscal oversight effect from other factors.

The authors conclude that “municipal fiscal health is not merely background context but a priced local risk factor in commercial real estate markets.” Real estate pros should thus expand their due diligence to include a basic understanding of recent tax revenue trends, reserve levels and pension and debt obligations. Those metrics appear to influence expectations about future city resources, public services and local risk premia, which all show up in property values.

For investors, this is less about avoiding fiscally weak cities and more about preferring ones that are on the upswing and getting out of ones headed the other way. Cities implementing stricter fiscal oversight are especially worth considering. Exercising caution seems especially warranted for gateway cities with fiscal red flags.

Understanding municipal finance will of course not replace traditional real estate analysis, but it is now a validated screen for market selection and another way to explain why similar properties in different cities produce different long-term outcomes. Most underwriting models don't have a line item for municipal fiscal health. The research suggests they should.

Who: Prophetic

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The Sparkle: Prophetic helps investors, corporate site-selectors, developers and homebuilders identify and qualify land parcels quickly. The AI has zoning and other regulatory information, plus environmental conditions, allowing for near-immediate feasibility studies and valuation. Plus it knows every entitled and under-construction project in the U.S., so you go into a land negotiation fully informed.

In a world full of screens, eyeglasses and windshields, it’s hard to imagine glass wasn’t always ubiquitous.

The oldest glass ever discovered dated from the third millennium BCE, but it was one thousand years later in Egypt and the Near East that glassmakers discovered ways to add color and structural stability, giving it artistic and decorative value. This gave rise to demand and a specialization of labor, with different regions producing molds, ingots and jewelry, and an international trade in glass-coloring materials.

Link: https://www.smithsonianmag.com/science-nature/a-brief-scientific-history-of-glass-180979117/

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