Your MSA Selection Has a Blind Spot. The Risk Factor Nobody Puts in the Underwriting

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.