Beware of Municipal Risk When Investing in Real Estate

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You’ve got cash for a down payment just burning a hole in your pocket, financing is lined up, you set up your LLC, you’ve even checked out things like insurance, and you’re ready to go. You’ve watched real estate listings for months but now you are looking with a serious eye. You’ve found one area with nice homes and safe neighborhoods that seems to be a bargain and decide that’s where you want to go. Did you ask yourself why that particular part of your investment area is cheaper than the rest?

If you’re like most new investors there’s an excellent chance that you overlooked one crucial factor. Have you checked the condition of the local municipality? Local governments can be a significant wild card in the investment game.

Municipal Risk

The real estate downturn and economic recession have hit many municipalities especially hard, some more than others. Many counties, towns, and cities large and small, are in a state of fiscal crisis. The steps these areas take to remain solvent will have an impact on residents, area businesses, and real estate investors. This usually means increased taxes and slashed services. If public safety is compromised property values will fall; if real estate taxes rise, prices will fall; if there are too many business that close, prices will fall.

The area where I live is comprised of the City of Las Vegas, the City of Henderson, Clark County (unincorporated areas of Las Vegas), and the City of North Las Vegas. The past few years have seen intense haggling with civil services unions over concessions. The municipalities saying they’re broke and the unions saying some combination of “they’re lying” or “take the money from someone else.” There are no winners in this game. Three of those locations have weathered the storm for the most part, but North Las Vegas is teetering on the brink of collapse. Days ago the city declared a fiscal emergency and cancelled union contracts; the unions will certainly sue to stop them. Layoffs of firefighters and police are looming and the city jail may be closed. They recently released dozens of non-violent offenders. Property values in North Las Vegas have plummeted far beyond levels of the surrounding municipalities. Do you really want to invest there?

Worth the Risk?

Municipalities in a financial crisis pose a significant risk. With risk there is often reward, but is it worth it? There is certainly opportunity as desperate sellers want to get out of Dodge, and fortunes have been made accepting such risks. As a real estate investor you need to determine if the potential reward justifies taking whatever risk you may encounter. I am not suggesting that you don’t invest in an area because of municipal crisis. What I am saying is do not overlook such a risk in your analysis, I see too many newbies doing just that. Whatever list of investment screening criteria you use be sure that an assessment of the local financial and political environment is on it. Investing successfully is difficult enough without being blindsided by something you failed to consider.

Risk comes from not knowing what you’re doing.Warren Buffett

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4 Comments

  1. The impact of a municipal fiscal crisis on an investment property is a classic example of the downward spiral. As businesses shut down and jobs disappeared, home values dropped, and people stopped spending. Municipalities get revenue from property taxes, sales taxes, and fees. In a recession, all three decline but the obligation of the General Fund to pay salaries and generous benefits remained, or actually increased. In California, the Legislature terminated the Redevelopment Agencies, shifting the obligation for bond repayment to the General Fund – the same fund that pays for paving roads, keeping the libraries open, and maintaining the parks – and layoffs occur, further impacting local spending. This situation will become more common, with some cities defaulting on their debt and filing for bankruptcy. Litigation between municipalities and their unions, between cities and counties, and between cities and their State governments, have already commenced over these issues. But the impact is so widespread that it will be very difficult to pinpoint a direct causal relationship on housing prices. Pay closer attention to the quality of the school district where you want to purchase – people are willing to pay dearly to live in good school districts.

  2. Al Williamson on

    We here in Sacramento are bracing for an 18% increase in wastewater rates (over 3 years) to offset treatment plant upgrades. I see rent increases on the horizon.

  3. One other municipal risk you didn’t mention is rental property rules.

    For example, in Minneapolis there are all kinds of ordinances you must follow to have a rental property including a yearly rental license. Then they have a scam where you have to pay a $1,000 inspection fee to convert any previous owner occupied property to a rental property.

    If you don’t follow the rules you can get sued and if you don’t know the rules you can cut into your investment returns.

    • As an attorney with extensive prior experience working on behalf of public entities in the area of zoning and land use issues, I feel compelled to comment regrading Mr. Wallace’s characterization of the application of a zoning regulation as a “scam.” It’s a law, usually enacted by ordinance, and quite common in most cities. A change in use of property commonly triggers a range of zoning requirements, and although no one likes to pay fees, many of these ordinances were enacted to address specific problems. Unfortunately, not all investors are conscientious about maintaining their rental properties in a safe and habitable condition.

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