The Power of Municipal Bonds
Municipal bonds have been around since the early 19th century, when New York City issued municipal bond obligations to help fund the construction of a canal. Since then, municipal bonds have come a long way and are now considered a staple in many portfolios, especially for real estate owners, operators and syndicators that might be looking to diversify their investment holdings in today’s economic climate.
These types of debt instruments, also known as “munis,” are typically offered by state and local governments to finance public works projects or to cover revenue shortfalls. The specific terms of each municipal debt offering (i.e. face value, interest rate and maturity date) are set by a registered broker/dealer at the time of issuance. The proceeds from the issuance are sent to the local state/government, who in turn has promised to make regular interest payments, as well as repay the original principal on the stated maturity date.
The main advantage to investing in munis is that their interest income is generally exempt from federal income taxes, and possibly even state and local taxes as well. This makes them particularly attractive to high income earners, especially those who live in states with high effective tax rates.
The municipal market is comprised of multiple sectors consisting of 80,000 issuers at both the state and local levels. The various rating agencies, such as Moody’s, S&P, and Fitch, can help because they assign a credit rating to many, but not all, municipal bond offerings. In general, the highest credit quality issues are categorized as “investment grade”, while the lower quality issues are categorized as “high yield”; however, some issues are categorized as “not rated” and their quality is unable to verify.
Some municipal bond issues are backed by the “full faith and credit” of the taxing authority of the issuing government, while others are only backed by the projects they fund (i.e. toll roads and bridges, hospitals, water plants, etc.).
The price of a municipal bond can fluctuate in value during its term, due to changes in interest rates and/or the credit quality of the issuer.
Liquidity is another important factor to consider. Municipal bonds don’t have a quoted price. Instead, they are offered for sale from a broker/dealer’s inventory. As such, it can be difficult to judge what is a “fair” price when buying or selling.
Investing in municipal bonds is a good way to preserve capital while generating interest income. But because of the many complexities of the municipal bond market, it is essential for investors to seek assistance from experienced professionals prior to making investment decisions. CLA Wealth Advisors, LLC can provide access to best-in-class municipal bond managers.
Thank you to Steven Jones and Omer Abramovich for authoring this blog post.
- Carey M. Heyman, CPA
- Managing Principal of Industry - Real Estate
- CliftonLarsonAllen LLP
- Century City (Los Angeles)
Carey is the Managing Principal of the Real Estate Industry at CLA. He is a trusted advisor with close to 20 years of experience providing accounting, assurance, tax, and consulting services to real estate industry owners, operators, family offices, developers and syndicators. Carey has a strong track record of helping clients build and retain capital by leveraging tax- and cost-saving strategies and employing tax credits and incentives. He also consults with high net worth individuals, large family groups, and owners of closely-held businesses on all aspects of tax planning, estate planning, and retirement planning.
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