Luxury real estate is the shiny new thing in muni bond markets

High-end real estate developments are tapping the municipal-bond market, leading to a slew of so-called luxury dirt deals and fueling returns for investors willing to take on the risk.

This year, state and local debt buyers have helped finance a vacation-home golf enclave in Florida, a resort near Zion National Park and a $4.2 billion redevelopment in Atlanta’s downtown. The deals — all high-yield and sold exclusively to sophisticated investors — represent a niche corner of a market that typically raises money to build schools, roads and bridges. 

Some of these offerings have been oversubscribed and repriced tighter, helping to boost returns for junk-rated muni-bonds to a 7.2% gain this year, outpacing their investment-grade counterparts by more than 5 percentage points, according to data compiled by Bloomberg. The risky state and local debt is also beating US high-yield corporate debt.

The demand for these luxury junk deals is emblematic of a broader trend where developments for the ultra-rich are outperforming an otherwise broken real estate market. Mortgage rates near multi-year highs for much of 2024 have less of an impact on deep-pocketed homebuyers.

Real estate backed state and local government debt is the “new flavor of the day,” said Paul Malloy, head of municipals at the Vanguard Group, noting that investors need to be very careful when looking at the most bespoke offerings. “It’s a merry go round in that space.” 

The bonds are often sold to finance the initial infrastructure for a development like water systems, street lights or roads. They’re backed by future revenue that will be generated after completion. That adds risk as there’s no guarantee the project delivers what was forecast. 

“You just need to do your homework on these deals,” said Craig Brandon, co-head of municipals at Morgan Stanley Investment Management. Some real estate-backed transactions sold in the early 2000s hurt investors’ portfolios after the housing market collapsed during the financial crisis, he said.

The luxury component provides a new nuance because they cater to a certain clientele, according to Brandon. 

“You have to look at how the US is doing economically right now, the higher income demographic is doing very well, so to that extent, projects like that could work,” he said. 

The deals have also been boosted by a mismatch in supply and demand. Money continues to flow into high-yield muni funds while sales of risky deals have lagged. Dirt deals with significant equity investment offer an opportunity, said John Miller, head of the high-yield muni credit team at First Eagle Investments.

“Dirt deal supply overall is fairly strong,” he said, noting the “unusual” pace of transactions with a size of more than $100 million. “There is a constant flow.”

Breakthrough Deal

In February, a local district in Florida issued a $40 million deal to raise funds for a luxury resort community, as developers and investors bet on a resurgence in golf. The plan includes about $145 million in total infrastructure costs to develop roads, storm-water management, water and wastewater utilities, landscaping, streetlights and underground electric utility lines.

A month later, a $246.7 million muni deal associated with Miami Worldcenter, a $6 billion, 20-acre initiative came to market. The project is seeking to turn what was once a tent city into a sprawling development reminiscent of New York’s Hudson Yards. Proceeds raised in that offering will finance a phase of the project that includes parking garages, retail space, a plaza and several walkways. The project — which features apartment condos selling for $1.5 million — includes a partnership with billionaire Adam Neumann.

One bond for that deal due in 2041 priced with a 5% coupon and a 5.25% yield — or about 208 basis points more than AAA-rated securities. Since it was sold, spreads have tightened. It last changed hands in July at an average spread of 160 basis points, according to data compiled by Bloomberg. 

The Miami Worldcenter deal marked a breakthrough for the sector, after interest rate hikes by the Federal Reserve last year spurred a slowdown on real estate-backed bond sales, according to Brennen Brown, managing director at D.A. Davidson & Co., the underwriter on the transaction. “We’re starting to see some risk appetite again.”

In May, Black Desert Resort, a 600-acre luxury center in Utah, tested that demand when it borrowed $180 million of munis. The development includes a golf course designed by the late champion Tom Weiskopf, more than 700 single-family homes and a boardwalk. That sale was more than 15 times oversubscribed, according to a person familiar with the matter who asked not to be named because they weren’t authorized to speak on the deal. 

And in Atlanta, munis helping to finance a development of an defunct rail yard downtown, have recently surged. A project dubbed Centennial Yards, backed by the co-founder of Ares Management and Atlanta Hawks owner Tony Ressler, sold bonds in August to help fund over 2,600 apartments and more than 2,900 hotel rooms, as well as space for retailers and a data center. 

Fixed-rate debt for the development due in 10 years priced with a 5% coupon and yield, roughly 237 basis points more than top-rated securities. In the last several weeks, that spread has narrowed to around 190 basis points or a yield of around 4.5%. 

“These deals are relying on cash buyers, a customer base that’s less sensitive to interest rates,” said Nicholos Venditti, senior portfolio manager at Allspring Global Investments. “They are, to some degree, agnostic to what’s going on from a broader macro sense.”