Income investors go back to school. These munis offer an opportunity as property values rise

Published Thu, Sep 7 202312:29 PM EDTUpdated Thu, Sep 7 20231:59 PM EDT

It's not just students who may be thinking about school this fall. Income investors have an opportunity to invest in bonds that help finance school projects — and can possibly earn a yield of around 6% after tax considerations are taken into account. Local municipal general obligation bonds help fund operations or specific projects. For school districts that can mean money for things like renovations or new buildings. They are backed by the full faith and credit of the issuer and, like all municipal bonds, interest is exempt from federal tax. In some cases, the bonds are free of state taxes as well. Right now, yields for local general obligation munis are historically attractive at about 3.7%, said Cooper Howard, fixed income strategist for the Schwab Center for Financial Research. For those in the highest tax bracket, that can mean yields can reach over 6% on a tax-adjusted basis, Howard said. Add in the waiver of state taxes from high-tax areas such as California and New York, and the yield could be even higher, he said. In general, the credit quality of local general obligation munis are pretty solid, said Richard Schwam, a municipal credit research analyst at AllianceBernstein. "The vast majority of them are still in very good financial shape given all of the stimulus that they received back in 2020 and 2021," Schwam said. They also got added tax revenue as Americans received stimulus money and pumped it back into the economy, he explained. While revenues related to income and sales tax may slow, property taxes remain stable. In fact, property values have risen significantly over the past several years, which could eventually translate into more revenue from property taxes, Howard pointed out. Those levies are based on the assessed value of the property, which means there is usually a lag before the assessed value catches up to the current market value. "It usually takes about three years for the market value to translate through to new higher revenues," Howard said. Local general obligation bonds also tend to be very highly rated, Howard said. About 45% are AAA rated, versus 21% in the broad muni market, he noted. "You are getting something that is high credit quality to begin with and we think the credit backdrop is relatively stable right now and could possibly improve," Howard said. "We think the valuation is relatively attractive right now." What to look for Not all municipalities are created equal, so do your homework on the area's credit, including its reserves and balanced budgets. Schwab's Howard advised looking for those areas that have a stable or rising population and higher income earners. "That tends to bode well longer term for the municipality meeting its debt service, even though we don't have a concern now for most municipal issuers," he explained. For instance, AllianceBernstein is underweight on San Francisco due to its shrinking population and office vacancies, said Schwam. Certified financial planner Ian Weinberg, CEO of Family Wealth & Pension Management, advised avoiding smaller municipalities that may have a history of financial problems. "There are so many general obligation bonds in the country that you can stay away from anything too tiny. There's just no need to take that kind of risk," he said. Weinberg also recommended diversifying with multiple states, but cautioned that buying a bond outside of your state means you'll likely be subject to state income tax. You can also invest through a mutual fund or exchange-traded fund. Those that may have a higher allocation to local general obligation munis than the broad index, which means more than 15%, are the ones to look for, Howard said. For instance, Schwab's Municipal Bond ETF has about 30% of its portfolio in general obligation bonds, according to its website, as does the Vanguard Tax-Exempt Bond ETF , per Morningstar. Also be aware of fees that are charged and the fund's track record.