Last year, such Colorado land districts sold $1.3 billion in bonds, the most since at least 2005. The securities, which are typically unrated, are repaid by assessments levied on homeowners and offer few protections to investors if the housing market goes south. In the case of the Castle Rock, Colorado development, even if the district skips interest or principal payments, it won’t count as a default, limiting bondholders’ legal power to recoup some of what they’re owed.
Real-estate backed bonds were hit hard by the housing bust over a decade ago, when a wave of them defaulted in Florida. That also happened in California in the 1990s and in Colorado the decade before.
Colorado’s real estate market has boomed over the past decade, leaving Denver’s higher above their pre-recession peak than any other major metropolitan area, according to ATTOM Data Solutions. But there have been some signs that the frenzy is slowing down, as it has elsewhere: in June, only about 12% of homes had competing offers, down from half a year earlier, according to Redfin. And the number of homes on the market rose 28%, according to a local realtors report.
The Castle Rock debt used a limited-tax structure, meaning that failing to levy the property tax pledged to the bonds triggers an event of default.
That security pledge helps ensure that investors eventually get paid on their investments, said Sam Sharp, a managing director at D.A. Davidson & Co., which underwrites the majority of Colorado dirt bonds. The use of surplus funds also provides protections, he added.
“The structuring we do is mindful of how cyclical the real estate market can be,” he said.
Foley said it helps that his firm doesn’t run a high-yield municipal-bond fund and can instead move in and out of securities when they reach “irrational” points.
“If you make a real call against the high-yield market, you’re making a big call that can cost you your job if it doesn’t go right,” Foley said. “The easy thing to do is keep buying more and more high-yield.”
--With assistance from Nic Querolo and Danielle Moran.
This article was provided by Bloomberg News.