With all the talk of higher interest rates impacting future housing demand, one area of concern has been overlooked, muni's.  Also known as municipal bonds, these are local and state level bonds issued with the backing of the respective taxing authorities.  For years these investment instruments have been the preferred vehicles for high net worth individuals and private equity funds for tax exempt interest income, often on both the Federal and local level.  With after-tax yields higher than comparable quality US Treasuries, the allure is unmistakable.  And today, they are still quite favored for their out-performance and relative safety.

There are two types of muni's: general obligation and revenue bonds.  General obligation bonds allow the local authorities to raise local taxes for any number of new spending and this makes them the preferred bonds for investors.  Revenue bonds are tied to specific projects and the cash flow from those tax receipts are less certain.  But, within that safety for investors, there's a burden for local home owners.  In order for state and local authorities to continue funding operations at a competitive interest expense, those authorities have to provide assurances of sufficient tax revenues and one major source, about 45%, is property taxes.

In California, we have been used to a 1% property tax with some special assessments that total up 1.2% of the assessed values of our properties.  This total tax rate has been regularly increasing as our spending continues to climb.  And, in the recent housing correction, rates have also been raised to offset the decline in assessed values.  Based on those two factors, we should expect rates to continue to climb.  On a positive note, we're still nowhere near the 2.7% property tax in Texas.

At the moment, the Brown administration is playing the role of Sisyphus in trying to cut our state spending.  While I applaud his efforts, I'm not expecting much to change in the next few years.  Meanwhile, unless property values quickly climb, our property tax receipts are not likely to go up.  This means, the most likely response of our local governments is to continue raising

our property tax rates, perhaps to 1.4% to cover our budget shortfalls and higher interest payments to compensate for investor concerns about our probability of default.  And, complaining to them won't help since the reality is that we're all asking for more out of our government than we are willing to pay.

In the meantime, as property values remain depressed, our property tax burden has not increased much over the past 7-10 years.  For the next few years, it should remain low.  But, if you're betting on the housing markets starting to recover in 2012, it's best to lock in purchases now before property values and taxes rates both boost the property tax burdens on the next wave of buyers.