Mar 9, 2017: A few thoughts about “water deals” in Colorado
By Spencer Williams
A few thoughts about “water deals” in Colorado
As some of you know, in addition to working with our land and water information software platform, Water Sage, I also advise clients on commercial implications in water rights transactions, investments, and markets. In this line of work, I generally help impact investors, traditional investors, and water rights owners develop and implement realistic water rights investment strategies.
I get a fair number of calls from individuals or investors that have been pitched some kind of water rights deal. I haven’t yet seen a deal in this context that I would be willing to invest in in any form. That being the case, I’m getting pretty good at pouring cold water (pun intended) on the aspirations of neophyte water rights investors.
Through this process, I’ve collected a running list of principles to help guide the evaluation of a water rights investment opportunity. Here are a few of the main principles:
1. Be wary of any deal where the majority of the forecasted capital appreciation is a result of a water court change of use.
The pitch books for deals like this boil down to something like, “We’re going to buy these water rights for x, spend 0.5x to change them to municipal use in water court, and then sell them for 3x to Front-range-opolis in 18 months. Easy.”
Among other things, these deals fail to realize the implications of the anti-speculation doctrine in Colorado water law. To simplify the concept, to change a water right to municipal use, you have to be a municipal user with municipal water demand.
Because of this limitation, municipal buyers will change the water rights themselves following purchase, based on their specific demands and infrastructure. This reality nullifies the arbitrage opportunity that most deal promoters are trying to sell.
It’s also worth asking if you can think of any investment you’d be willing to make that required over a year of civil litigation to realize your return? Ponder that.
2. Be wary of any deal that doesn’t have the majority of the necessary infrastructure in place to deliver water to potential buyers or users.
Deals like this generally claim, “Major City is growing at astounding rates and purchasing water rights for over x dollars to meet future demands.” Every potential investor should then ask, “1. Where is Major City; 2. Where is the water right; and 3. Is there an existing, efficient means to deliver water between the two?”
Here are a few automatic red flags:
- Water in Wyoming, Major City in Colorado
- Water in Colorado, Major City in California
- Water on Colorado West Slope, Major City on Colorado East Slope
These are red flags because the greatest inhibitor to widespread, normalized water-use markets is the impracticality of moving water uphill and/or out of its basin of origin. Where the physical challenges can be overcome, political and regulatory hurdles abound, raising costs beyond the tens of millions. So, any opportunity that relies on building reservoirs, pipelines, or even approving river exchanges via water court (see point 1) in order to deliver water to market should be seriously scrutinized.
Sadly, I’ve also seen pitch books that grossly over-exaggerate the proximity of delivery infrastructure. The takeaway: confirm for yourself how the water right you buy will someday be delivered to the next qualified buyer.
3. Carefully evaluate forecasted cash flows, hold periods, and market conditions.
At least in Colorado, if anyone promises you significant cash flow from a water rights-only investment, you can spit in their eye and tell them I told you to. If it’s just water rights, the best you can expect is to lease the water rights to another owner on the ditch system for the cost of the ditch company assessment.
If you buy land and water rights, then you are likely in the farming business. Like any other business, there are farmers who do well, and those who don’t. Farming irrigated land certainly has the potential to generate cash flow, but understand it isn’t the easiest business to break into.
The backbone of any water rights investment is summed up by this graph:
Colorado–Big Thompson, or “CBT,” units are roughly 0.6 acre-foot volumes of easily traded and reliable water use allocation available in Northern Colorado. Units are bought and sold on an open market and can be changed without going through water court. As a result, CBT prices are a good indicator for the water rights market in Northern Colorado.
The opportunity is obvious. You did really well if you bought 100 CBT units in 1975 and sold them in 2015. Then again, if you bought in 1980, or 2001, you had to wait 20 and 14 years respectively to recoup your investment. Also, don’t forget, you were very likely farming, paying someone else to do so, or leasing land to farmers through your entire hold period.
So, the long-term trend is good, but water is subject to market volatility like nearly everything else. The takeaway is to honestly evaluate your financial goals with the realistic performance of a water rights investment.
Despite these cautions, water rights can be a great investment, as long as you buy correctly and understand what you are getting into. The next time you get a call about a water rights investment, feel free to give me a call and I’ll help walk you through due diligence. Or, if you’re interested in getting into the space in the right way, I’d be happy to talk about that too.