Three warning signs you're about to drown in a water deal
Water rights can be a great investment as long as you understand what you're getting into
I get a fair number of calls from individuals and investors who 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. That being the case, I’m getting pretty good at pouring cold water (pun intended) on the aspirations of neophyte water rights investors.
And as more people flood into Colorado in the coming years, I expect news of these schemes will only grow.
So I've collected a running list of warnings to look out for and principles to help guide the evaluation of a water rights investment opportunity.
#1: Be wary of any deal in which the majority of the forecasted capital appreciation is a result of a water court change of use.
The pitch for deals like this boils 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, or at minimum, have entered into firm contracts with such an entity.
Because of this limitation, municipal buyers will change the water rights themselves upon purchase, based on specific demands and infrastructure. This reality nullifies the arbitrage opportunity that most deal promoters are trying to sell.
#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.
It’s also worth asking if you can think of any investment you’d be willing to make that required more than a year of civil litigation to realize your return?
Deals like this generally claim, “Major City is growing at astounding rates and purchasing water rights for over $X to meet future demands.” Every potential investor should then ask themselves, “First, where is this Major City?” and second, “Where is the water right?, and third, “Is there an existing, efficient means to deliver water between the two?”
Here are a few automatic red flag examples:
- Water in Wyoming, major city in Colorado
- Water in Colorado, major city in California
- Water in Colorado's Western slope, major city on Colorado Eastern 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 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 so. 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 (data source, Norther Colorado Water Conservancy District) The backbone of any water rights investment is summed up by this graph (data source, Norther Colorado Water Conservancy District) The backbone of any water rights investment is summed up by this graph (data source, Norther Colorado Water Conservancy District) The backbone of any water rights investment is summed up by this graph (data source, Northern Colorado Water Conservancy District).
The backbone of any water rights investment is summed up by this graph (data source, Northern Colorado Water Conservancy District) .
The opportunity should be 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, think about these warning signs and contact a water rights professional before you jump in with both feet.