How Arizona Water Regulations Affect Origin Investments’ Portfolio

Over the past week, we have received inquiries from a few investors regarding recent water restrictions in Arizona: Specifically, a move by state officials to limit the amount of new construction around the Phoenix area due to concerns about the long-term availability of water. The headlines have created some confusion and concern about the future of development and economic growth in the state. So, we’d like to give our investors some background on the topic, how our current pipeline is affected (there’s no bad news here) and our long-term perspective on the situation.

Why are these restrictions occurring now?

To answer this question, some background is helpful: Arizona’s mostly desert climate means that the state has taken its role as a steward of water usage, retention and reclamation seriously for decades, notably with the Groundwater Management Act of 1980. This act required that new housing developments in “actively managed areas,” or AMAs, had to prove that the water supply could sustain residents for at least a century without relying primarily on finite groundwater reserves. The highly regulated AMAs—five city areas including Phoenix and Tucson—are required to rely only on sources that are legally, financially and physically available and have a renewable supply. In both the Phoenix and Tucson areas, only about half the water usage is municipal, with the rest going to agriculture, industry and tribal concerns.

And while this may seem hard to believe, Arizona’s water usage actually peaked in 1980. According to the Arizona Department of Water Management, overall usage fell 3% from 1957 to 2021. While it’s partly due to an evolution from more water-intensive agriculture, the decrease is astonishing: That’s despite a whopping 555% increase in population and a 2,137% increase in gross domestic income—fueled by the economic expansion and development that has added to the state’s reputation as a great state to live and work. It’s evidence that responsible water management and reclamation work.

Arizona reclaims and reuses 93% of total water usage. But despite these limits and innovations such as water banking, more recent issues of drought and climate change, along with the rapid and broad geographical growth of homes and businesses, are straining supplies. The recent new-housing restriction is just one way the state is tackling the issue. Ongoing initiatives have included a water lease with Colorado River Indian tribes; modification and enlargements of area dams; a $5.5 billion desalination proposal; and more than a billion dollars in grants and funding to augment, study and conserve water in the state.

So, even though these moves have made national headlines and appear alarming, it’s not accurate to say they are sudden: They are a continuation of an ongoing water management and conservation strategy that municipalities and developers have worked within for decades, and which has helped residents and businesses thrive.

What exactly is being restricted?

Specifically, the state’s water agency will stop approving new single-family, for-sale housing developments that rely on groundwater. The action is based on a state analysis that studied groundwater levels over the next 100 years and found that aquifers serving 4.6 million people across the Phoenix AMA will fall slightly short. Multifamily developments do not have this requirement. There is no concern that current residents will run short of water soon, and new developments that have already been approved will stay that way. The intention of the decision is to protect available water for the long term, and it mostly will affect more rural developments that would primarily rely on groundwater.

Does this affect Origin’s investments?

No. We have four multifamily investments in various stages of development, in infill areas where demand exists. They are located in areas that have had long-standing designations of “assured” water supply. That is, they are in municipalities—Phoenix, Goodyear, Gilbert and Casa Grande—that have sufficient water of suitable quality that will be continuously available to meet anticipated water needs for at least 100 years. The state views its water supply issue in terms of centuries, not months or years, which means that our developments aren’t at risk of running out of water any time soon. More than that, the availability of utilities such as water are a key part of our site-selection and due diligence processes; as you can see from the map below, our developments are located in AMAs where water is assured for decades to come.

Map: Active Management Areas (AMAs) and Origin Developments

What is Origin’s long-term strategy in states like Arizona?

Arizona is taking steps to manage the future supply of water. These new regulations will result in fewer housing developments—particularly in outlying areas that don’t have AMAs in place—hitting the market. That will make it more expensive to build. And because supply will likely fall as expected population growth continues, we believe it will increase our ability to raise rents on the real estate assets that we have, in areas where water is being managed responsibly. In general, we view this as a positive to our existing Arizona real estate portfolio.

Being located in AMAs, the submarkets in which Origin’s real estate funds are invested are protected from these types of restrictions. But we don’t fool ourselves into thinking that they are immune from challenges—Phoenix, for instance, is one of the long-term beneficiaries of the May agreement by Arizona, California and Nevada to put temporary limits on the amount of water drawn from the Colorado River.

As one of the target markets for Origin Investments’ real estate Funds, we understand and work within the challenges Arizona faces. This is essential to good risk management. Origin’s real estate Funds choose to be in markets such as Arizona and Florida that are business-friendly, low-tax, offer great lifestyle options and have good weather—all things that are drawing employment and residents, and those choices are made with an understanding of the totality of the markets in which we operate.