In California, real estate developers that have paid water companies for the installation of new water infrastructure to serve their projects are often repaid their costs over time via a Refund Contract.

A Water Main Extension Contract or "Refund Contract" is entered into between the Water Company and the real estate developer who needs additional water services extended for their project.

The Refund Contract includes the following terms:

• Developer advances to the water company all of the money needed to pay for the cost of the water facilities, that may include water mains, which are the pipes lying in the streets, and special facilities such as wells, tanks and pumps for larger projects.

• The water company installs the water infrastructure, and retains ownership of the facilities.

• Because the developer paid for the water facilities, and the water company retains ownership, the water company is required to refund the developers construction advances over time. 

• Following completion of construction, the water company begins making refund payment to the developer. Rule 15 requires that the water company pay the developer 2.5% of the original cost for a period of 40 years. For example, if the original cost was $400,000, the water company will pay $10,000 every year for 40 years to repay the full refund amount of $400,000.

Rule 15 of the California Public Utilities Commission regulates water companies and established the rules for the repayment of developer advances for the extension of water utility services.

California Public Utilities Commission

Water Companies that are privately held, as opposed to municipal water districts,  operating within the state of California fall under the jurisdiction of the California Public Utilities Commission (CPUC).  

Exclusive Right To Offer Water Services

Water Companies are operated within established geographical boundaries called service area boundaries, which are specified on service area maps filed with the CPUC as part of the Water Company’s tariffs. Water Companies operate with an exclusive right to sell water services to its customers within their service area.

Authorized Profit Margins

The CPUC establishes pricing schedules for each Water Company’s water services that are calculated to provide a reasonable return to the water company, called the "Authorized Rate Of Return". By way of example only, if the Authorized Rate of Return for a particular water company is 8%, then the Water Company’s water service rates are adjusted to provide an after tax Authorized Rate of Return to the Water Company and its stockholders after all expenses including income taxes are taken into account. 

As the Water Company’s cost of doing business varies, the authorized rates for water services are adjusted to maintain the Water Company’s opportunity to achieve its Authorized Rate Of Return and Approved Profit Margin.

For example, if the Water Company faces increased costs of operations or increased investment needs that would prevent it from earning enough profit, then the CPUC will recognize an increased revenue requirement and will authorize increased rates calculated to produce the required revenue to maintain the Authorized Rate of Return.

If the Water Company appears set to earn excess profits, such as when corporate tax rates were reduced from 35% to 21%, the CPUC may order a reduction in rates to prevent the utility from earning above its Approved Profit Margin.

Therefore, Investor Owned California Water Companies i.e. Class A Water Companies are operated without competition and enjoy a reasonable operating profit set by the CPUC.

Water Companies finance much of their infrastructure expansion through developer advances. When a developer requires water services to be extended to serve their project, the developer pays the Water Company the cost of extending the facilities.

The amount paid by the developer is referred to as a construction advance.

CPUC Rule 15 requires the Water Company to repay the developer’s construction advance over 40 years, without interest, in equal annual installments. Rule 15 reads that the water utility shall pay “2.5% per year of the original amount advanced” to the applicant, which is the developer who made the advance. 

The 2.5% figure is not interest; it is the percentage of the original construction advance that must be paid to the developer in the form of an annual payment. At 2.5% per year, it takes 40 years for the developer to recoup their construction advance.

Example: $100,000 advance, divided by 40 years = $2,500 per year for 40 years.

Refund Contracts are frequently transacted with remaining terms of less than 40 years.

Water Contract Transfers

Developers are willing to sell their contracts to Neptune Investment Company because 40 years is far too long to use the cash flows for business purposes, and the developer business earns a far greater rate of return than the discount rate used to purchase the contract.

Most Refund Contracts are purchased from real estate developers that entered into the contract with the water company when the Refund Contract was created. Sometimes, private investors holding Refund Contracts decide to sell. 

Neptune Investment Company purchases and then resells the Water Contracts to its investors as a long-term investment contract, with a payment stream similar to an annuity. 

While Refund Contracts start out with a 40 year term, remaining terms vary. 

Refund Contracts are transferred by an assignment document. Each Water Company has an approved form that is used. The assignment is a three party document executed by the Assignor, Assignee and the Water Company. 

A Refund Contract purchaser receives a fully executed original assignment directly from the Water Company, acknowledging the transfer, and stating the address where the Water Company will send the annual payments. The owner receives their annual payment directly from the Water Company.

About Neptune Investment Company

Neptune Investment Company is a DBA of Stratera Investment Management, LLC, an Arizona limited liability company. Neptune Investment Company has been purchasing Water Contracts for 50 years, and have longstanding relationships with real estate developers and investors. 

Who Buys Refund Contracts?

Investors in Refund Contracts include Pension Trust Funds and Insurance Companies, individuals, family trusts, foundations, family offices, qualified plans such as IRA’s, 401K, pension and profit sharing plans, and defined benefit plans.

Pensions and Insurance Companies

Refund Contracts are great for pensions and insurance companies because they fit well with future payment liabilities. 

Pensions can solve part of their future pension liabilities, effectively reducing future employer contributions, by adding Refund Contracts with higher yields into their fixed income asset portfolio. 

Similarly, Life Insurance Companies have predictable payouts based on their actuarial tables that Water Contracts may fit well as an alternative investment asset class.

Retirement Accounts

If purchasing with retirement funds, your existing retirement account custodian may accept alternative investments.  If they accept alternative investments, then that is probably ok. If they do not you may need to open an account at a different custodian. 

Retirement account investors usually will open an account at Mainstar Trust which is a custodian that many of our investors use to hold Water Contracts in their IRA. 

To buy Refund Contracts using retirement funds, contact Mainstar Trust, open an account, and either make a current contribution to the account, or transfer funds from an existing qualified plan account i.e. IRA, Roth IRA, 401K, etc. 

Refund Contracts are an alternative investment, meaning they are not a publicly traded security such as a stock or bond. Most custodians such as Charles Schwab or Fidelity only accept publicly traded securities, whereas other custodians such as Mainstar Trust accept alternative investments.

Summary

Neptune Investment Company only purchases Refund Contracts of the “A” rated companies, which is a CPUC rating scale for the largest Water Companies operating in the State of California. There are only 9 Water Companies operating in California that are Class A companies. At a minimum, the Class A Water Companies serve entire cities or substantial portions thereof. Most are in numerous markets and several are National in scope. Together, the 9 Class A water companies have approximately 1.5 million customer accounts in California, serving approximately 6 million persons or approximately 15% of the State. 

Water Companies are afforded exclusive operations with their tariff boundaries – no competitors and a captive market. Water is a necessary resource. The CPUC sets Water Company Authorized Profit Margins.  

Acts of God have little effect on the operations of the Water Company. For example an earthquake may break several water mains but has little effect on the overall operations of the company. Such extraordinary costs are allowed to be recaptured in subsequent periods through rate base adjustment. 

Similarly, reductions in water usage and Water Company sales revenues from conservation efforts are recorded in balancing accounts that are recognized in adjustments of the Water Company rates, in an effort to maintain Approved Profit Margins.

Neptune Investment Company employees have experience with more than 5,000 transactions involving Refund Contracts.  Class A Water Companies have never defaulted on Refund Contract obligations in any respect whatsoever, which knowledge extends to the early 1970’s.