Investment grade municipal bonds are debt issued by U.S. states, cities, counties, school districts, and public authorities and rated BBB‑ or higher by S&P or Fitch, or Baa3 or higher by Moody’s. Interest on most municipal bonds is exempt from federal income tax, and often from state and local tax for in-state buyers, but some municipal bonds are taxable; the credit rating and the tax treatment are separate questions. The same BBB‑/Baa3 threshold that governs corporate bonds applies here, and it anchors how investment grade net lease investors judge tenant credit quality.
What Are Investment Grade Municipal Bonds?
A municipal bond is a debt obligation of a state or local government or of a public purpose authority, such as a water district, hospital system, or transportation agency. Investment grade municipal bonds are those an agency rates in the top four categories. Municipal credit is different from corporate credit: general obligation bonds are backed by taxing power, and essential service revenue bonds (water, sewer, power) are backed by fees residents cannot easily avoid. Municipalities can still fail. Chapter 9 bankruptcy is available to municipalities when their state authorizes it, as Detroit used in 2013, while states themselves cannot file for bankruptcy.
Investors use municipal bonds for tax-exempt income, diversification, and capital preservation. Current prices, yields, official statements, and ratings for individual bonds are available on the MSRB’s EMMA website. For the complete guide to investment grade across asset classes, see the Investment Grade Guide.
How to Compare Municipal Yields With Taxable Bonds
The taxable-equivalent yield (TEY) converts a tax-exempt yield into the taxable yield that would leave an investor with the same after-tax income:
TEY = tax-exempt yield ÷ (1 − marginal tax rate)
Because tax-exempt interest is also excluded from the 3.8% net investment income tax, high earners can include that tax in the rate. In-state buyers can add the state tax saved on in-state bonds. The table uses a 4.00% tax-exempt yield to show the math.
| Investor’s marginal rate | Rate used | Taxable-equivalent yield of a 4.00% tax-exempt bond |
|---|---|---|
| 24% federal | 24.0% | 5.26% |
| 32% federal | 32.0% | 5.88% |
| 35% federal | 35.0% | 6.15% |
| 37% federal | 37.0% | 6.35% |
| 37% federal plus 3.8% net investment income tax | 40.8% | 6.76% |
Compare the result with taxable yields of similar quality and maturity. Today the ICE BofA AA-rated US corporate index yields 5.80% and the A-rated index 5.84%; the 10-year Treasury yields 5.24%. Current municipal yields for specific bonds are on EMMA.
Municipal Bond Rating Scale
S&P, Moody’s, and Fitch use the same letter scales for municipal bonds as for corporate bonds. Historically, rated municipal issuers have defaulted far less often than corporate issuers with the same rating, as both Moody’s and S&P report in their municipal default studies, and recoveries have tended to be higher. That record varies by sector: hospitals, senior living, and project finance bonds have defaulted more often than general obligation and water and sewer bonds.
General Obligation vs Revenue Bonds
General obligation (GO) bonds are backed by the full faith, credit, and taxing power of the issuing government, which can raise taxes to pay debt service within legal limits. State GO bonds are among the highest-rated municipal credits; state-level defaults have been extremely rare since the 1930s, when Arkansas defaulted. A small group of states carry the top rating from all three agencies; check each state treasurer’s site or EMMA for the current ratings, which change over time.
Revenue bonds are backed only by the income of a specific project or enterprise: water and sewer fees, tolls, airport fees, hospital revenue, or electric utility receipts. The issuer has no obligation to use tax revenue. Essential service revenue bonds often carry ratings comparable to strong GO bonds; hospital, higher education, and project finance bonds carry more risk.
Investment Grade Municipal Bond Sectors
The municipal market is organized by issuer type and source of repayment. Yields within each sector vary by issuer, structure, maturity, and call features.
| Sector | Credit profile |
|---|---|
| State GO | Backed by state taxing power; the strongest municipal credits |
| Local GO (city, county) | Property tax backed; varies with the local economy and tax base |
| School district | Often enhanced by state programs, such as the Texas Permanent School Fund guarantee |
| Water and sewer | Essential service revenue; historically among the lowest default rates |
| Public power | Rate-regulated electric revenue |
| Transportation | Airports, toll roads, transit, and ports; depends on traffic |
| Hospitals and health care | More volatile; credit varies widely by system |
| Higher education | Flagship universities strong; smaller colleges face enrollment pressure |
| State housing finance agencies | Often supported by mortgage collateral and federal programs; see the housing bonds guide |
| Special tax and tax increment | Backed by dedicated sales or incremental property tax revenue |
See Investment Grade Housing Bonds for state housing finance agency debt.
Tax Mechanics: Why Tax-Exempt Matters
- Federal tax. Interest on most municipal bonds is exempt from federal income tax. Taxable municipal bonds also exist, issued for purposes that do not qualify for the exemption.
- State tax. Interest is often exempt from state and local income tax for residents of the issuing state.
- Net investment income tax. Tax-exempt interest is excluded from the 3.8% tax.
- Alternative minimum tax. Interest on certain private activity bonds is a preference item for the individual AMT.
- Gains and market discount. Selling a bond for more than its adjusted basis produces a taxable gain, and bonds bought at a market discount can generate ordinary income.
General information, not tax advice.
Investment Grade Municipal Bonds vs Investment Grade NNN Real Estate
High-income investors often weigh municipal bonds against investment grade NNN real estate. Both emphasize credit quality and predictable income, but the economics differ.
| Attribute | Investment grade municipal bond | Investment grade NNN property |
|---|---|---|
| Income | Fixed coupon, usually federally tax-exempt | Rent, taxable, partly sheltered by depreciation of the building |
| Current yield measure | Yield to maturity on the specific bond | Cap rate; today the median asking cap rate on Dollar General listings is 7.00% |
| Income growth | None on a fixed-rate bond | Rent increases if the lease provides them |
| Price changes | Market price rises and falls with rates and credit; face value repaid at maturity absent default | Property value can rise or fall; depends on tenant, lease term, and location |
| Tax deferral on sale | Gains taxable | 1031 exchange available |
| Liquidity | Trades over the counter; liquidity varies by issue | Weeks to months to sell |
| Typical minimum | Often $5,000 face per bond | Usually $1 million or more per property |
| Management | None | Limited under a true NNN lease, but the owner bears tenant and re-leasing risk |
Municipal bonds are hard to beat for pure tax-exempt income with daily pricing and no property risk. A net lease property can produce more pre-tax income and adds depreciation, rent growth, and 1031 deferral, but it concentrates risk in one tenant and location. How much depreciation shelters depends on the share of the price allocated to the building, the investor’s other passive income, and whether a cost segregation study is used; depreciation is recaptured on a taxable sale. Heirs generally receive a basis equal to fair market value at death for inherited real estate, whether the property was bought directly, through a 1031 exchange, or through a Delaware statutory trust; estate and exchange planning need separate tax advice.
How to Research Specific Municipal Bond Issuers
EMMA (Electronic Municipal Market Access), operated by the Municipal Securities Rulemaking Board, is the official public source for municipal bond data: official statements, continuing disclosures, trade prices and yields, and credit ratings for nearly every outstanding municipal security. Issuers are organized by state:
- California Municipal Issuers on EMMA
- Texas Municipal Issuers on EMMA
- New York Municipal Issuers on EMMA
- Florida Municipal Issuers on EMMA
- Illinois Municipal Issuers on EMMA
- Pennsylvania Municipal Issuers on EMMA
- Ohio Municipal Issuers on EMMA
- New Jersey Municipal Issuers on EMMA
- Massachusetts Municipal Issuers on EMMA
- Virginia Municipal Issuers on EMMA
Each issuer page shows bond issues, official statements, continuing disclosure filings, recent trades, and ratings.
Related Municipal Bond Research
Investment Grade Municipal Bonds FAQ
What is an investment grade municipal bond?
A bond issued by a U.S. state, city, county, school district, or public authority and rated BBB‑ or higher by S&P or Fitch, or Baa3 or higher by Moody’s. Most pay interest that is exempt from federal income tax, but some municipal bonds are taxable.
Is municipal bond interest really tax-exempt?
Interest on most municipal bonds is exempt from federal income tax and the net investment income tax, and often from state tax for in-state residents. Interest on certain private activity bonds is subject to the alternative minimum tax, some municipal bonds are fully taxable, and gains on sale are taxable.
How do I calculate taxable-equivalent yield?
Divide the tax-exempt yield by one minus your marginal tax rate. A 4.00% tax-exempt yield equals 6.35% taxable at a 37% rate, or 6.76% at 40.8% including the net investment income tax.
What is the difference between a general obligation bond and a revenue bond?
General obligation bonds are backed by the issuer’s taxing power. Revenue bonds are backed only by a specific revenue stream, such as water fees or tolls.
How risky are investment grade municipal bonds compared with corporate bonds?
Rated municipal issuers have historically defaulted less often than corporate issuers with the same rating, according to the municipal default studies published by Moody’s and S&P, and recoveries have tended to be higher. Risk is higher in sectors such as hospitals, senior living, and project finance.
Which states have AAA general obligation ratings?
Several states carry AAA ratings from S&P, Moody’s, and Fitch, but the list changes as agencies act. Check each state treasurer’s investor relations page or EMMA for current ratings.
Where can I research specific municipal bond issuers and trades?
On EMMA (emma.msrb.org), run by the Municipal Securities Rulemaking Board, which publishes trade prices, official statements, continuing disclosures, and ratings.
Educational content only. InvestmentGrade.com is a commercial real estate brokerage and educational publisher. We do not sell, broker, underwrite, or solicit any bonds, securities, or investment products. Yields, ratings, and prices referenced are approximate, fluctuate continuously, and are sourced from public market data as of the date noted. Nothing on this page constitutes investment advice, an offer to sell, or a solicitation to buy any security. Consult a licensed broker-dealer, registered investment advisor, or tax professional before making any investment decision. For official municipal bond disclosures and trade data, visit EMMA at emma.msrb.org. For SEC investor education, visit investor.gov.
