By Kriss Bergethon — Tax liens get a bad rap in the alternative investing world. Yes, they are unglamorous and somewhat complicated, but if approached with knowledge and a healthy amount of caution, they can offer returns in excess of 15 percent. There’s no hard and fast rule for returns, as each state’s certificate yields are different, but while returns in the 5-10 percent range are certainly realistic, much greater rewards are possible for diligent lien buyers. The current rate range for tax lien yields, for all states, is between 5 percent and 36 percent.
How and Where to Purchase
Tax liens are actually an offshoot of the real estate market and are not one of the better-known forms of alternative investing. Entering the market calls for plenty of research and due diligence but the yields can be quite high. Property owners who can’t pay taxes on their property are at risk of foreclosure. The municipalities to whom they owe these taxes can sell the liens to anyone who wants to purchase them. New owners of the liens are now free to collect the back taxes plus interest from the property owners.
As is the case with all balance-sheet collectibles, there is no guarantee that even one dollar can be retrieved. In actual practice, investors usually get the amount of back taxes along with some interest. The operative words in that last sentence are “usually” and “some.”
A good starting point for investors who want to know what’s out there and which states offer the best deals is a website called Tax Lien Investing Pro. The site describes tax lien yields and regulations in all the U.S. jurisdictions that sell them, provides essential facts about auctions and discusses the unique aspects of each state’s tax lien situation. There are literally hundreds of websites and online resources for investors who want to locate tax liens for purchase.
- Tax liens are relatively easy to purchase. The deals are done through state auctions, wherein buyers pay the amount of taxes that the property owner owes.
- In most cases, tax liens “live” for between six months and three years. That’s how long the property owner typically has to repay the taxes plus interest.
- When property owners don’t pay the taxes and interest within the redemption period, the owner of the tax lien certificate can begin foreclosure. (This almost never happens because owners routinely pay the taxes and interest).
- Tax lien investing can be conducted as a business by those who do research and know the market well. Investors who become full-time tax lien dealers can earn large returns for their efforts.
- Interest rates on many tax liens are in the 20 percent to 35 percent range, which means they are one of the most attractive investments for those who want to participate in this unusual corner of the real estate sector.
- Tax liens have priority over first mortgages in the case of bankruptcy, which means the lien holder does not have to “stand in line” behind banks who made the original loans to the property owner.
- Tax lien investing is complicated and it takes most investors several months to learn the ropes of buying good, repayable liens.
- Auctions, where tax liens are sold, are conducted in one of two ways. They either sell the liens to the bidder who is willing to accept the lowest interest rate, or they’re sold to bidders who are willing to pay the highest premium above the stated rate. Investors need to begin slowly and learn how the system works. It helps to specialize in one or two states, and one or two kinds of property in order to hone one’s expertise as quickly as possible.
- There is a lot of homework and serious research involved. You have to really know the details of the property before bidding on a lien. After factoring in the many hours of research and billing yourself at a reasonable rate, the actual yield on the certificate can decrease considerably.
- There is a certain amount of “wasted time” in researching properties that don’t end up in the auction. States give out lists of properties that they intend to sell tax liens on. However, many property owners pay the back taxes and interest before the lien auction takes place. This means that unless you have an up-to-date list, you could end up researching dozens of lien properties that never appear at auction.
- There are various obligations for lien holders. Many states require you to notify the property owners that you hold a lien. Often, little details like this have time requirements and if you fail to do such-and-such by a particular date, your right is null and void.
- Perhaps the biggest disadvantage for tax lien investors is the “effective” interest rate, referred to above. Auctions are notorious for bidding down the stated interest rate on the lien, which means once you own it, there might not be much of that juicy 35 percent yield left. It could be more like 20 percent once you hold the lien. After factoring in your time , trouble and research expenses, the tax lien might end up yielding no more than a typical certificate of deposit.
- Because institutions have gotten into the tax lien market in a big way, interest rates at auctions get bid down pretty quickly. For the lone investor that can mean not much left on the plate.
Tax lien investing might seem like a big hurdle with a lot of downside for an individual investor. In reality, there are lucrative tax liens sold at auction every day. Institutional investors don’t have the market cornered, yet. This type of investing is truly for active, hands-on people who enjoy learning a new skill and watching their investments closely. For those who like the “buy it and forget about it” kind of activity, tax liens are probably not a good choice.
In fact, many of the most ardent tax lien investors are retired people who have a considerable amount of time on their hands, enjoy doing the research, and understand the real estate market.
Note: This above information is not to be taken as tax or investing advice, nor is it a solicitation to buy or sell anything. Websites and companies mentioned are used only as examples of how or where to find tax lien information. The article itself is offered only as an educational tool for consumers who wish to know how the tax lien market works.