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November 2, 2019 by Ryan Shaw Leave a Comment

Investing in Tax Liens without getting burned

The more research I do on tax lien investing–the more I realize how complicated it can be to get started.

There are so many “gurus” pitching their theories on how to get started–all claiming that it’s a lucrative area for real estate investing with returns at or above 20%.

Like you, I decided to dive in and learn more about this “goldmine” or an opportunity (or is it more like an abandoned coal mine…we are about to find out).

So, here’s what I’ve learned.

Buying Tax Liens vs. Buying Tax Deeds

First, understand that tax deed investing is different (and probably more exciting) than tax lien investing. 

When you invest in tax liens, what you’re buying is the right to collect the back taxes owed on a property, plus a predetermined interest rate owed from the owner of the property.  The county is selling these liens to investors in an attempt to collect the back taxes that are owed to the county.

In short, it’s a way for counties to raise money from outside investors when they are unable to collect from the property owner.

If the owner fails to pay you, the investor, you can eventually foreclose on the house and you will have the first right to own the property as the property tax holder (even before a potential mortgage holder, like a bank).

The holy grail for tax lien investors comes when the property owner doesn’t pay you the back taxes and interest you are owed–opening the door for you to get a property for just the back taxes owed.

That’s the dream going in–that you might actually get the property for pennies on the dollar.

The reality is (of course) much different from the dream scenario.  In almost every case, the property owner does eventually pay the tax lien holder the back taxes plus interest–so you don’t come away with any property as the investor (but you might come away with a really hefty return on your investment).  

Tax Lien Investing is a Regional Business

Tax lien investing is extremely regional and the rules are different for literally every county in the US. 

The amount of interest you can collect, how you can proceed on foreclosure due to non-payment, and everything else is all up to the discretion of the county. This is a local game all the way through.

Trying to work out the rules for a bunch of counties that you’ve never been to and investing without actually seeing any of these properties poses a good deal of risk.  

My first suggestion is to pick a county that you live in or close to and stick with that.  Go deep with just one or two local counties. Get to know the folks that run those auctions, get to know the rules, and understand the laws for tax lien sales in that area. 

What Makes Tax Liens a Risky Investment

Tax lien investing is not without some risk.  The common problems are:

  1. You can’t see the condition of the property before bidding and buying  
  2. You’re likely going to fast a lot of competition
  3. You might have to pay for other liens on the property if you take it over
  4. Selling the property once you become the owner is not as easy as you think

Let’s break down the risks one by one. 

Unknown Property Conditions

When you’re bidding on tax liens, you’re not able to get a look inside the property.  If you’re far away from the property, you may not even be able to drive by. 

If the property has massive issues, you’re just stuck with it and it could be worthless. 

A lot of tax lien investors just focus on buying vacant land to avoid those sorts of issues, but the big “prizes” or always the improved land (you know, things with a structure on them–hopefully something that someone can live in).

Tons of Competition

The internet is a wonderful invention.  In fact, I’m talking to you through it right now.

The problem is it’s also opened up the entire world to being able to bid on those tax liens.  If the auction is being held online–that means a huge amount of competition coming from out of town.

The low price point for tax lien real estate investing also allows just about anybody to get started.

There are liens out there for a mere 200 – 300 bucks.  Contrast that with the tens of thousands you’d need to purchase a multifamily property or a fix and flip.

Unexpected Additional Liens on the Property

When you purchase a property through a tax lien sale–you’re inheriting all the other lower-level liens that might on the property.

Did the previous owner not cut the grass?  Is there some sort of environmental violations that are sitting as extra liens on the property?

Every little city or county ordinance must be settled up before you can actually sell the property–assuming you can actually collect on the property if the lien holder doesn’t pay you the back taxes and interest. 

Some of these extra ordinances can be a big expense to resolve–and might make it not worth the time or money to deal with. 

And now for the big elephant in the room that tons of newbie tax lien investors don’t consider.

Even if the property owner doesn’t pay, you still might not get the property outright

In some counties, the property goes to an open “tax deed” auction where other investors can come in and make a bid to actually acquire the deed to the property ( forget about the lien, this is a real deal auction where you come away with the property as the owner). 

So even if you’ve done all the heavy lifting as the lienholder–you still might not end up with the property if the taxes aren’t paid.

Having a tax lien on the deed makes it hard for you to sell

When you invest in a tax lien and end up with a successful foreclosure of the property and assume ownership, there is one more sticking point before you can cash in.

The person purchasing the property from you needs to be able to secure title insurance, and titles are very hard to ensure when there is a tax lien in the chain of ownership. 

What this means is you could potentially have a hard time selling that damn thing you worked so hard to buy. 

Damn!

Luckily there are services that can help you with this, but you need to keep in mind it will definitely be an extra cost–up to $1,000 or more depending on if you use a lawyer or another service. 

Spending $1K to clear the title on a piece of land worth maybe $3K changes your profit margins dramatically ( and your bidding strategy).

This is what most of the self-proclaimed gurus don’t tell you about tax lien investing–you need to keep the exit in mind and understand the costs associated with selling the property once it’s in your position.

You’ll want to bake in the costs of clearing the title issues when you make bids.

All this being said–tax lien investing isn’t all bad and there are reasons why investors continue to flood into this niche of real estate investing. 

You just have to know exactly what you’re doing and get 100% educated before jumping in — otherwise, you could lose your money in a hurry. 

You can only successfully invest if you fully understand the risks before jumping in. 

The Positives of Buying Tax Liens

Some pros of investing in tax liens include:

  • The property might have a solid amount of equity 
  • Homes with big loans on them are the most likely to have the lien paid back
  • Some homes could have a ton of equity

No existing loan on the property

Some tax liens happen when the original property owners dies and the property is inherited by heirs.

The person inheriting the property may not have the money to cover the tax bill and may not be interested in dealing with the property.

There could be some issues where a homeowner dies and the home isn’t claimed by anyone. 

In any event, some of these properties might have equity in them–which means you might get something worthwhile if it never gets redeemed. 

Homes with loans means the bank will likely redeem one day

If a home has a nice loan remaining on it– this means that the bank will likely make a strong effort to acquire the property, so the liens on the mortgage don’t get wiped out.

What this means for you is you’re very likely to get paid back with a nice return.  The amount of your return depends on how far you were bid down by the competition.

It could turn into a nice return if you weren’t bid down too much.

A nice return on your money is definitely possible–once you’ve been fully educated on your target county. 

How to Get Started Investing in Tax Lien Properties

Here are the steps you’ll want to follow to get started with your first deal:

Understand when the auction is in your chosen areas of focus 

Once you’ve narrowed down the areas you are going to invest in, you’ll need to understand the dates and process of the auctions. 

You’ve likely heard the whole “guarantee” of over 20% returns that are set by the county as the interest rate for returns on tax liens.

In those counties, that’s actually the starting interest rate–which is bid down during the auction. 

In reality, these rates could get bid down to 6, 8 or 10% (all depends on the area and the bidders).

Attend a few auctions as a trial run

Attend a few auctions as a trial run and see who else shows up.  You’ll likely find the same few investors that go to every auction and buy most the decent liens. 

Pay attention to what they bid on.  The more you know about the folks you’ll be competing against–the more you’ll know what lane you can take to profitability.

The key is to find the useful liens that the bigger bidders avoid.

If the auction is online, try watching a few run through digitally to get a feel for things.  

Online auctions are going to be a lot more competitive–so if a lower amount of competition is what you’re looking for–you may want to focus on counties that have live auctions offline. 

How you can look up properties that are coming up for auction

Once you’re comfortable with the process, have picked your target county(s) and have attended a few auctions as a trial run–you’ll be ready to take the next steps.

Tax liens typically list right after tax season on properties that haven’t paid their taxes for a number of years. 

As the bidder, you put down a deposit and can bid on the lowest rate you’re willing to accept as a return.

Every state and county is different in the amount of time they give the property owner to pay the redeem.

In Florida, you’re typically looking at a 2 year window.

There may be cases in which an extra penalty is assessed to the taxpayer that puts a natural floor on what you can earn from an interest rate perspective.

For example, in Florida there is a 5% penalty rate for the first 6 months of a tax lien.

If the interest rate you bid on is, let’s say 8%–you’ll collect the 5% penalty for the first 6 months. 

If the owner redeems in month 7, you actually get the 6 months at 8% since it’s beyond the penalty window.

I can’t stress this enough: there rules are different for every county in every state that does tax liens.

You need to educate yourself on specific counties to know specifics on your situation.

Next, you’ll want to identify your actual bidding strategy. 

If you’re focused on the earning interest and don’t want to deal with forclosing the property–you’ll want to bid on single-family homes that have a mortgage.

Redemption rates for these types of properties can be over 90%–since they’re actually worth something to someone (the bank or the homeowner). 

You’ll also want to understand the length of the redemption period is going to dictate when you might get your money back out–and it might dictate whether other tax liens will pile on after yours. 

Let’s say you purchase a tax lien for the first of two years that the property homeowner has to redeem. If someone follows on with a lien after you–they are first in line and not you in the event the property needs to enter foreclosure proceedings.

So if you want to actually acquire the property, you’d have to win the bids for subsequent years as well.

If someone does go through the court proceedings on a foreclosure and acquires the property–they would be required to settle up the liens with all other lien holders–so you can still come out smelling like a rose if a follow-on lien holder comes in the years after your lien was purchased.

Outcomes you want to avoid

You’ll want to stay away from properties that are really undesirable and has no loan on it–because that means those taxes aren’t likely to be paid by anyone and you’ll have to foreclose on the thing and it might not even be worth the taxes that are owed on it.

You’ll want to make sure you really don’t need the money you’re investing for a long period of time.

Tax liens might actually be the most illiquid asset in the real estate game in the sense that there is zero secondary market for certificates.

Once you buy the lien, it could take months or years to get paid out and you have no control over when that happens.

So many people get burned by investing money that they are going to need in 3 months.  Have an emergency fund, have six months of expenses in the bank, have multiple streams of income established–then invest the rest.

Conclusion

Tax lien investing when done correctly can be an extremely safe way to earn 5, 10 or even 15%+ on your money.

While you’re not likely to acquire any properties for “pennies on the dollar” you can earn a solid rate of return with an outside chance of acquiring a property.

Tax lien investing is different than tax deed investing — with tax deeds, you are buying the actual property itself (and not just a lien for property taxes owed). If you’re really looking to buy properties for a fraction of their worth, you’ll want to focus on tax deed sales. 

As with anything, be smart and get educated before diving in and you’ll have a much greater chance at success investing. 

Good luck!

Filed Under: Investing

About Ryan Shaw

Ryan Shaw is the original founder of The Real Estate Witch, a site dedicated to thoughtfully answering the questions of home buyers, sellers, and real estate investors.

Ryan's work has been cited in a number of real estate and personal finance publications, including Inman, Tech Bullion, MSN, and RealTrends.

Education: BA Political Science — University of Southern California

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