With so much stock market volatility these days, combined with low CD and savings rates, some savvy investors seeking higher yield returns are turning to property Tax Liens (TLs) as an alternative investment vehicle. In 2017, more than $14 billion in property taxes went unpaid, that equates to about 4% of the U.S. total property taxes due that year. Depending on the state, annual yields to investors can hit double digits. On the surface these yields can look very attractive to investors. However, while TLs can provide excellent yields, they also may represent substantial risk. Novice investors should be very aware of the rules, regulations and potential pitfalls involved with TL investing. While highly knowledgeable investors can make good returns investing in tax liens, novices may get burned.
Local government agencies cannot function without enough tax revenue coming in. As a result, when property taxes do not get paid, those agencies undertake action to collect the overdue amounts, as well as any interest or appropriate penalties, fees, etc. that are due. The entities obviously benefit from private TL sales because they are able to quickly recoup monies owed to them on the properties in question.
The two main collection actions that local government normally undertake to collect are either public auctions (online or in person) or some states sell what are known as Tax Lien Certificates (TLCs) over the counter (OTC). NOTE: Laws vary from state to state so be sure to research this subject thoroughly before investing, including advice from appropriate legal and accounting professionals.
The truth is, these days, many if not most tax liens purchased at auction are often sold at annual yield rates under 10%, and sometimes less than 5% The reason for the low potential yields is that the winner of a tax lien certificate at auction is typically the investor willing to accept the lowest interest rate. If the owner of the property fails to pay the property taxes (and fees and interest) by the end of the redemption period (typically 1-3 years), the investor (lienholder) can move to foreclosure and eventually take ownership of the property. However, that rarely occurs: In the majority of cases, the taxes are usually paid before the redemption date.
How it Works with TLCs and Auctions
About 20 states offer OTC TLC sales. However, be warned that at least some of the OTCs are (potentially undesirable) “auction leftovers”. Other states conduct auctions, or some hybrid of OTC/TLC and auction. Liens sold at auction (and in some cases those you can buy OTC) may carry the following potential risks:
1. If you are forced to eventually foreclose on a TL property, there may be other liens that already exist against the property; those other liens may prevent you from actually taking possession of the property, and/or owning it free and clear.
2. Even if you get possession of the TL property, you may face unforeseen costs, i.e. to evict the current tenants, for needed repairs or possibly paying any overdue bills (utilities, insurance, HOA, etc.).
3. Bidding wars at auction. It sometimes happens that people get emotionally carried away and wind up overbidding for a lien, thereby setting themselves up to actually lose money down the road.
4. Tax deed vs. Warranty/grant deed warning. In some counties/states, even if you successfully wind up owning the property, you still may not actually have free and clear title to it. That is because the entity may provide you with a “tax deed”; this is not the same thing as a grant or warranty deed. Be on the lookout for this type of situation. It can take time and even more money to turn the tax deed into a grant or warranty deed. Ask your real estate attorney for specific advice about this.
5. TLC investors need to actively vet each property before bidding at auction or buying a TLC OTC. For example, through appropriate due diligence you may discover that the property you are about to bid on was recently ravaged by fire, or has been condemned by the city, or is in an economically depressed area and that has caused the current fair market value of the property to plunge. You could wind up in situation where the dollar amount you bid on the lien is more than the property is actually worth in today’s real estate market. A bad bet to be sure.
Once you become a “lien owner”, there are certain responsibilities you need to be aware of after you receive the TLC or, some cases and states, after you win at auction.
A. Property owner notification: You must let them know in writing of your lien holder status within a stated amount of time.
B. Near the end of the redemption period, you are usually required to send the property owner a second letter of notification, warning them that if full payment is not been made by a date certain, you will be forced to foreclose on the property.
C. Be cautious of any expiration dates as they apply to redemption periods. Once the lien expires, the lien holder (that would be you, the investor) may actually be blocked from collecting any unpaid balances due to you.
Reference: National Tax Lien Association
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