Now that the Great Recession of 2007-2009 is in the past, people have more money to invest in their future. Those people are looking for safe and lucrative investment vehicles. For some, a property tax lien investment can be just the thing. If you’re considering getting into this kind of investment, you’ll need to understand the basics of how it works.
Tax lien investing in a nutshell
A “lien” acts as a legal restriction that prohibits the sale of a property until the owner pays off a delinquent financial obligation. Property liens are issued for a variety of reasons, including a court judgment or, in this case, the failure of the property owner to pay property taxes. These liens are created by the government entity responsible for collecting those taxes.
Municipal governments levy property taxes on property owners to raise money for public purposes. When those taxes go unpaid, the municipality loses the revenue it needs to maintain its public obligations. State laws allow governments to sell the property tax debts owed to them in order to recoup that lost revenue. Buyers of the debt will pay it off in full, so the municipality no longer has an interest in the property. The buyer can then collect the value of the debt, plus interest and any other fees that might be available, from the property owner. A redemption period of anywhere from six months to three years follows the sale, during which the property owner must pay back the debt. If they fail to do so, the lien holder can force the sale of the property (a “foreclosure”) to recoup the outstanding amount still owed.
Tax lien sale terms are governed by state law
There are two kinds of tax liens, and each state has passed laws regarding which type is available in their jurisdictions.
Tax Lien Certificates: Some states allow for the sale of a Tax Lien Certificate, where the purchaser buys only the lien and may also have to pay a fee or premium to the government.
Tax Deeds: Other states allow for the sale of a tax deed, where the purchaser buys the tax debt as well as the property. The investment value is much higher for a tax deed property, but the new owner can use the property for other financial opportunities, such as a rental property.
Some states permit payment of a “premium” (fee) when purchasing a tax lien. In a tax lien auction, the person who is willing to pay the highest premium will win the auction. The premium gives the government entity extra cash and is eventually collected as part of the total debt owed by the delinquent property owner.
Interest rates vary widely, again based on state law. Most are around 12 to 18 percent annually.
Repayment of both types of liens includes the principal (the amount of the taxes), interest (usually set by state law), and sometimes fees that the lien holder was required to pay when purchasing the property.
Benefits of tax lien investments
From an investor point of view, a tax lien investment often offers a reduced risk of loss since there is only one entity — the property owner — responsible for repayment of the debt. Other investment vehicles are often dependent on the actions of numerous people or corporations to generate the revenue necessary to repay the investment, and there are many things that can go wrong at any stage of that investing process.
Also, interest rates on tax lien investments are usually much higher than those available through more traditional investments, and the return on the investment can happen in as little as six months. Recouping on more traditional investments frequently takes much longer to accomplish.
Challenges of tax lien investing
Especially for tax lien certificates, lien holders who are not familiar with real estate and real estate laws can find themselves on the losing end of the investment.
- Collecting is not always easy: The tax lien exists because the original property owner did not pay the taxes. Those property owners aren’t offering any assurance that they will pay that debt now, either, and the redemption period may come and go with no repayment made. When that happens, and the lien is still not fully repaid, the certificate holder can force a foreclosure sale to recoup the balance due. Foreclosure sales, however, take time and are usually managed through an auction process. The desired result of the auction — sale of the property — may not yield sufficient revenue to clear the lien.
- Not all properties are alike: The location of the property can affect its lien value and the opportunity to capture the return on investment. Properties in desirable locations have more value. In the event of a foreclosure sale, for example, a waterfront home will have a higher value than an undeveloped plot of land sitting in a swamp. Investors who are interested in taking on a tax lien certificate should do their research regarding the location and value of the subject property.
Understanding local rules is critical
All jurisdictions have rules that must be followed precisely in order to recoup a tax lien certificate. Most require that the property owner receive notification of the transfer of the lien, and may also require subsequent notices regarding the expiration of the redemption period or other lien-related details. Failure to comply with the rules may invalidate the lien, and require additional actions by the lien holder to reinstate it. If there is an expiration date and the lien holder fails to execute the lien before that date, the lien may expire completely and leave the lien holder with no other option except to accept the loss.
Tax liens offer an interesting and engaging investment opportunity
For many investors, a tax lien investment can act as two investments: one in a financial transaction and the other in a real estate transaction. At the Matterhorn Group, we specialize in Tax Lien investing and can help you engage in this exciting investment opportunity. To learn more, call us at (708) 588-9611 or contact us online.