Property tax lien investing is growing in popularity among savvy investors because it allows them to invest in real estate without actually having to experience the headache and uncertainty of owning property. It is also desirable because of the relatively low-risk associated with investing directly with local governments.
For those looking to diversify their investment portfolio through this centuries-old government program, this article will outline what a tax lien is, what property tax lien investing means, the benefits and risks associated with it, and how to get started in property tax lien investing.
What is a Tax Lien
In short, a tax lien is a legal claim that a local government makes on a property where the homeowner has failed to pay property taxes.
Governments prioritize tax payments because the money collected is used to pay for essential services such as police, fire, hospitals, libraries, garbage collection, etc. When homeowners fail to pay their taxes, the local county has the authority to place a lien on the property, which prevents the property owner from selling or refinancing the property until the back taxes are paid.
What is Property Tax Lien Investing
The property tax lien investing process starts when homeowners fail to pay taxes and the local government places a lien on the property and produces a tax lien certificate, which is then sold at auction.
This certificate represents the amount of taxes owing, plus a high rate of interest. The interest rate varies depending on the location of the property, but can range anywhere from 12% to as high as 36%.
Property tax lien certificate auctions and interest rates vary from state to state and county to county, but in general, bidding begins at the amount of back taxes owed. One of two things will happen when an investor wins the auction and is awarded a certificate:
- The homeowner will redeem the certificate by paying the back taxes, plus a high rate of interest (dependent on local laws), and penalties. In this case, the local government then issues the lien certificate owner (investor) a check for the amount of back taxes plus the designated interest rate; or
- If the homeowner fails to pay the taxes, the certificate owner/investor has the right to foreclose on the property and is free to do with the property as they wish. This could include living on the property, renting the property out as passive income, fixing it up and selling it at market value, or selling it as-is at a steeply discounted rate from market value.
In short, the investor either makes a guaranteed 12% – 36% profit on their investment, or they make an even greater profit by selling the property that they paid pennies on the dollar for.
Do all States or Counties Sell Tax Lien Certificates?
Not all states or counties offer tax lien certificates for tax-defaulted property. In less benevolent states, the government has the authority to seize the homeowner’s property and sell it at a tax deed auction when the homeowner fails to pay their property taxes.
These are referred to as tax deed states. Approximately half the states in the U.S. are tax deed states, with the other half being tax lien states, and within both of those categories are states with a hybrid system.
Benefits of Property Tax Lien Investing
High ROI
From the standpoint of making a profit, property tax lien investing offers a healthy return on investment. Interest earned can range anywhere from 12% to 36% depending on where the property is located. It should be noted however that some auctions work on a bid-down basis – in other words, investors ‘bid down’ the interest rate they are willing to receive on their investment.
No Property to Manage or Sell
Property tax lien investing is a near-perfect real estate investment for those who don’t want the hassle of actually owning real estate. The investor is bidding to own the lien on the property, not the deed to the property, as in the case of property tax deed investing. Historically, homeowners redeem the lien on the property by paying their back taxes plus interest and penalties, which you collect from the local government.
Relatively Low Risk
Your investment is secured by the property itself, so you will make a healthy profit either way. You invest with the government, not a third party. By law, you either get your investment back plus the state/county-mandated interest rate, or you get the property, which you paid pennies on the dollar for and can now sell for at or near-market value.
Risks of Property Tax Lien Investing
As with any investment, property tax lien investing is not without its risks. Before you dive headfirst into it, be well aware of potential pitfalls and educate yourself on how to avoid them.
You May End Up With Property
About 97% of homeowners will pay their property taxes before the deadline to foreclose, so the chances that you will end up with property is quite slim, but the possibility still exists. Before you bid, get very clear on your exit strategy. Fortunately, even if you sold the property as-is at a steeply discounted price, you still stand to make a healthy profit on your investment.
Neglected or Worthless Property
A homeowner may allow their property to go into foreclosure when they discover that the property holds very little value. There may be environmental issues or zoning complications, or any number of reasons that would make the property nearly impossible to sell.
Even though a tax lien certificate does not make you the owner of a property, if that certificate expires, you do become the owner and are now responsible for the maintenance and taxes going forward.
This risk highlights the importance of doing your homework and researching the property you want to bid on well before the auction date.
How to Get Started in Property Tax Lien Investing
If after weighing the pros and cons of property tax lien investing you would like to get involved, how do you get started?
Your first step should always be to educate yourself as much as possible about this real estate investment opportunity. What are the auction rules in the state or county that you want to invest in? What is your budget?
In this blog, we explored property tax lien investing from a very high level. There are several details and strategies that still need to be explored if you are going to successfully invest.
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Property Tax Lien Investing – Conclusion
Property tax lien investing can be a lucrative business and an excellent addition to your investment portfolio. Understand the risk, do your research, and find a professional expert to mentor you through the process.