THE HYPE

The first thing we want to point out is that if you expect 50%, 100%, and 1000% returns as portrayed by infomercials and slick web salesmen, you may as well not read any further. Tax lien investing should be looked at as a modest return, lower risk investment. Goals should be set between 10% and 15% as a net return each year. Sure, you may get a foreclosure and hit a home run once in a while, but after your overall costs and almost guaranteed mistakes or foreclosure difficulties, your return will probably match these numbers. If your return is any higher, you have been very diligent in your research, efficient in your due-diligence, and very lucky in foreclosures. Foreclosures do not come easy or often as portrayed in most ‘sales’ literature and seminars.

THE MARKET

Property tax liens are issued by municipal taxing authorities (counties) in return for the payment of delinquent property taxes. For municipalities with poor tax collection rates, the sale of liens not only generates revenue from non-performing assets, but also spares governments the politically awkward chores of eviction and foreclosure. They earn interest as specified by state statutes (8%–50%) and are secured by the underlying real property. The liens are issued when a property is delinquent on its property taxes. This includes industrial, residential, commercial, and specially zoned property and land. These liens are then auctioned on the open marketplace to individuals, firms, large corporations and whoever else shows up at the auctions.

Tax liens are superior to all other liens, including the IRS and mortgages. Tax deeds are the actual conveyance of the real property itself subsequent to foreclosure by the municipal taxing authority.

$7.6 billion dollars in delinquent property taxes are created each year with total size of the market at any given time being in the $20 billion dollar range. There are 566 municipalities that sell municipal liens in NJ alone. The industry is growing at a rate of 8 to 12% per year. There are currently about 31 states that issue tax liens.

MAKING MONEY

There are two types of returns in tax lien investing:

1. Redemption – A lien redeems (pays off) during its redemption period and you make back your principal, fees, and a percentage return on your principal investment. Redemption periods vary state to state and range from a period of one to four years.

2. Foreclosure – taking possession of the underlying property after the property owner has failed to redeem within the redemption period. Foreclosure laws vary from state to state and difficulty of foreclosure is just as varied.

There are various parts of the marketplace where you can make money in one of these two ways. However, almost all ‘product’ begins at the auctions.

Depending on time of redemption, the bidding system and state law, a tax buyer can earn anywhere from 12% to 24% interest the first year by purchasing certificates. Interest earned for the second year can range upwards from 24% to 50%. Each redemption rate of interest can be found in the code or statute of a given tax lien type state. This interest rate is set into law and can only be changed by an act of legislation.

In each case, the individual, estate, or other entity that owes those taxes has a period within which they have absolute right to pay that lien off (redeem). That varies by state (FL is 2 years, SC is 1 year). They pay your principal (what you paid for the lien at the auction), fees (filing, notices, etc), and any penalties that may be issued according to state statute. If they do not redeem the deed within this time period, the lien holder has the right to file for deed. The statutes and procedures vary by state, so refer to the state statutes for exact details and process. The Tax Collector’s office is a good source for this information.

CAUSES OF DELINQUENCY

Understanding the underlying causes of delinquency is important because they reflect the taxpayer's ability to eventually make payment. The following situations are other reasons that taxes are delinquent other than the complete inability to pay.

A.      Taxpayers may miss payments simply because a municipality lacks the resources or expertise to effectively service receivables. These taxpayers will typically pay after the introduction of more aggressive servicing techniques, such as the threat of foreclosure.

B.     Taxpayers that skip payments due to short-term financial distress or temporary lack of liquidity are also likely to redeem outstanding liens. When this type of taxpayer lacks necessary funds or faces more insistent creditors, municipal redemption periods of one or two years typically provide sufficient opportunity for the taxpayers to become current. Because tax obligations are relatively small, these taxpayers generally make payments after their more pressing financial difficulties are resolved.

C.      Some commercial property owners and larger taxpayers do possess sufficient resources for payment, but use delinquency as a form of financing. If the jurisdiction’s delinquency penalties are competitive with the rates charged by regular lenders, a tax lien offers property owners a 'no documentation' loan for the length of the redemption period. 'No documentation loan' delinquencies will realize a high voluntary payment rate, but only as foreclosures become imminent. 

D.      Voluntary redemptions are dramatically lower if the underlying property value is less than the sum of outstanding taxes and other claims on the property. Cash flows from this type of property are limited to liquidation proceeds. If foreclosure and liquidation expenses exceed the property's liquidation proceeds, these properties will not generate any cash flow.

There are other reasons that a property may be tax delinquent but these are the main causes.

IS TAX LIEN INVESTING FOR ME?

There are several questions you must ask yourself first to help determine whether or not you should even be investing in tax liens and by what means.

1. Does this fit my investment goals and strategies?

   • Is an investment instrument that brings the return of 10-20% something that interests me?

   • Can I afford to have capital illiquid for a number of years if that’s how long it might take to redeem or foreclose?

      You should have a YES answer to all of these questions to plan on moving forward
       with tax lien investing.

2. Can I handle the investment?

   • Do I have the time to go to auctions, do due-diligence work, find opportunities, assess data or afford to pay for those services?

   • If I end up with real estate, will I have the means to manage the foreclosure and REO (property realized through foreclosure)?

You should have a YES answer to all of these questions to plan on moving forward with tax lien investing.

3. Do I mind getting my hands dirty?

   • Do I mind competition (and sometimes stiff competition) at an auction?

   • Do I have the wherewithal to deal with the inconsistencies, and sometimes, downright stubbornness of the county?

   • Can I really take someone’s property from them if that is what it comes down to?

       You should have a YES answer to the first two questions to plan on moving forward
       on tax lien investing. You can always pass on taking someone’s property, but you
       will also pass on profits.

TIME & COSTS

Next step in determining whether this is a good investment instrument for you is realizing there is time and costs involved in tax lien investing and requires dedicated funds needed to not only make the purchases with, but to maintain them as well. The level of time and costs will vary and increase depending on your personal involvement and your level of diligence in your research to make good investment decisions.

A. Due-diligence:

You can get a list of tax liens for an upcoming auction, which typically comes out 3 to 4 weeks prior to the sale. Some counties have 10’s of thousands of parcel #’s (Broward Co, FL – approx. 33,000 in 2002). So you can see, time may be of a real issue depending on your capabilities. The list will typically have parcel #’s, owner name, address or legal description, land use, and assessed value. Since this is all the typical investor has available to them, we will work off this. There is other information available sometimes and better ways of obtaining it.

The first tasks will include the following and the amount of time doing this will vary depending on the size of the list.

1. Decide what kind of properties you will bid on

2. Determine amount of investment capital you have for the auction

3. Decide what price range you will bid on

4. Decide what areas you will bid on

5. Mark those on the list

Cost - $0.00 if you use the list that is published in the local paper prior to the sale. They will also
          have a list at the auction and sometimes charge a few bucks for that.

You may then decide that you want to look at these properties, like any smart person would do. How many properties can you drive by in 3 weeks and do you have the time to do it at all. Some people skip this altogether and take their chances by buying based on the list information. You can decide if the added risk in not knowing exactly what you are buying is acceptable because of your time restraints. However, if you are going to look at them, the following time is involved.

1. Decide which properties you are going to look at

2. Map those properties

3. Drive those properties

4. Either make notes on the value of that property and area or just mark yes on properties that seem to be OK. You can also develop your own rating system.

Cost – Gas and film if you are taking pictures and not using a digital camera

If there is a property without an address, you may choose to go to the assessor's or appraiser's office to retrieve tax maps. Tax maps are either aerial or plat maps that identify the exact confines of a property and its exact location. In some municipalities, we recommend getting tax maps for every property you are considering purchasing liens on because of inconsistencies in the county’s address information. Nearly every office has a different system for pulling tax maps but go to the Tax Collectors or Tax Assessors office and ask them. Once you are there doing it, they may do it for you or you may have to do it yourself. Some map systems are very hard to read and finding each property may take 5 to 10 minutes just to locate. So, if you have a list of more than 20 properties that need tax maps, plan on at least a full day to retrieve maps.

1. Have your list of properties to retrieve maps for with parcel or property account numbers ready

2. Pull maps and locate each one

3. Have copies made

4. Map

5. Physically look at property

Now you have your list of what you are bidding on.

B. Auctions:

Some auctions charge a bidder fee but other than that you just need to bring the money you are planning to invest. Some counties require you to pay at the end of the auction for everything and some will allow 24hrs for payment, but I would not count on that. Be prepared to pay at the end of the auction.

Cost – up to $150

C. Servicing:

During the life of your portfolio you are going to have to maintain it if you want a better outcome and this includes filing notices and receiving redemption checks (which takes tracking and accounting). If you are a larger investor and your portfolio is $500,000 or more, it may make sense to hire a professional Servicer to manage your portfolio. Typically this will cost you about 2% of the value of your portfolio each year.

Costs – be prepared to pay filing fees (which vary) and depending on your level of investment you may have to pay subsequent or prior taxes if you want to proceed to foreclosure. These taxes, filing fees and other minor charges from the county are ‘rolled’ up into your initial investment and you will earn interest on that as well.

RULES OF THE GAME

Ground Rules

Ground rules are handouts, mail outs or information given to potential investors from county governments outlining the requirements for the sale. Information usually included in these ground rules are time, place and date of sale; deposit requirements, if any; interest rate; redemption periods; bidding system; bidding increments; and/or summarization of statutes. These ground rules do not necessarily teach you how to become a successful tax lien investor and will not include very specific information about all the other aspects of investing, filing deeds, filing notices, or foreclosure details, etc.

To find out what the exact rules are on tax lien investing and foreclosure laws for your area, refer to your state statutes. Some counties or state websites will have this information posted or the Tax Collector’s office may provide all of this information to you as well.

Registering For The Sale

Procedure varies by county. You must have a social security or tax ID number and complete a W-9 form (W-8 form for foreign individuals or entities).  In addition, the county may require their own registration form for general contact information.

Also know as a Buyer Number, a bidder number is assigned by the Tax Collector at the time of registration, similar to an account number allows you to bid under that number.  In most counties your bidder number stays the same from year to year. You may have more than one bidder number if you want to have two separate portfolios. When you win a successful bid, that bid will be assigned to your number for that particular parcel.

Bidding Systems

Some states bid-down an interest rate, meaning that bidding starts at a particular percentage (in FL 18%) and participants bid in increments. The bidder willing to take the least amount of interest on the money owed wins the bid. If you bid 10% on a particular tax lien, you get that rate of return over the redemption period. If the lien is paid off in 1 year and the lien was $10,000, then you will make $1,000 plus filing fees and sometimes other penalties.

Other states are over-bid. Bidding starts at the amount of taxes owed and bids up from there. This may continue to bid up to assessed value or more depending on the competition. You will then have to pay the taxes owed and place as a ‘good faith’ deposit the amount of the overbid. You may only have to place a percentage of this overbid as a deposit and the amount of interest you earn and the amount earned on will vary.  

Some states, such as NJ, are a mixture of both type auctions where bidding will start at a percentage rate, bid down to zero and then bidding with a premium attached begins. Both these type states obviously require more investment capital and are not recommended for beginners.

COMPETITION

There are basically 5 different groups at the auctions.

A.      Spectators (25-35%)

B.      ‘Mom & Pops’ (45-55%)

C.      Local real estate ‘experts’ (10%)

D.      Mid size portfolio holders (5%)

E.      Institutional and corporate investors (including banks) (1-2%)

Characteristics of auctions vary from place to place, but the above is a close scenario to what you will experience at nearly all auctions. Over the last several years, the Institutional and Corporate investors have created the most competition.

DEVELOPING AN INVESTMENT STRATEGY

In general you can choose the type properties you are willing to purchase liens on and then do one of three things. Set you investments geared on buying liens that are more likely to foreclose or that are more likely to redeem. However, if you are a bit more sophisticated in your strategy and want to try and realize foreclosure but also want a relatively steady cash flow in the interim, you may want to do both. Once you think you have a strategy down for buying liens that are more likely to redeem, you can allocate a certain percentage of your funds to purchasing those type liens. Then you can allocate the rest into purchases that are more likely to foreclose and wait out the redemption period or purchase more mature liens. This is not an exact science, but it is likely if you have an interest and inclination to do so, that you will consider the following information when determining a bidding strategy for yourself.

CALCULATING REDEMPTION & RISKS

The reason we are mentioning risk here is the acceptance or avoidance of risk is strategy in itself. If you accept the risk of investing in liens in general and on certain properties, then you must have a plan with dealing with the reality that may come from that risk. Many situations can be overcome if you have the means to deal with it, some will plainly be a loss or write-off, and a few could become ‘nightmarish’. Although the likelihood of redemption can be assessed to some extent, we will consider the advantages and disadvantages as if they were on foreclosures, since that is where your potential for single largest profits and single largest losses are.

Vacant residential –

Potential Advantages

1. You know exactly what your getting

2. If large enough you can divide into multiple lots, potentially increasing your investment

3. Clean slate for development

4. In some areas, these resell like hotcakes

Potential Disadvantages

1. If next to or very near a gas station or other potential EPA risks, there could be an EPA risk for the lot as well

2. Many times, these lots are unkempt and get fines piled on by the city for the owner not maintaining the property

3. There can be zoning issues that arise since no structure is currently there when trying to build something new. If the city so desires, they can change or deny zoning for the property because of this

Vacant Commercial –

Potential Advantages and Disadvantages are same as above with zoning and EPA issues being potentially larger problems

Vacant Industrial –

Potential Advantages and Disadvantages are same as above with zoning and EPA issues being potentially much larger problems. Selling land zoned industrial can be very difficult because of these potential issues, especially since it is likely that there are EPA issues with the property itself.

Common Areas & Easements –

Potential Advantages

1. None

Potential Disadvantages

1. Impossible to develop

2. Impossible to sell

Zoned Other – usually parks or schools

Potential Advantages

1. Better have a good lawyer

Potential Disadvantages

1. Better have a good lawyer

However, if you are able to look further into the properties that are zoned ‘Other’ you may locate a good find – something that is very likely to pay off or is just a strange, but marketable commercial property. If there is good data from the county and you have the ability to dig a little, I would not necessarily discount these.

Government & University Land

Don’t even think about it

Mobile Homes

The potential advantages are not very significant, either they are going to pay off or they are not with one potentially big problem – they can drive off at any time if they are not one of the larger affixed mobile homes

Residential

Potential Advantages

1. Large profit potential

2. Likely to pay off if ‘Lien-To-Value” is low

3. Can provide for good rehab opportunities, thus providing flip or income property

Potential Disadvantages

1. House burns or is destroyed in some other way and the resulting property is worth less than the lien you bought plus any priors or subs you may have to pay off to foreclose

2. Bankruptcies and other legal issues – these can pop up but are usually listed in the information with the county. But they can occur between the time you buy the lien and redemption period end

3. You have to choose whether or not you want to take a loss or take some poor old ladies home. Its something you may have to deal with. Just the truth here folks.

Commercial Property

Potential Advantages and Disadvantages are basically the same with EPA risks being an issue depending on type property. You will see a higher rate of foreclosure on lesser quality properties due to the higher likelihood that it may become a write-off for a corporation or individual if the ‘Lien-To-Value’ is higher. Remember though, it typically takes a lot more knowledge and effort to rehab a commercial property

Industrial Property

These are always a bit risky due to zoning restrictions, potential EPA risks, and the marketability of such properties. If the business looks to be in good shape, ‘Lien-To-Value’ is not exceptionally high, and there are no large EPA or zoning issues, they are likely to pay off. If you end up in foreclosure and the lien has not cost you that much, as long as you can fund the asset until it sells or re-leases, you probably made a lot of money.

Government & University Property

Don’t even think about it

AFTERWARDS

Prior Taxes

If a redemption period expires and you gain the right to file tax deed, you may need to pay off prior years to file deed. This then becomes another investment. The Clerk’s office or Tax Collector’s office will provide this information once you claim interest in filing deed. You must determine investment vs. market value, then decide if it is worth it to continue with filing the tax deed and subsequent foreclosure, if available. If not, you will hope that some other lien holder from another year will find it worth it to do so or the property owner eventually pays off the lien. Otherwise, you may be stuck with your investment.

Subsequent Taxes

When property owners become delinquent in paying their taxes, these are called defaulted, delinquent, or back taxes. If taxes aren't paid the second, third or fourth year, these are called subsequent taxes. In some states a tax purchaser is required to pay these subsequent taxes, thus resulting in an increased investment. Some states will have a subsequent tax sale and the original tax purchaser is redeemed. In others, you may lose your investment for failure to pay these taxes. All states have their peculiarities on the procedures for handling these subsequent taxes. You will earn interest on subsequent taxes.

Tax Deed Process

Tax Deeds are issued by the Clerk of the Court. Once the redemption period has passed and all subsequent or prior taxes are satisfied, if need be, the right to file deed becomes realized. In some states, such as SC, the deed is immediately issued upon the filing of deed. In other states, such as FL, the deed is then placed on the tax sale roll for the deed to be auctioned at a tax deed sale. The actual sale may not occur for that particular property for a number of months, but in most states you will earn the maximum interest on total taxes owed during that time period. You may still  be outbid at the tax deed sale by a competitive bidder, since the sales are held as an open marketplace as well. They will then in turn pay everything that is owed to you. So, its still not such a bad deal.

Notices & Foreclosure

Notices are of the extreme utmost importance. Giving the proper notices is just as important as bidding. If you are the successful bidder on a valuable piece of property and you acquire this property, you can lose everything if you have failed to give the proper notices. In some counties, the treasurer, tax collector or auditor will perform this task for you. However, it is your responsibility to get these procedures done, even reminding the county official to do this.

In every state code or statute there are notice requirements. Mortgagees, lien holders, creditors, heirs, owners of record, etc. that have an interest in property are called "interested parties." All interested parties have to be notified, either by publication, certified mail, by personal service by sheriff or just a posting. If interested parties aren't notified as prescribed by law, then tax buyer will not receive a deed, or deed will be attacked at a later date. Each state's statutes or codes always have sections pertaining to the requirements for notification of interested parties. Some of these requirements are in detail. These notices are given not only for the benefit of the property owner, but for the interested parties. This is due process of law. These notices give the interest parties the right to "not lose their property at a tax sale, or the right to redeem or recover ownership of their property or interest in property."

If all notices are given properly and you are not redeemed, then that is just too bad for the interested parties. You will receive the property. Interested parties forfeit ownership to property for a multitude of reasons.

Title Issues

Title insurance companies will not insure a tax deed. In some cases they may insure the title after the tax deed has been issued for 4 years, others say they will after 20 years. If you want to sell the property and offer title insurance you must file a Quiet Title Suit. The Quiet Title process is not complicated, but it will require hiring an attorney. It is recommended that you use a company/attorney that specialize in Quiet Title Suits. The minimum fee is $300 - $500 for a non-contested suit. If the former owner files an answer this will require more of the attorneys time and possibly appearing in court for a hearing, increasing your cost.

During the tax deed process a title search is conducted on the property, you paid for it and you have a right to obtain a copy of it. Make sure you always get a copy. It will be helpful and should save you additional expense in the event you chose to file for a quiet title. It is also recommended that you write letters to former owners and offering to pay them a small fee ($100 - $200.) in exchange for them signing a Quit-Claim Deed. This will avoid the Quiet Title Suit and their name being published in the paper. Few will take you up on your offer, but it is well worth the try, and you get to at least verify their address so your attorney can serve them with notice if you file the Quiet Title Suit. If you receive and record a Quit-Claim Deed you can offer title insurance.

CONCLUSION

Indisputable References

> United States Constitution, IV, Sec. 3(2); plus the V, IX & X Amendments

> United States Supreme Court, Chief Justice Marshall, McCulloch v. MD (1819)

> United States Court of Appeals 5th Circuit, 554 F.2d. 216 (1977)

> United States Court of Appeals, 2nd Circuit, Mikulec v. IRS (1983)

> United States District Court, Birdville v. Hurst, RTC, FSLIC, General Elect. (1992)

> Internal Revenue Service Code, Reg. 301-6323 (states tax liens are superior to IRS liens)

> Article III of the Uniform Commercial Code (UCC) - as adopted in all 50 states