Investing in Property Tax Liens

The increasing volatility of the stock market—combined with still historically low interest rates—has caused many investors to seek alternative avenues that can provide a decent rate of return. One investment niche that is often overlooked is property tax liens.

This unique opportunity can provide knowledgeable investors with excellent rates of return in some case. Property liens can also carry substantial risk; novice buyers need to understand the rules and potential pitfalls that come with this type of asset.

When a landowner fails to pay the taxes on his or her property, then the city or county in which the property is located has the authority to place a lien on the property. A lien is a legal claim against the property for the unpaid owed amount. Property that has a lien attached to it cannot be sold or refinanced until the taxes are paid and the lien is removed.

Similar to how actual properties can be bought/sold at auctions, these property tax liens can be purchased as well. In 2017, approximately $14 billion in property taxes were not paid, according to Brad Westover, executive director of the National Tax Lien Association (NTLA). About a third of those liens are subsequently sold off to private investors. Local governments benefit from private sales because they immediately recoup the monies owed on the property in question. Thirty states sell tax lien certificates, Westover says.

Westover has no national numbers for 2018, but he notes that in the state of Florida, unpaid property taxes dropped from $1.2 billion in 2008 to $740 million in 2018, "almost half of what it was at the peak," and that drop in availability of liens for investors is likely a national trend. "With a healthy economy, it makes sense that more people are paying their property taxes," he says.

When a lien is issued, a tax lien certificate is created by the municipality that reflects the amount that is owed on the property, plus any interest or penalties that are due. These certificates are then auctioned off and subsequently issued to the highest bidding investor. Tax liens can be purchased for as little as a few hundred dollars for very small properties, but the majority cost much more.

The auctions may be held in a physical setting or online, and investors may either bid down on the interest rate on the lien or bid up a premium that they will pay for it. The investor who is willing to accept the lowest rate of interest or pay the highest premium will be awarded the lien. It should be noted that buyers often get into bidding wars over a given property, which will drive down the rate of return that is reaped by the winning buyer.

While the national foreclosure rate on properties with tax liens is only about 4%, according to Westover, buyers need to be cognizant of the cost of repairs and other unknowns that they may need to pay if they assume ownership of the property. Those who then own these properties may have to deal with unpleasant tasks, such as evicting the current occupants, which may require expensive assistance from a property manager or an attorney.

Those who are interested in purchasing a tax lien can start by deciding on which type of property they would like to hold a lien, such as residential or commercial, or undeveloped land versus property with improvements. They can then contact their city or county treasurer to find out when, where, and how the next auction will be held. The treasurer’s office can tell the investor where to get a list of property liens that are scheduled to be auctioned, as well as the rules for how the sale will be conducted. These rules will outline any preregistration requirements, accepted methods of payment, and other pertinent details.

Buyers also need to do due diligence on properties that are available, because in some cases the current value of the property can be less than the amount of the lien. The NTLA advises dividing the face amount of the delinquent tax lien by the market value of the property. If the ratio is above 4%, potential buyers should stay away from that property. Furthermore, there could also be other liens on the property that will prevent the bidder from taking ownership of it.

Every piece of real estate in a given county with a tax lien is assigned a number within its respective parcel. Buyers can look for these liens by number in order to obtain information about them from the county, which can often be done online. For each number, the county has the property address, the name of the owner, the assessed value of the property, the legal description, and a breakdown of the condition of the property and any structures located on the premises.

Investors who purchase property tax liens are typically required to immediately pay the amount of the lien in full back to the issuing municipality. In all but two states, the tax lien issuer collects the principal, interest, and any penalties; pays the lien certificate holder; and collects the lien certificate if it’s not on file. The property owner must repay the investor the entire amount of the lien plus interest, which can range anywhere from 5% to 36% (the rate will vary from one state to another) but is typically between 10% and 12%. If the investor paid a premium for the lien, this may be added to the amount that is repaid in some instances. 

The repayment schedule usually lasts anywhere from six months to three years. In most cases, the owner is able to pay the lien in full. If the owner cannot pay the lien by the deadline, the investor has the authority to foreclose on the property just as the municipality would have, although this is a fairly rare occurrence.

Although property tax liens can yield substantial rates of interest, investors need to do their homework before wading into this arena. Tax liens are generally inappropriate for novice investors or those with little experience in or knowledge of real estate.

Investors also need to be familiar with the actual property upon which the lien has been placed to ensure that they can collect the money from the owner. A dilapidated property located in the heart of a slum neighborhood is probably not a good buy, regardless of the interest rate that is promised, because the property owner may be completely unable or unwilling to pay the tax that is owed. Properties that have suffered any kind of environmental damage, such as from chemicals or hazardous materials that were deposited there, are also generally undesirable.

Lien owners need to know what their responsibilities are after they receive their certificates. They must usually notify the property owner in writing of their purchase within a stated amount of time, then they must send a second letter of notification to them near the end of the redemption period if payment has not been made in full by that time.

Tax liens are also not everlasting instruments. Many have an expiration date after a certain period of time has elapsed after the end of the redemption period. Once the lien expires, the lien holder becomes unable to collect any unpaid balance. If the property goes into foreclosure, the lien holder may discover there are other liens on the property, which can make it impossible to obtain the title.

Many commercial institutions, such as banks and hedge funds, have become interested in property liens. They’ve been able to outbid the competition and drive down yields. This has made it harder for individual investors to find profitable liens, and some have given up as a result. However, there are also some funds now available that invest in liens, and this can be a good way for a novice investor to break into this arena with a lower degree of risk.

Property tax liens can be a viable investment alternative for experienced investors familiar with the real estate market. Those who know what they are doing and take the time to research the properties upon which they buy liens can generate substantial profits over time. However, the potential risks render this arena inappropriate for unsophisticated investors.

Westover calls property tax liens "good opportunities for those that are educated, wise, and savvy—and a terrible investment for those that do not do proper due diligence. If you buy swampland in Florida or desert land in Arizona that has no value, chances are that the owner won't redeem [by paying their taxes to you with interest] and the land you get will have no value." For more information on property tax liens, consult your real estate agent or financial adviser.