For Newbies

How Real Estate Investors Handle Tax Lien Leads

How Real Estate Investors Handle Tax Lien Leads

Real estate investors have a drill for targeting tax-delinquent properties: you get the list of properties from the county, you reach out to find motivated sellers with a marketing campaign, you deliver your pitch, and you close the deal. This is fairly standard, and every investor knows it.

Tax lien leads allow real estate investors to make a profit through an alternative route. In a perfect scenario, investors get to repossess a property by covering its due taxes. You literally buy a house for pennies on the dollar, however, for this to take place, many other aspects of the investment have to align.

There are a lot of “ifs” and we’ll examine most of them in the text that follows.

Tax Lien Basics

Tax liens are issued by the local government as a means to collect delinquent property taxes from property owners. They are also known as tax lien certificates, tax executions, or tax sale certificates.

In essence, tax liens are debt collection instruments. The county is only interested in collecting due property taxes, they don’t need or want the property itself, although, if the tax is not paid within a set period (2-5 years, State laws vary) the local government can initiate tax foreclosure.   

Since the focus of the local government is to collect taxes, counties offer tax liens to investors at a public auction. It’s how counties delegate debt collection to other entities – anyone can purchase the tax debt at the auction. Why do investors buy tax debt? Well, investors pay the due amount to the county, and from that point on, the homeowner has to repay the tax debt to the investor, plus interest. The incentive for purchasing someone else’s property tax debt is the interest on the debt, which in some cases can be as high as 18% (more on this below).  

 Before we take a look at auctions and the debt collection process itself, let’s discuss the opportunity for investors.

What’s the Appeal of Tax Liens for Real Estate Investors?

Investors have two motives to get into tax lien properties: profit from the interest rate (if the property owner pays) or property repossession through tax foreclosure (if the property owner doesn’t pay).

Let’s put profit from tax liens into perspective. Generally speaking, within a couple of years, the accrued tax debt for a property is in the thousands of dollars (< $10.000), while the value of the property is in the tens of thousands of dollars (sometimes > $100.000). If the property is owned free and clear, and the property owner doesn’t repay the tax lien, a real estate investor gets the property way below the market price. Even if there is a mortgage on the house, tax liens can be a great way to increase your real estate investing portfolio.

However, property owners hardly ever allow their tax liens to result in tax foreclosure. Exact figures differ by state, but less than 5% of tax liens end up with repossession of property. Does that mean that real estate investors lose their capital in 95% of the cases? Of course not. As we mentioned earlier, the property owner pays the debt plus interest, so the real estate investor will walk out with the interest.

Interest rates for the tax liens are determined by state laws:

Interest rates vary by the jurisdiction or state where offered. For example, Florida offers a maximum interest rate of 18%, while Alabama offers a fixed rate of 12%. Arizona has an interest ceiling of 16%, while Iowa offers 2% per month on the unpaid balance.

And before you start calculating returns per maximum interest rates in your state, do note that interest rates are further reduced in the auction. It’s a competitive bidding process, where investors can “bid down” in order to buy the tax lien. In fact, investors with deep pockets can place bids with really low interest rates with the intent to box out small investors like yourself at live auctions (more on this in the next section). 

Even if you get the tax lien, you have to complete certain procedures within a set time frame to profit from it.

Tax Liens: The Auction   

The county sells tax liens to bidders based on two types of criteria:

  • the highest cash offer, or
  • the lowest interest rate.

 

Investors either bid with cash offers that go up during the auction, or they bid down against each other to the lowest interest rate that’s acceptable for them. As with PPC marketing for getting house seller leads, bidding wars are a big no. In tax lien investing, a bidding war can pressure you to bid down the interest rate to a level that makes the whole investment not worth the effort.

Risks of Tax Lien Investing

This brings us to the most important “if” of tax lien investing – the risks. I mean, if the process was easy and the returns were guaranteed, everyone would be making money off of tax liens. Unfortunately, it isn’t so, and some of the risks associated with tax liens aren’t even apparent until you’re well into the process.

In no particular order, these risks are:

 

  • Lien is more expensive than the property itself – it’s rare, but it can happen. Sometimes the market value of the tax delinquent property is lower than the amount of taxes due. In this case, you basically don’t have collateral for the debt, and if the owner doesn’t pay you, you’ll suffer a loss.

 

  • Liens can be stacked – one on top of the other. As a lienholder you’ll be responsible for covering all subsequent liens that are issued for the same property, be they tax-related or not. The owner may take other loans using the property as collateral, so you might need to pay more debt than what was originally due when you bought the lien. You have to settle all of them before you can transfer the property to yourself through foreclosure.

 

  • The property can be in grave distress – homeowners aren’t motivated to pay taxes on environmentally damaged properties, and you might land on a lien for such property. As a real estate investor, you’ve probably seen a lot of code violation properties, and you can quickly estimate rehab costs, however, we are talking about getting rid of hazardous materials like gas or chemicals here.

 

  • Hefty property expenses – your end goal is to acquire the property, but you have to clear the property from all debts before you can do that. We mentioned the possibility of multiple liens above. You might need to cover penalties, legal fees, costs and expenses as well, and they not only make a dent in your profit, but they can also turn the whole investment into a loss.

 

  • Procedural errors – failure to comply with tax lien process regulation may jeopardize your investment. This is quite sneaky. State legislature differs greatly, and if you miss a deadline in the process, the lien is null and void. We’ll look into this next.

Tax Liens: The Process

Tax sale regulation is different across US states – this can’t be overstated. Only 30 (or so) states sell tax liens and you need to read the fine print in these regulations to understand the intricacies of the process. Let’s break down some of the basics.

Redemption Period

Property owners are granted a period in which they can pay the tax lien and reclaim their property. This is known as the redemption period and is regulated by state laws. The lienholder has to inform the property owner that the redemption period has started, usually through a letter.

Expiration Date

Liens have an expiration date. This date comes after the redemption period, so both the lienholder and the property owner have to take action within a set time frame. If the property owner hasn’t paid the lien (tax + interest), the lienholder has to start foreclosure to collect the debt. Failure to initiate foreclosure before the expiration date results in debt forgiveness: the tax lien has expired and everyone is back to zero.

Tax Lien Technicalities

Lienholders need to adhere to strict procedures. Some of these procedures are easy to follow, for example notifying the property owner via a letter about the action they need to take before you go to the next step. However, if you don’t follow the procedure, your investment can fail, on a technicality.

Sometimes, the differences between State legislatures on procedures for dealing with tax delinquent properties can be big: some states issue tax deeds instead of tax liens.  

Tax Liens vs Tax Deeds

Now, there are tax deed States, too. Tax liens and tax deeds are both tax based investments in property, however, the procedure is different.

When you purchase a tax lien, the property owner can redeem the lien by paying back due taxes and interest to you. This implies that the lienholder doesn’t own the property until they are through with the foreclosure process.

On the other hand, tax deeds transfer the rights to the property to the deed holder. So, in a tax deed State, you can buy the property at an auction – then and there. This type of auction can trigger a real bidding war, and the bids might come close to the actual market value of the property.

In general terms, tax lien investing is for investors who are focused on profits from charging interest on someone else’s debt, and tax deed investing is for investors who are after property investment. That’s not to say that you can’t get the property through tax lien, rather the process to do so takes more time, more patience, and involves higher risk. On the flip side, tax liens are very affordable, while tax deeds depend on the availability of high amounts of cash.

Redeemable Tax Deeds

There is such a thing as redeemable tax deeds – they combine elements from the process for both tax liens and tax deeds. Usually, the investor in redeemable tax deeds has the right to the property right away, but if the original property owner pays the due tax, accrued interest, and heavy penalties, they can redeem the deed.

Due Diligence on Tax Liens

As you can see, tax lien investing is not a simple feat. However, your knowledge and experience in real estate investing can help you prepare for the auction in advance. You are already familiar with the ways to get the tax delinquent property list, which is within your legal rights.

Once you have the list you can research each property. There is no secret method to single out properties whose tax liens are worth investing in. You can even find investors who share their methods on social networks: it’s an exercise in filtering property data. The county can provide their estimate of the value of the property, however, they are not appraisers and they aren’t interested in the property itself, so you should double-check the listed property appreciation. Also, counties set the minimum bid amount for a tax lien (the opening bid), and this is an indication about the taxes which are due for that property.

Tax Lien Investing Strategy

Real estate investors choose a strategy that is in line with their goals. Often, they’ll pick half a dozen tax liens to place a bid on. This is because most property owners end up redeeming their houses, while real estate investors want to get a property when they buy a tax lien. As tax liens mature, homeowners pay their debts, and only a small fraction goes through to tax foreclosure.

On top of that, it takes years for a tax lien to mature. Depending on the state laws, this can be a period from 6 months to 3 years. So, it’s recommended to develop a long-term tax lien investing strategy before you attend an auction. Going after multiple tax liens is a way to diversify your portfolio, but you should introduce other steps for risk mitigation as well. Remember, some of these properties will incur costs further down the line.

Another useful tip for tax lien auctions is to determine your highest bid for each property before you enter the town hall. The preparation is time-consuming because you have to factor in all sorts of data, but setting a budget and maximum bid amount in advance is crucial to avoid taking part in a bidding war. Otherwise, emotions take over and you can make a costly mistake. Failure to pay the amount for the tax lien right after the auction can get you penalized.

Competition at Tax Lien Auctions

Real estate investors are used to dealing with strong competition: each lead in their pipeline probably talks to other investors as well. However, at a tax lien auction, you will also find people who are investors in financial instruments (as opposed to real estate investors).

People buy debts to collect interest on the principal amount that was borrowed. You know this from your interactions with private lenders, they lend you money because of the interest you’ll payback. Well, this concept is used in other financial investments as well – people invest in private equity for the same reasons.

However, stocks and bonds carry a significant amount of risk, so investors turn to debts that are backed by collateral, and real estate is one of the safest types of collateral there is. Investors escape stock market volatility by purchasing tax liens backed by the value of the property.

Motivated Homeowner vs Motivated Seller

While real estate investors launch marketing campaigns to find motivated house sellers, finance investors are after motivated homeowners. Motivated homeowner is a property owner who wants to keep their property, so they are willing to pay back the tax lien and interest to the lienholder.

Sometimes people are motivated homeowners for the exact same reason others are motivated house sellers – because they can’t sell the house, they can’t refinance their mortgage, nor can they take other loans until they clear out the lien on the property. Also, tax liens reduce the homeowners personal credit score, so there’s another incentive to redeem the property as soon as possible.

Why Finance Investors Buy Tax Liens

Tax liens have high interest rates (double digits). Compared to other credit products, like certificates of deposit, tax liens can provide high yield returns.

Also, tax liens are an active form of investing – you need to comply with all those procedures we listed above. Finance investors are more inclined to active investments relative to real estate investors. While real estate investors might need help from lawyers and experts to deal with additional liens on the property to clear the property title, for finance investors, solving this type of issues is second nature.

Keep this in mind as you rub shoulders with finance investors at tax lien auctions.

Tax Lien Groups

Aside from finance investors, all sorts of real estate trusts and groups participate in tax lien auctions. The biggest organization doing this is the National Tax Lien Association (NTLA) and more than 80% of tax liens end up being sold to their members. Membership plans start from $500 and investors get access to educational resources and reports through the NTLA.

Consider Your Motive for Tax Lien Investing

Before you go and place bids on tax lien auctions, make sure you are fine with all potential outcomes. What’s your motive for buying tax liens? If you are after the interest payments, you can consider becoming a private lender yourself.

If you want to diversify your investments, while potentially getting a property below its market price, tax lien is the right way to go. For some real estate investors, this is the best way to tie up money outside of their main business operations. For example, investors who’ve already put a lot of money in a rehab project, and they want to diversify their portfolio by investing in tax liens.

When the property owner redeems the tax lien, you get interest, and when they fail to pay, you get the property. It’s a win-win situation. Although there are other ways to process properties from the tax delinquent list.

How Real Estate Investors Handle Tax Lien Leads

There are two ways to deal with tax-delinquent properties. We started this piece with the primary way: real estate investors contact owners of tax delinquent properties before the property itself gets to an auction. The alternative is to buy a tax lien on a property at the auction and to hold on to it – maybe you’ll be able to repossess the property through foreclosure.

Real estate investors may prefer one over the other – it all boils down to their strategy.

Marketing to Owners of Tax Delinquent Properties

If the homeowners respond to your marketing campaign, you have 7 touch points (or less) to close a deal. Although this process isn’t exactly fast (sometimes it takes months to complete), it’s way faster than dealing with tax liens. Even if you don’t close, you’ll know where you stand with that particular lead. Tax liens can be redeemed (most often they are) and all you get after a couple of years is the interest on the due taxes.

In fact, you can include the prospect of tax sale auction to the owner of a tax delinquent property as a sales tactic. Something along the lines: “When your property ends up in a tax sale auction, you can lose it just because someone will pay its due taxes. I offer cash payment, and I can close in a week.” This is a typical real estate investing pitch.

Investing in Tax Lien Certificates

The bar for buying a tax lien at an auction is really low. All you have to do is to stray away from bidding wars, and you can get a property tax lien for only a couple of thousands of dollars. The outcome is uncertain, and you may have to settle other liens and costs, but you are either getting the property, or the interest on the tax lien.

Tax liens require active investment and following through on procedures, but once you get past that, you may end up with a property. To flip a house, you need a lot of capital, both for the purchase and for renovation, while the profit is uncertain. As a lienholder, you aren’t responsible for property maintenance until you repossess the property. From this perspective, tax liens are cost-effective real estate investments, much better than house flips.

Bottom Line

As with many other topics in real estate investing, there isn’t one definitive answer on processing tax lien leads. If you ask someone like Ned Carey, a real estate investor from Baltimore who was featured on Bigger Pockets as a successful tax lien investor, he’ll probably advise you to place bids at auctions. Others might consider tax liens a waste of time and an investment in which returns are uncertain.

You’ll have to decide on your own whether pursuing tax lien certificates aligns with the business goals of your real estate investing business, with your risk tolerance, and with your time frames for collecting returns.  

 One last closing thought: Don’t take tax liens lightly, it’s a complex legal issue, and none of what you just read is legal advice. Do your own research (or hire a lawyer for expert advice) before buying tax liens.

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