(Bloomberg News) After Brian Finkelstein first heard about tax-lien investments three years ago, the former bond trader found the potential for 18 percent returns so compelling he jumped into the business full-time.

Like other investors, Finkelstein, chief executive of Broad Financial LLC in Monsey, New York, is hunting for yield as the Federal Reserve indicates it may keep interest rates "exceptionally low" through 2014. Yet high fees, illiquidity and a lack of transparency are a few of the pitfalls investors may encounter with private funds that buy claims to delinquent property taxes, said Alan Zafran, a partner with Luminous Capital.

"It's caveat emptor: Buyer beware," said William Waller, a Washington-based real-estate lawyer who has worked on about 2,000 to 3,000 tax-lien cases, referring to the fact that jurisdictions that sell the liens generally don't guarantee the condition or market value of the properties.

Tax liens, or tax certificates, generally are sold to investors at auctions and are secured by claims on the underlying real estate that take priority over mortgages. Interest generally accrues on the taxes owed at rates set by auction, which property owners must pay to clear up the debt. If they don't, an investor who bought the lien may foreclose on the property.

About $7 billion to $10 billion in delinquent property taxes are sold to investors annually, according to estimates by Trace Platform LLC, which provides clearing, transfer and escrow services for tax-lien trades and isn't related to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Counties and cities in 28 states and Washington, D.C., sell the liens to investors, according to Brad Westover, executive director of the Jupiter, Florida-based National Tax Lien Association, a membership group for tax-lien investors and servicers.

The certificates generally are regulated by the states, Waller said. Rules on maximum interest rates, waiting periods before a foreclosure may proceed, how fees and interest are assessed on the debts and how auctions are conducted vary among jurisdictions, said Tom McOsker, head of the tax-receivables brokerage unit for New York-based GFI Group Inc., which runs a secondary market for the certificates. Florida auctions the certificates online, and the District of Columbia holds live bidding. In New Jersey the maximum interest rate a lien may accrue is 18 percent, and in Iowa it's 24 percent.

New Jersey Auction

At an auction in December, bidders on a first-name basis with one another chatted in the aisles and cracked jokes as they trickled in to the second-floor courtroom of the municipal court in West New York, New Jersey. In the hour leading to the auction some bidders, a few wearing wireless headsets and hunched over laptops, combed through lists of the more than 400 liens up for sale with highlighters.

Kerri Tierney-Campen, the tax collector for the Town of West New York, began the auction by calling out liens that were no longer available because they'd been paid off that morning. The liens up for auction ranged in size from $189 in taxes owed to one debt of $105,478. Once bidding started, potential investors called out the interest rates they'd want to earn on each lien, with bids starting at 18 percent and then moving lower. About 20 people attended, including about 13 bidders.