As the economy continues to falter, more residential and commercial real estate owners are falling behind on their property taxes-creating opportunities for investors, who are increasingly looking to tax liens for attractive returns with virtually no correlation to stocks and bonds.
When an owner fails to pay property taxes, local governments will usually attach a lien for the balance of the delinquency, with the property serving as collateral until the taxes are paid. If the taxes remain unpaid, the taxing authority may sell the lien, often at public auction, and award the successful bidder a "tax lien certificate" as evidence of the purchase.
The tax lien certificate gives the purchaser the taxing authority's right to collect the unpaid taxes, plus interest and any applicable fees, as well as the right to foreclose on the property if the total is not paid before the mandated redemption deadline.
Selling tax lien certificates allows a county or municipality to collect needed revenue immediately from the investor. If the taxes are paid before the certificate reaches maturity, the lien is released and the government sends the investor its principal and interest.
Twenty-eight states and the District of Columbia sell tax liens. Interest rates are set by state statute and vary from 6% to 36%. Industry experts say that a diversified portfolio of these alternative investments can consistently return between 10% and 15% when the certificates are held to maturity, typically one to three years.
"Short-term, low-risk, moderate-to-high yield, well-collateralized debt receivables," is how Howard Liggett, a 30-year industry veteran, who recently retired as executive director of the National Tax Lien Association, characterizes these investments.
Redemption rates average 95% nationally, with 65% of the redemptions occurring in the first year, so investors stand a good chance of profiting fairly quickly, according to Liggett. The certificates are also secured by real estate, with lien-to-value ratios averaging 10% or less nationwide, he says.
Tax liens almost always have superior priority over any existing non-tax liens, including mortgages. On properties with mortgages, the first priority status of tax liens can encourage mortgagors (typically banks) to protect their positions by paying any back taxes and interest if the owner doesn't. This is a plus for investors, as it increases the chance that liens will be redeemed and decreases the chance that investors will have to foreclose. Foreclosure requires the investor to pay court costs and attorneys' fees, plus the costs associated with marketing and selling the property. Experienced investors, particularly in an unfavorable real estate market, usually prefer to recover their capital with a decent rate of interest-and no foreclosure hassles.
A Multi-Billion-Dollar Market
Television and Internet advertisements aimed at "mom and pop" investors endlessly promote tax lien investing as an easy way to make gobs of money with little risk or effort. But this is a serious business for professionals and it takes a disciplined approach.
"It's not the shenanigans you hear about on late-night infomercials. This is a relationship between communities and investors who are willing to put their capital at risk," says Liggett.