He estimates that between $7 billion and $10 billion in tax liens are sold at auctions annually, although the volume of tax liens advertised for sale is much greater.  "If the auction is advertised, as required by statute, the owner or mortgagee will be the recipient of that advertisement and will often pay the bill before the sale begins," he says.

The market for tax liens has grown substantially in recent years.  According to one survey, the decline in the real estate market caused the supply of liens to grow by 30% in 2008 and 20% in 2009, because of the jump in delinquencies by property owners. A simultaneous rise in demand occurred, driven by hedge funds and banks seeking better yields (with less perceived risk) than those available in other debt receivables markets.

Getting In On The Action
While local auctions still attract retail investors, who typically buy tax liens only in the area in which they reside, the advent of online auctions has allowed hedge funds and banks bidding in volume to dominate the market. Competition is so fierce that reinvestment of idle cash from early lien redemptions is actually a major hurdle for some investors.

Several hedge funds and about five banks currently invest in tax liens, although players come and go in this ever-evolving industry. The largest hedge fund in this space is New York-based Fortress Investment Group. M.D. Sass Investors Services, another New York hedge fund, has almost two decades' experience in tax lien investing. Florida-based BankAtlantic is currently the oldest institutional purchaser of tax liens, while two other banks, Bank of America and JPMorgan Chase, recently sold their portfolios and exited the business.

For family offices and high-net-worth individuals, one way to enter this asset class is to buy into a fund. To date, there are no public funds in this alternative-investment space, but there are a number of private funds, with minimums typically ranging from $100,000 to $1 million.

Another option is to hire an acquisition and servicing firm to build a custom portfolio. These companies locate available liens, perform pre-purchase due diligence on the properties, bid at the tax auctions, handle redemptions, provide bank reconciliation and custodial services, foreclose on the properties if necessary and manage investors' portfolios. Most sophisticated investors, including hedge funds, outsource acquisition and day-to-day portfolio management to servicers, rather than attempt to navigate the complexity of varying state property tax laws and the quirks of local tax sale rules and real estate markets.

"The number one rule to remember in the tax lien business is that every state is different," says Dan Friedman, president of Elmhurst, Ill.-based Optimum Asset Management. Optimum provides acquisition and servicing for wealthy individuals, family offices and institutional investors with a minimum of $1 million to invest. The firm charges a 1% acquisition fee and an annual servicing fee of 1% of assets under management.

Friedman says his company concentrates on investing in six to eight states that offer good yields on liens and a friendly regulatory climate. "Some states are more protective of the property owner. Others are more weighted in favor of the investor. Obviously, we prefer the states that are favorable to investors," he says.  Currently, the states most popular with investors include Florida, Illinois and New Jersey.

When it comes to buying tax liens, Friedman thinks high-net-worth individuals and family offices with "friendly bankers" may have an advantage in the current low-interest-rate environment. "Investors who have access to borrowiwng are able to maximize their yield. If you can borrow at 6%, and buy tax liens that yield 16% or 18%, the returns can be remarkable," he says.

Minimizing Risk, Reaping Rewards
Investing in tax liens is not risk-free. Experienced servicers screen for a multitude of factors that affect lien values, including the assessed value and condition of the property, the location, the amount owed, the likelihood the debtor will eventually pay, whether the property is mortgaged or the owner has filed for bankruptcy and the possibility of other claimants taking the property (e.g., IRS tax liens).