Real estate investing is an entrepreneurial effort whether you are a flip or buy and hold investor. After flipping nearly 30 plus homes and renting a few million dollars of multifamily properties, I was still working 12 to 14 hour days, 6 to 7 days per week. As I woke up one Sunday morning to a frantic call by my property manager of water flooding into one of my tenants units, I thought that there has to be a better way! My mind reminisced about the real estate education products infomercials that promised a lifestyle filled lounging on the beach while your properties paid you like ATM’s. Where did I go wrong?
The Problem: I had Toilets and Tenants!
When I started looking into what sucked up a lot of time during the week I noticed a pattern. Toilets and Tenants sucked up a lot of my time and the resources of my company week to week. Hence I started down my “No Toilet” Investment journey. Last week we spoke about NNN investing as a No Toilet Investment Asset class. This week we talk about one of my favorite “No Toilet” asset class: Tax Liens.
Why Tax Liens?
With five-year bank certificates of deposits paying 1.6% and ten-year Treasurys yielding 1.9%, I was searching for yield with minimal effort. One night I was digging around the internet for alternative investments within the real estate asset class and I came across Tax Liens/Tax Deed. Tax Liens promised returns up to 18% (in New Jersey) with minimal day to day management. Hence I had to dig more into Tax Liens.
What are Tax Liens?
Tax Liens come about as function of cash flow management by municipalities If a property owner doesn’t pay their quarterly property taxes, then a municipality places a tax lien on his or her property. Twenty-eight states, Washington, D.C., Puerto Rico and the U.S. Virgin Islands allow those liens to be sold to private investors, and about $6 billion in liens come up for sale each year. The local government gets its cash immediately, and the buyer gets the right to collect the delinquent tax, a penalty and interest on the late payment that can (in theory) run as high as 12% to 36% a year, depending on the state. 12 to 36% per year! Being a capitalistic driven investor. I had to dig even further and learn more about the pros and cons on this asset class:
Pros & Cons of Tax Liens
- Limited Capital: If you have small capital savings then you can invest into this asset class with money as little as $100. Young Investors (under the age of 25) who use the excuse of no capital cannot do so anymore.
- Lower Risk: Tax Liens contains risks associated with real estate, municipal fines, bankruptcy and government errors. Even with these risks, tax liens are lower in risk profile when compared to other assets and investment styles.
- Stabilized Rate of Returns: Unlike cash flow or flip investments where you returns can be high volatile. When you invest into tax liens you will know your going-in yield with a high degree of certainty subject to bankruptcy risk.
- On Going Cash Flow: If you are looking for monthly cash flow then Tax Liens are not the investment for you. Tax Liens investment are paid off in a lump sum at the redemption which includes both your principal and your interest earned return.
- On Going Investment Dollars: Once you buy an initial lien then you will have to buy the subsequent liens to protect your interest in a property because new liens hold priority over older ones. So tax lien investing requires a sizable chunk of cash that you won’t need for a while.
How to Invest in Tax Liens
There’s usually stiff competition for liens from lien investment funds and money managers and individual investors. So can you go about investing into tax liens with this much competition?
As an individual investor, you can compete against bigger funds and money managers by having an understanding on what drives these funds and managers. Here are a few insights that I have picked up during my lien buying experience:
- Funds need to deploy millions of dollars in order to move their investment return needle but cannot buy everything within one municipality due to diversification risk.
- Funds dedicate man power and research to go through liens but cannot analyze every single lien that comes out as they are typically analyzing multiple municipalities at the same time.
- Bigger funds and money managers will have a typical investment criteria that you can gather by requesting their investment presentation or private placement memorandum if you are an accredited investor.
Use the above insights together with a niched investment approach to be an effective individual tax lien investor:
- Investment Strategy: Are you targeting liens for redemption or non-redemption?
- Investment Areas: What are the towns that you want to own tax liens within? Are they urban, suburban, white collar, blue collar? There are many ways to define your investment area.
- Minimum Lien Size: What is the minimum amount of capital that you want to invest into liens? Bigger funds and investors will not typically into the $100,200 or even $500 liens as they need to invest a large amount of capital so they prefer higher dollar value liens to help move their needle. Use this to your advantage as a smaller investor you have more flexible investment thresholds.
- Understand the Process: When investing, it is important to know just how much return on investment is to be expected and what the bidding process while participating in the tax lien auctions. Talk to the municipal or county tax collector before an upcoming auction so that they can advise you about the process and procedures of bidding at their upcoming tax lien auctions.
Tax Liens have been a great investment tool for my personal portfolio as I have been able to invest idle cash into these instruments and earn a blended 15% return on capital. Use this “No Toilet” Asset class to grow and/or diversify your personal and business investment portfolio.
Learn more about tax lien investing by asking me questions through the comments below.
Happy Investing
Photo: propertysnaps
{ 36 comments… read them below or add one }
Tax Liens: The “No Toilet” Method to Real Estate Investing by Ankit Duggal is very refreshing article.You have written in a very friendly easy to understand language.
I wonder if you will be continuing this article about what happens when everything goes right or wrong.Can you sell these liens in case you need the cash within few days.
Tax liens in Canada, you can make a fortune.The city sells the property for the amount of taxes owing.
I am looking forward to read your next article.
Mr. Chandhoke
I appreciate the kind words. I can write tax lien investing part II if other readers want me to talk more about how to analyze liens along with the answer to the questions that you have raised.
Ankit
Ankit,
What type of lien do you suggest a novice investor go after? I personally feel going after tax liens with a high probability of redemption is best — but what is your preference? Is it possible to lose with tax liens in the non-redemption scenario?
Also (although no one has a crystal ball) how do you recommend targeting municipalities or liens with a high likelihood of redemption?
Avisha
Great questions. Novice investors can go after water and sewer liens as those are typically lower in dollar amount and more likely to get redeemed.
I am also a real estate investor so I like going after tax liens that have a low probability of redemption so that I have a chance to make above average returns.
Regarding your municipality question, I would target those municipalities where the median household income is greater than your state average and you have a large quantity of housing units.
I hope my answer provide some further guidance.
Ankit
Ankit, great post. What is the typical capital commitment you have seen with tax lien investments? Until redemption, investors are required to pay the tax bill quarterly right? What should new investors expect before investing?
Thanks Shamoon. The typical capital commitment will vary depending on your available cash. To give a general rule of thumb: I usually follow the 1/3 rule wherein you take your target cash allocation to alternative or proxy real estate investments and split it in third’s. Utilize the first third at the time of initial acquisition and the next 1/3 for payment of subs and the 1/3 for payment of lawyers and other costs associated with non-redemption.
Until redemption, investors are required to pay tax bills quarterly right?
No you do not have to pay quarterly but you would have to if you wanted to keep yourself in priority position. In addition as Ned pointed that you will need to make up the subs or pay them off prior to getting a executed order to get affidavit of non-redemption in the state of New Jersey
What should new investors expect before investing?
Continuing need to pay into the lien especially if you bought it at an auction and paid a premium. Buying subsequent liens help increase your return profile prior to getting redeemed.
No cash flow. You will not be getting quarterly dividend checks and this is a lump sum return investment. So if you quarterly or annual cash flow is needed for your investment plan then this may not be the asset class for that type of plan.
I hope that helps.
Ankit
Ankit,
Interesting post. Would love to see a follow-up with some simple mechanics of how to go about getting my feet wet with tax liens. Certainly the yield metrics are compelling, but I wouldn’t even know where to begin to actually look into buying up liens. Regardless, really interesting post – I’ll be looking into this further.
Daniel
Daniel
What type of mechanics would you be interested in learning more about and I can write a follow up article on the topic. Give me your top three questions and I will work on addressing those in my follow article on this topic.
Ankit
Ankit, it is refreshing to see an honest article about tax liens. So many Gurus push the “no risk”, and “Pennies on the Dollar” lines without even mentioning, bankruptcy risk or that there is a lot of competition from big players in the business.
Thanks Ned. I do not like the Gurus who push that angel as every investment has risk. Our job as investors is to understand that risk and make sure that our reward compensates above and beyond that risk element.
I don’t mean to step on Ankit’s toes but I love tax liens and will take a crack at answering the questions above.
“Is it possible to lose with tax liens in the non-redemption scenario?”
Absolutely, The biggest risk in tax lien investing is bidding too much. If the cost to foreclose and take the property is more than the property is worth you lose. I have walked away from many properties I had tax liens on.
” how do you recommend targeting municipalities or liens with a high likelihood of redemption?”
1) Bid on properties with high values. No one is likely to walk away from a valuable properties just for the amount of the taxes.
2) Bid on properties with mortgages. Banks can be wiped out in a tax lien foreclosure. So banks will usually redeem the property to protect their interest.
“What is the typical capital commitment you have seen with tax lien investments? ”
Tax liens start at $250 in Maryland. I buy lots of liens under $1,000. Yet some bidders in Maryland spend several million dollars the day of the sale and do it again within a month in another county. You can start with a very modest amount of money, just don”t expect to take over the world if you buy one $500 lien.
I started with $17,000 at my first tax sale. I manage a 6 figure portfolio today.
“Until redemption, investors are required to pay the tax bill quarterly right?”
Not necessarily. In Maryland you don’t have to keep up with the subsequent taxes. However if you do foreclose on the property you have to catch up all the taxes to record your deed.
This demonstrates why you need to know the rules in your particular area. They can vary quite a bit from state to state.
Ned no stepping on toes at all here. This is Biggerpockets the more insights the more knowledgeable we all become.
Ankit
Ankit,
Very timely article, thanks for writing it. Coincidentally, I’ve been researching tax liens for some time now. I think it would be an enormous learning tool if you could post an over-the-counter tax lien list and go through step-by-step how you would go about seperating the good from the bad. Do you look at lien to assessed value ratios? Prior redemptions? Do you visit each property? What if you want to invest in higher yield states, how do you research a property/TLC from afar? Here’s an example,
https://www.bidmonroe.com/results
This is the tax lien list for Monroe County FL. This list contains the certificates that were struck to the county after the last auction and therefore available over-the-counter at the full pay rate of 18%. So my question is, step-by-step, how would you select which certificates to buy if you had say $10,000 in total capital to invest in TLC?
Thanks,
Vincent
The first thing before even jumping into the OTC liens or any tax lien investment. You need to define your investment plan (no great investor makes an investment without a plan). Here are the typical things needed in your plan:
1) Investment strategy i.e. redemption v. non-redemption
2) Honestly Look at your & your teams core skill sets and do they match the strategy?
3) How much ongoing capital commitment are you willing to make the investments
4) What is your target investment period and does that match the ongoing capital that you are willing to commit to the investments.
5) Is your investment team picked out (foreclosure attorney, bookkeeper, lien due diligence team)
I know you want a step by step investment filter but it is hard to provide as each person’s investment plan is varied and different.
Finally I tried to click on the link that you provided but it took me to a log in screen.
Ankit
Great article. I’ve been interested in tax lien investing but have absolutely no idea how to start. Can you recommend any books or websites that might be a good way to learn every step of the process from A to Z. Everything I’ve seen online seems to have some sort of sales pitch attached with seminars and weekend crash courses…not what i’m interested in. I just need a good book or resource to give me enough knowledge and courage to understand the entire process and do it. I’m in NJ and invest primarily in buy and hold properties out of state and learned through some very good real estate books. After purchasing several investment properties I would now like to try something different as a way to build more capital to buy more properties and diversify.
Jim
I feel your pain as when I am looking for information. I want access to information that is not really expensive and does not upsell me into another information product. If you are in New Jersey (which is where I invest) this is the book to read on the subject of buying tax liens in NJ: Tax Lien$ by Michael Pellegrino
Ankit
Hello Ankit, Thanks for you article. Interesting subject, but I have concerns I did not see mentioned.
In order to ask the question, I need to tell a story to lead into it first. Several years ago I invested in tax liens thinking that the 15% returns being offered at the time was simply too good to pass up for such little risk. So, I bought $180K worth in one auction, all on either residential or commercial real estate with improvements (a house or a building) on them. The cheapest was less than $500 and the most expensive about $3,000. The location was Douglas County Colorado. The problem I experienced is that all but 1 of these redeemed, but most (nearly 2/3rds) redeemed in the 1st 6-9 months (all of these became money losers), about 30% redeemed prior to the end of 18 months (this group broke even) with the balance taking up to 3 years to redeem. The last one (only 1 of about 90 tax liens purchased in the original group) did not redeem and ultimately went to a federal tax lien sale which had powers of sale whereas my tax lien did not, so I got paid well for that one, because it took so long. Anyhow, net net, my $180,000 investment returned about $1,500 in real profits over the entire period of 3 years, which means my ROI was less than 1%, or about 1/3 of 1% annualized. Most of the problem was the premium that was paid on each lien in order to “win the bid” in a large room of bidders. These premiums averaged about 8% of the tax lien amount. The cost of these premiums was part of what sapped my returns, but the fact that most liens were redeemed within the first year was the other reason. And, the ONLY tax liens that didn’t earn a premium were those left behind at the end of the auction, which no one wanted, because the underlying property just wasn’t worth much. These were little slivers of land adjoining subdivisions and were in the form of easements, mineral rights, or other non-marketable properties that were part of open space in a condo project, or something that even if you could eventually get the title, there would be little if any marketability because of what it was, where it was and who it mattered to. Sorry it took so long to get to the question, but here goes: Do you know of any tax lien auctions that occur without these expensive premiums? In other words, if all counties conduct auctions in a similar fashion, which requires the buyer to cough up a 7%-10% premium just to win the bid, then [arguably] winning really isn’t winning at all, because the premiums are not part of the tax lien and this particular county does not allow them to be collected from whomever finally redeems the lien. So, the only way you make any real money is to have them all take 2-3 years to redeem, which never happens statistically. I am anxious to jump back into the pool of bidders, but I know for a fact that it makes no sense to do it in Colorado. And, if an investor purchases these liens thinking they will be able to file for the Treasurer’s deed at the end of 3 years (depending on your state), be careful, because the odds of this happening are usually less than 2%. Perhaps you can steer me towards a state that allows recapture of the premium. I am all ears. Thanks much in advance.
Bryan,
Thanks for sharing your experience. You bring up some of the pitfalls that I was wondering about myself such as quick redemption periods. Coming from a commercial real estate back ground, we look at the equity multiple as much as the IRR because it takes time to raise and place capital. An IRR of 18% really doesn’t make much sense if the property owner redeems in 1 or 2 months. That’s why we typically look for IRRs in the high teens PLUS a multiple of 2 or greater. I’d love to know how to deal with this in the world of TLC.
Very interesting post Ankit and much appreciated. I just attended a semiar/sales pitch today about tax liens. It seems to be profitable IF you know what you’re doing. I hope you post a follow up to of some of the things to look out for when doing tax liens. Thanks for your insight.
I will do. Anything specific you want in that follow up post other than the pitfalls/risks?
Ankit
There are over 3000 counties, each has a tax sale, each is a little different. It’s not easy but you have to do the work to learn how the areas you would invest in handle the sales. In Maryland some counties use bid premium, some don’t. Those that don’t use premiums often cap bidding at three times assessed value and then pick a random bidder. Early redemption is a big drawback to the lien process.
Wayne
Great point. The biggest hurdle is understanding the lien process as each county/city has different methodology at times. Hence a great tax lien attorney is needed on your tax lien investment team.
Ankit
I’ve recently been investing in tax liens in NJ and thought I would share some experiences that I didn’t see mentioned here. NJ is a bid down – premium state. Meaning that the interest rate starts at 18%, and at any of the auctions I’ve been to, then gets bid down to 0%. Next, a premium is bid up. Recent examples- $400 premium on a $95 water lien and a $10,300 premium on a $3,418 tax lien. The town holds the premium, with no interest paid on it and returns it if the lien is redeemed in five years. There was a comment earlier about paying sub taxes. This is one of the arears where you can potentially make your money, but not always. As an example of what can go wrong, I have two liens bought at 0% interest along with a health premium on each. In both cases, the bank or home owner has decided to pay the taxes going forward, but not redeem the lien at this time. If nothing changes, I’ll have my money tied up for two years with little return until I can start a foreclosure at which time the owners will probably just pay off the lien. So be aware that you need to understand the process and that there are always risks in making money.
So if you are getting 0% interest, paid a premium, and expect them to be redeemed where was the profit going to come from?
The main source of profit was tied to the possibility, of the opportunity to pay sub taxes. Unfortunately, you don’t know if you’ll have the opportunity until the next quarters taxes are due after you have purchased the lien. In NJ, there is another source of profit on liens that I didn’t mention in the form of penalties. I didn’t mention it because I was just trying to simply make the point that the “buy tax liens and make 18%” that you so often see on line is just not the reality of the current market. If your curious about the penalties, they are 2% for liens between $200 and $4,999.99, 4% for liens between $5,000 and $9,999.99 and 6% for liens of $10,000 or more. The penalty is on the lien amount only, not the premium. Also, some towns apply an additional penality of 6% for sub taxes at the end of the year for amount over $10,000. Because the premiums are currently so high, the penalty as a percentage gets diluted when you look at your investment as lien and premium. The challenge as I see it in NJ right now is that there are so many Wall Street bidders right now that are okay with a few percent return on a safe investment. I’m trying to learn the business with the hopes that once interest rates start going back up, the pro money will go elsewhere and the lien business can become a little more profitable for the small investor.
Glenn
I would suggest that you make it a part of your investment strategy to not pay premiums into tax liens as that can be a liquidity no return trap as you correctly pointed out via your experience. Here is what you have to remember with tax liens:
1) Your capital is not at risk and it will come back
2) Consider the money you put in as a refundable option to either foreclose or get the subsequent as there will come a time when the bank/homeowner misses a payment so watch the liens like a hawk.
From my experience, you can buy liens that provide a double digit rate of return without premium payment would happen by buying in:
A) Urban markets such as East Orange, Newark, Paterson etc. I have purchased liens in these urban markets that has provided high double digit yields as the big funds do not want to deploy all their capital into these types of markets given the potential of non-redemption
B) Buy liens on non-single family assets i.e. condos. There are more risk involved, but I was able to purchase a lien on a condominium in Clifton, and I paid a premium. I got the ability to buy subs since this type of asset is lower on the bank priority payment so now my lien has grown at an average return of 8% per annum.
C) Buy water or sewer liens to tie in small capital so that you have the ability to buy delinquent taxes as they come up in future quarters.
I hope these ideas help as you continue your tax lien investment journey in NJ.
Thank you for the clarification Glenn.
BTW looking at my initial comment I see it looks a little jerky sounding. Not my intention, I really was curious to know what the profit center was since I assumed there most have been one.
Ankit thank you for the advice in how to avoid some of those pitfalls.
(Not sure why they stop letting there be replies after a few layers so I had to respond on the same level)
Shaun,
No worries, never saw your comment as anything other than what was intended. I’m new here, but assume where all here to learn and help each other.
Regards
Ankit,
Thanks for the feedback, although I was hoping you weren’t going to suggest those three cities! Can’t say they are my favorite place to spend a day although for a better return I might just have to check it out. I had an interesting lesson yesterday. I followed up on a lien with the tax collector and asked if “anything was open” on it. She checked and said the taxes had been paid. I thanked her and turned to leave when she asked me if I wanted her to check for open sewer and water bills. I assumed my original question covered all three items, but apparently not. There was a seperate clerk with a seperate computer and a seperate database for sewer and water. It ended up, that money was due. Nothing compared to the tax bill, but at least it was something.
Regards,
Glenn
Very interesting post. A follow up would be wonderful. I would like more information on how to start on TLC, I can`t start in NYC, since the don’t sell lien to the public.I will look into NJ next. How about Connecticut?
Thanks
Ady
Ankit,
I was wondering, in terms where the tax lien does not redeem and you are able to foreclose on the property, don’t you still have to pay of the mortgage and such in order to be in full possession of the property so you can sell it or rent it out? The info out there on acquiring the house for resale through tax liens is confusing me a little bit.
Thanks,
Spencer
Spencer
I am not a lawyer but based on what my lawyer has advised me you do not have to pay off the mortgage as you wipe them out through a tax foreclosure process since they are provided notice about your intent to foreclosure. Now typically if there is a mortgage on it then you will need to put the property at the sheriff auction block and the mortgage company would most likely redeem your tax lien certificate and interest owed.
Hi Ankit,
This thread about tax leans is very informative and accurate. Thank you so much for posting!
Can you explained the reason you said buying tax liens on condos is riskier?
Buying tax liens on condo can be riskier as you are obligated to satisfy outstanding home association due once you are able to take over the property assuming you did not get redeemed. If you strategy is redemption then you can buy condo liens just make sure you know that there is a large first mortgage on the unit so that you have a higher likely hood of getting redeemed.
Thanks for reading and commenting.
Happy Investing
Ankit
Thank you for explaining Ankit!
When tax lien on a sale is taxed to “XXXXX Living trust”, or “XXXXX trustee”, or “XXXX for life”, are these liens more likely to redeem or no? There is any particular risk involve with these ones?
Tough question as it depends on whether that asset has a mortgage on it. The fact that it is in a trust would give me no indication that it would have a higher probability of redemption unless you notice a pattern with older tax lien certificates.
Hello again Ankit!
Perhaps this is a sticky question to ask since I don’t want to get you or anyone else in trouble, but I’ll ask it anyway: Can you or anyone else please comment buy tax lien thought this website “Taxlientutor.com?
What would be the advantages and disadvantages of using this method versus going to the county directly?
Thank you for your feedback!