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.