Tax Lien Investing: 5 Important Risks to Consider
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Local governments generally collect a majority of their revenues from taxes on real estate. These property taxes fund all sorts of government operations, from police to parks to schools. Therefore, local governments really want those property taxes to be paid. If property owners fail to pay their property taxes, various states provide methods for local governments to get what they are owed.
Depending on the state, a local government may place a tax lien on a property. This can then be sold to a private investor. Or they can take the property and sell it outright through a tax deed sale. Tax liens and tax deeds are both generally sold at a public auction and can present great investment opportunities.
Tax Lien Investing: 5 Risks to Consider
Investing in a tax lien or tax deed may sound easy. You go to an auction, buy a lien or deed, and then collect interest on the lien or take title to the property. An investor can get some really good returns (as high as 18%) or get a property for pennies on the dollar. But those fantastic returns do not come without risk. There is a reason why the returns can be so good, and that is because there could be a considerable amount of risk.
Here are five things you should carefully consider before investing in tax liens or tax deeds.
The underlying real estate may be worthless.
Or it may be almost worthless. That tax deed property you picked up in Tennessee may be a sliver of land 3 feet wide by 10 feet long. What are you going to do with that? That tax lien you picked up in Florida might be located in the Everglades and have a perpetual flood easement over it.
No wonder these property owners stopped paying the taxes on them. They did not want them and neither should you. In fact, now that you own them, you have incurred liability and have to pay to maintain them. Do your due diligence and know what you are getting into. There are reasons some properties have been on the tax sale books for decades.
The underlying property may not be maintained.
Property owners that get in to arrears with their property taxes often have few resources to maintain their properties or have no desire to do so. Remember with a tax lien you do not actually get title to the property, just a lien on it. The owner may take what you thought would be a nice little income property and let it crumble into the ground. With a tax sale property, the original owner usually has a redemption period where they can pay you for the taxes owned plus interest and get the property back.
What if a tree falls through that property during that time and the owner either cannot or will not fix it? Guess who that will fall on? You. How much do you want to spend on a property you do not own yet? Code enforcement can also be a real pain here. They may levy fines for a whole host of problems, from tall grass to broken windows. I have even heard of folks buying properties or liens and then going by the property a month later only to find out the property was condemned and torn down by the city. Now what are you going to do with that vacant lot? Again, know and research what you are getting into.
The government makes mistakes.
Hard to believe, I know, but they do. Some can be really big ones. Imagine buying a property at tax sale only to find out that the government did not notify the proper owners they were taking it. Now you are stuck in the middle of a lengthy court battle. Or the government can declare you tax lien in error and take it back with only a 0.5% interest rate. Not quite the return you expected to get, is it? Be sure and ask to see all the records the government has related to the property. Do your own title search to make sure the right people were notified. It can save you a lot of trouble later on.
Laws and politics change.
All it takes sometimes is one story about an old lady getting thrown in the street by a "greedy" real estate investor to have a world of hurt come down. You may have every right to do what you do and also have the law on your side. But that does not mean that an elected judge or official is going to side with you and throw old ladies into the street, so to speak. Plus, the recent foreclosure crisis has heightened awareness of these issues. There's not much you can do when politics are going against you, but make sure everything you do is proper and legal while understanding the risk.
Bankruptcy law varies.
Bankruptcy law varies from state to state, just as the methods for dealing with delinquent property taxes do. If a property owner declares bankruptcy, that could potentially delay or crimp your investment. A bankruptcy could reduce the amount of interest on a lien or alter the payment schedule. They could also delay a planned tax sale. Again, the recent foreclosure crisis has heightened awareness of these issues, and some judges are taking more active roles in these matters.
All in all, tax liens and tax deeds can be great real estate investments. However, savvy real estate investors perform significant due diligence and know the risks of what they are getting into. If you plan to purchase either of these two items as a part of your real estate portfolio, you should as well.
Have you tried out tax lien investing? Anything you’d add to this list?
Leave your questions and comments below!