Tax Lien Investing - Why bid a premium?

10 Replies

Hi,

I participated in an online auction recently for tax liens. This was my first time doing this so I played things as safe as possible (bidding only the max possible of 18%, in nice areas of the town on properties that were not in foreclosure or pre-foreclosure). I was only bidding on liens that were $350 and under. Unfortunately, I did not win any of the liens, and when I saw the winning bid, all of them were premiums (ranging from $300 on a $130 lien to $1,100 on a $350 lien). I was wondering what the benefit of bidding a premium is since the property owner does not have to reimburse the premium of the lien. 

Thanks! 

Looks like the bidder who pays a premium is doing so because they are happy with a lower return than 18%. So if you are owed $23.4 on a $130 lien (18%), and someone pays $300 for it, then they are happy with an 8% return (23.4/300).

I know NJ also has unique rules around the winner in certain circumstances getting the right to collect interest on subsequent tax payments without having to go to auction. Maybe a NJ investor can chime in on that piece

@Chris Laino :

It probably depends most on the location where you are purchasing the liens. What state are you buying? Every state and sometimes the counties within the state have slightly different rules for property tax liens/deeds. I know massive surpluses are common in my home State of Indiana. Most any property that is decent and especially ones that are move in ready really draw a lot of interest. 

Thanks,


Chris

(502) 552-9158

@Abel Teklu If an investor buys at a premium, does the interest get deferred to year 2, and if so at what percentage? Also, if the property owner pays right away, wouldn't the investor technically lose money since there is no interest being paid? 

Thanks!

Hi @Chris B.

It really depends on the state and the goals of the investor.  You mentioned this was a Lien auction so I assume a number of the bidders were looking for decent returns. As @Abel Teklu mentioned, an overbid might be because these investors are willing to accept less than the maximum interest.  Another strategy is to bid on liens that are less likely to be redeemed which MAY result in the investor having a path to owning the property.  In that case, the bid may not even consider the interest and only be focused on the property value.  

@Roy Oliphant thanks for the response! I wasn't buying in hopes that I could foreclose on the property, just looking to make a little profit starting out. How is the interest percentage determined if you are bidding a premium (the auction started at 18% and gets bid down to 0% and once it reaches 0, then investors started bidding the premium) so how does interest rate get determined in that situation?

It really depends on the jurisdiction and how they handle it.  For example, some states have a multi-year redemption period.  If your premium goes below 0, there may be a chance that the second year will provide some return and you could calculate that over the two years for an actual rate.  

BTW: even if you are only bidding for interest, you need to plan an exit strategy that includes what happens if the property does not get redeemed.  For example, I would not generally take a lien on a old chemical storage site.  It might not get redeemed and then you could wind up on the title and responsible for an EPA mandated clean up.  ALWAYS know what you are bidding on and what your strategies are.

@Chris Laino

 If you haven't yet, listen to podcast 56 with Ankit Duggal. Great podcast on tax lien investing in New Jersey. There are some good books too, Profit by investing in real estate tax liens by Larry Loftis, and The complete guide to investing in real estate tax liens & deeds by Alan Northcott.

From what I have read, if the Interest is bid down to zero and you pay a premium, then you get 0% interest in the first year, but you can choose to pay off subsequent taxes at the full interest amount. There is also a  penalty ranging from 2-6 % depending on the amount of the lien certificate in some municipalities. I am curious if the premium bid is ever recovered once the lien, interest and penalties are paid.

@Chris Laino I can't speak specifically to NJ liens, however premiums are usually designed to be a benefit to the property owner or a benefit to the local municipality.  I suspect while the property owner does not reimburse you for the premium that it is returned by the county upon redemption. My guess is the county simply holds it in escrow until the property redeems. This is how it works in MD. 

In MD the "High bid premium" was designed to stop people from grossly overbidding then keeping the property in tax foreclosure limbo until they got paid. 

As @Roy Oliphant said laws vary tremendously by state. The reason for the premium varies by state also. The reason some are bidding a very high premium could be greater knowledge or could be stupidity.

Sometimes someone may have specific knowledge about the property that demonstrates the property is more valuable. On the other hand someone could be bidding ignorant of the rules and how they affect the return.  In MD the bid premium and how it affects the overall return is very complicated. We see a regular pattern and big national bidders come in for a couple of years then realize they aren't making the returns they expected. they leave never to be seen again.

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