My First Tax Lien Auction (Boulder, CO)
I went to my first tax lien sale yesterday (Boulder, CO) and wanted to write about my experience. The interest rate this year was 11% and if the account owner doesn't pay for the following year you get the first opportunity to purchase those outstanding taxes as well (also at 11%). After 3 years of delinquency you have the opportunity to apply for a treasurer's deed.
A couple of days before the sale I came up with my strategy.
1) I was taking a purely investment approach and completely discounting possible homeownership. From what I understand, actually getting a house from a tax lien sale is extremely rare, and happens less than 1% of the time.
2) I was planning on spending up to 15k since this was my first auction. I was only going to bid on liens that were in the $1000 to $3000 range. My thought process was that since I wasn't planning to spend a ton of money I wanted to diversify this money across several liens.
3) I was only going to bid on tax liens that were backed by residential property. I didn't want to mess with any random weird lots of land in the middle of nowhere with no access and no utilities. I did some due diligence using the tax assessor's website, google maps, and redfin/zillow to look at the property backing the lien. My initial impression is that it takes forever to do this research. Even though my criteria was pretty narrow it still took quite a bit of time to go through hundreds of listings to figure out what actually matched my criteria. Does anybody have tips on how to optimize this task?
4) I was looking for around a 9% ROI, assuming that it takes the account owner a full year pay the outstanding taxes. Of course, if they pay off faster that number goes down, if it takes them longer that number goes up. But as a starting baseline I was assuming 9% after a year. I put together a quick little ROI lookup table that told the the percentage return at varying price points.
When I got to the auction I learned that we were actually going to be bidding on the premium amount (number of dollars over the tax lien value), not the total value you would be purchasing the lien for. This meant the quick ROI lookup table I had put together was garbage. No worries, I did some quick math to figure out my max premium bid for each of the liens I wanted to bid on, and re-sorted the listings to match the order in which they would be auctioned off. Basically, I was willing to pay a 2% premium and still meet my target of roughly a 9% ROI.
Once the bidding actually started it became abundantly clear that I wasn't going to end up with any liens. Everything was going for like a 6% premium. At that rate, if the account owner pays off their lien within 6 months they end up losing money on the deal. If it takes a year for it to be paid off, they are essentially getting a 5.5% return. If it takes 2 years, and they are able to buy the outstanding taxes for the second year as well, then it starts to approach a 9-10% effective annual rate of return.
Of course there were people bidding like 8-10% premiums on certain liens. And there were other people who were bidding on all of the really low value tax liens. They would pay like an $80 premium on a tax lien worth $40. I didn't really understand that at all. Why would somebody pay $120 to get a tax lien worth $40, backed by some 0 acre piece of undeveloped land in the middle of nowhere?
My big take away was that I felt like I was missing something. I just didn't get what people's strategies were. The handful of people I talked to definitely had an investment approach and were realistic about how rarely you actually get the property deed. So it didn't seem like people were bidding in order to win deeds to the property. But still, at 6% premium you are making anywhere from a small loss on your money up to 9-11% return on your money, depending on when the lien gets paid off. It feels a bit unpredictable, a bit like gambling.
This was definitely an older crowd, so I was half wondering if some of these people were just using the tax lien investment vehicle as an alternative to bonds. That could make sense, as your money is typically only on hold for up to 3 years, and the returns probably look pretty decent compared to bonds. It might not be such a crazy idea if you are looking to rebalance your portfolio and take money out of the market as you get older.
But I don't know... I kept coming back to just investing in performing notes. You can get these for a pretty solid return of 9-10%, which is the most you will be making on tax liens anyway. They are also backed by real estate, and they are pretty safe as well. I'm just not seeing the advantage of tax lien investing over note investing when I compare the two. I just don't think the returns are as good or as predictable. Regardless, I'm glad I went, as I definitely learned a lot.