Tax Lien Investing: What It Is & How to Find Properties

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Real estate offers a variety of investment options. Tax lien investing is another method for real estate investors to make money, and while it is a little different than your typical buy, flip, and sell, there are some similarities. Some tax lien investments turn into property ownership if the property owner fails to pay back the property taxes on time.

Finding homes with delinquent property taxes is more challenging than looking for a standard investment property. You have more hurdles to jump and factors to consider. Here are the steps to take and the pros and cons to consider.

What are Tax Liens?

A tax lien is a legal claim counties have against a property when the property owner doesn’t pay the required tax bill. A property with a tax lien cannot be refinanced or sold without satisfying the tax lien first, as the tax lien is a legal claim.

Tax liens take priority over any other liens on the property, including a mortgage lien. Property tax liens are involuntary, compared to a mortgage lien, which is voluntary because you choose a mortgage to buy a house. Delinquent taxes can turn into a tax lien sale, giving investors the option to buy the delinquent taxes and earn a fixed interest rate.

Tax lien vs. tax lien certificate

A tax lien certificate is a legal document from the county showing the amount of local property taxes owed and any penalties. Investors earn a tax lien certificate when they are the local government’s winning bidder in a tax lien auction.

Real estate investors can buy tax lien certificates to pay off the tax liens, and the certificate entitles the investor to repayment from the property owner by the expiration date.

The tax lien certificates allow the investor to collect the full amount owed from the property owner plus stated interest and fees. If the owner fails to pay, they can begin foreclosure and take ownership of the home.

How Does Tax Lien Investing Work?

To invest in tax liens, you must find properties with unpaid property taxes. This is a matter of public record but may take some work.

When the county places a lien on the property, they issue a tax lien certificate, which individual investors can purchase, aka invest in. You essentially buy a property owner’s tax debt.

Tax lien auctions can be cash-based, awarding the certificate to the highest bidder, or interest-rate-based, awarding the tax lien certificates to the bidder willing to accept the lowest interest rate. Either way, the investor pays the tax debt, and the homeowner has the redemption period to pay the debt.

How To Find Tax Delinquent Properties

Locating properties with tax delinquent property taxes is more challenging than finding income-producing properties. But, once you understand the process, it’s easy for private investors to find tax-delinquent properties to earn profits.

Remember, you won’t always take ownership of properties with tax lien certificates. If you purchase the certificate and the property owner pays the amount owed before the expiration date, they satisfy the lien and keep the property, and you walk away with a profit.

However, if the homeowner fails to pay the amount owed, you may have the right to start foreclosure and take possession of the property. For that reason, consider following these steps.

1. Look for tax delinquent property lists

Tax delinquent property lists are public records but still require some digging. Many counties publish the information on their website, making it easy to find. You will just need time to weed through the listings on the county’s website.

Other counties archive the information, which takes much more work, including going through the physical files yourself. If that’s the case in the county you’re interested in, consider hiring a list provider who can research for you to help you make the most of your time.

2. Find owner information

You can narrow down the property owner information once you can access tax lien property lists. The list should have the property address and owner information. Always fact-check the owner’s mailing address to ensure it remains the same. You can usually search tax records to check this.

You will need the owner’s information to contact them to determine their willingness to sell the property and/or pay their tax lien. Chances are they won’t be happy to hear about their unpaid tax bill, so prepare yourself for difficult conversations.

However, you may come across motivated sellers willing to sell their house for the right price and get themselves out of the unpaid taxes.

3. Evaluate the area

Before investing in tax-delinquent properties, check out the area. Determine your plans with the property, such as renting or flipping it and selling it if the owner doesn’t pay their taxes. This will help determine which tax lien certificates are the best purchase.

For example, if you can’t see the property making you a profit, investing in the tax lien certificate may not be worth it because owning the property may be more of a burden than an investment. This often happens in areas where property values are decreasing or rental demand is low. Some tax lien investors do not want to be bothered with property ownership. They are simply interested in the returns from unpaid taxes.

To evaluate a property and the area, consider the area’s median prices, rental income, cap rate, and cash-on-cash return. Make sure the money you would invest in the property and the property taxes will create an opportunity for a solid return.

If you are adding the property to your real estate portfolio, be sure it is located in an area with high demand for rental homes and there is potential for profit when selling the home.

4. Look for other liens

Chances are that if a property has tax liens, it may have other liens too. If you take ownership of the property, you would be responsible for all liens, which could lead to losing money on the purchase.

You can determine if a property has liens by visiting the county recorder’s website. Most records are available online for free, or you can visit the county recorder’s office in person.

If there are other liens besides the owner’s current mortgage, reconsider the purchase since the liens travel with the property, not the owner. If you have to foreclose on the property, you become responsible for the other existing liens, decreasing your profits.

5. Contact property owners

If you are looking for motivated property owners with unpaid taxes, use the tax lien properties list to send them letters. Write a letter that is short, sweet, and to the point, telling them what you are offering. Chances are the owners are already in distress since they may lose their house, so they want only the facts when evaluating offers.

Ensure your letter states your intention in the first couple of lines, comes off empathetic, and provides clear contact information, including your name, phone number, and email address.

If the property owner wants to know more about your offer, they will want your contact information readily accessible. They may be ready to make a spontaneous and fast decision or need a lot of information from you to make the right choice.

While your letter should be pleasant and to the point, it should also create a sense of urgency. Let property owners know that this is a limited-time offer. Since they risk losing their house, they may jump on the urgency if they do not have other options ready.

6. Weed out unmotivated property owners

Not all delinquent property owners will be in a rush to sell their houses. They may be exploring other options or hoping that something will come through that allows them to keep their home.

When you get property owners on the phone, ask questions about the home’s value and their asking price. If the asking price is right around the appraised value, they aren’t motivated and likely have other options to satisfy their tax liens, and you would be better off investing in the tax lien certificate than trying to buy the house.

7. Prepare for a public auction

You can also find tax lien properties at public auctions. If the county foreclosed on the property, they may sell it at a public auction, but be prepared to repay the property taxes too.

If you choose to go the auction route, ensure you are ready for bidding. Unlike a typical sale, you must act fast, often putting a large amount of cash down when they accept your bid.

Before attending an auction, determine your budget to ensure you do not bid more than you can afford. Also, be ready to come up with the remaining funds within the contract’s time limits. If you need to finance the property, complete as much of the mortgage process as possible.

Before attending an auction, determine the rules. Some counties allow individual investors to inspect the property before the auction, or you may pay an inspector or contractor to evaluate the property.

Pros of Buying Tax Lien Properties

Buying tax lien certificates or a tax lien property has many benefits.

Higher return on investment

Many tax lien properties have a much higher return on investment (ROI) than traditional investment properties.

If you purchase a tax lien certificate, you earn penalties and interest on your investment. You’ll know the exact amount you will earn at auction and can determine if it is a good investment.

But if you purchase a house from a distressed homeowner, you may be able to purchase the house for a much lower price, earning home equity faster.

Low competition

Most real estate investors focus on fix and flip or rental properties. Purchasing tax lien properties is much more challenging, especially if you need mortgage financing, so it decreases the amount of competition.

Build a diversified portfolio

You can build a diversified portfolio with tax lien certificates and properties with unpaid taxes you buy and rent out. Diversifying your portfolio reduces the risk of a total loss and increases the rate of return.

Cons of Buying Tax Lien Properties

Like any investment, there are downsides to buying tax lien certificates and properties, including the following.

Owners don’t always pay their tax lien

You’d think homeowners would be motivated to pay their unpaid amount quickly, but not all homeowners can cover their delinquent property taxes. This may force you to undergo the foreclosure process, which is long, complicated and leaves you with a property you might not have wanted to own.

Payment can take time

Each county has different term lengths for its tax lien certificates, but you can sometimes wait three years to get paid. While you will earn a rate of return on the tax lien investments, you tie up your funds for quite a while.

The property may be in bad shape

If you end up foreclosing on a property due to unpaid property taxes but didn’t do your due diligence evaluating the property, you may find it is in much worse shape than you thought. There’s no guarantee you’ll make money on your investment, especially if you have to spend a lot of money fixing up the property before renting it out or selling it.

Tax Lien Investing: Final Thoughts

Buying tax liens can be a great way for experienced investors to diversify their portfolios. It may take some getting used to since there is no guarantee you will take possession of the property, and you must invest capital for up to three years before you see a return, either with paid taxes or taking ownership of the property.

If you do enough research and participate in tax lien investing in areas where the properties have the potential to help you turn a profit, it can be a great investment. Whether you take possession of the property or get repaid for the delinquent taxes, you’ll earn a decent return on your investment and diversify your portfolio.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.

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