Tax Liens

By Steve Gillman - 2005

Why tax liens? They can be a relatively safe investment. A good return on your money is also possible. The catch? Everyone knows about this now, and the bids are pushing down rates of returns.

We recently went to the local tax lien sale here in Fremont County Colorado. We were amazed that a little community like this could have so many investors wanting to buy tax liens. This is good for the county, but not for an investor.

Tax liens are handled differently in each state, but they are essentially a lien that secures the debt that a property owner owes for late taxes. Investors buy them. Then, to not lose their property, an owner must pay the balance plus whatever fees and interest rate the law specifies. Here in Colorado, that is 15% annually. We liked the idea of a 15% return on our money.

It wasn't as simple as that. While it is true that the property owner will pay 15% interest and the county will forward that money to you as the lien holder, you don't necessarily get to buy the lien at face value. It used to be that a few investors in any given county would more or less divvy up all these great little investments among themselves and that was that. However, now there are hundreds of people bidding on them, even in little county like this.

For example, if the taxes due on a property were $1,000, the bidding started there. But as we watched, most of these liens were bid up to about 10% over face value. They call the extra the "premium," and it goes straight to the county, which is why they employ a professional auctioneer to get those bids up there. This means that if the owner pays his taxes in a year, the lien holder will get just $1,000 plus 15% or another $150: $1150 total. If he paid $1100, that extra $50 is an annual return of just 4.5%.

Wait, it gets worse. If the property owner pays his late taxes a month after the tax sale, the investor would get just $12.50 in interest. In other words, he would lose $87.50 because he paid a $100 premium, which the property owner doesn't have to repay. It seems that most of the investors thought the late payers wouldn't pay for a couple years (after three they lose the property), since a 10% premium was average.

Did any go for face value? Out of hundreds of liens auctioned, we saw three or four went at face value. They were $30 or $40 tax liens on small properties.

There are "leftovers" in some counties. These are liens that didn't sell at the auction, and can be purchased at face value over the counter (if you can find the right person). Maybe this was more common before there were crews of marketers roaming the country selling "get rich with tax liens" seminars and course. I have only checked in the several states I have lived in recently, but we have found no leftovers.

Suppose you do find a place where you can buy tax liens at face value, and they pay a decent rate of interest in that state. What kind of risks do you take? Not much.

Unless the tax assessor is insane, the property can't be worth much less than half of what he says. Since taxes even in the worst areas are not likely to be more than 5% of the assessed value each year, and owners lose their properties (perhaps to you) after two or three years depending on the state, you should never have to invest more than 15% of the value of the property, or 30% if the assessor is half insane in his assessments.

In other words, you are safe unless the owner never pays, and after you take the deed to the property, you find out it is filled with toxic waste. To avoid this potentially bad scenario, simply buy only liens on residential property, and spread your money among numerous liens. If you make 15% interest on ten liens for two years, and you have to throw one away, you still have abetter over-all return than in the bank.

This strategy of simply spreading the risk is one that has been used for years by big insurance companies. Some of them buy up these liens by the thousands, and they don't waste their time doing the research that the seminar presenters recommend (maybe they just want to scare you into buying the materials that will teach you how to do this "research"?). If ten out of each a thousand turned out to be never-to-be-paid liens on toxic waste dumps, it would reduce their return by just 1%, and you don't have to take title to the property.

However, there are other things to watch for. Here in Colorado, for example, if the property owner doesn't pay the lien by the deadline, you have to publish a notice three times before getting title to the property. If it is a small lien you could spend all the interest you gained posting ads in the classified section of the local newspaper, just to have the property owner pay up (he doesn't have to reimburse you for the ads). For this reason and others, I would only invest in liens of $400 or more.

In some states, instead of bidding a "premium," buyers bid down the interest rate. The rate mandated by law may be 16%, for example, but the bidder who will take the lowest rate gets to buy the lien. I presume that the county keeps the additional interest.

Tax liens can be profitable in most states, if you can buy the liens at face value, and if you understand how it is done. It is done in many different ways. Find the county employee that know how the whole process works, and have it explained to you. In my experience, they often don't want to explain it to you, but your taxes pay them, so bug them until they do.

What about actually getting the title to property this way? Far less than 1% of liens auctioned off are left unpaid until the deadline passes. You could do research to find the property owners least likely to pay their liens, but who wouldn't sell their property before losing it over a few thousand in back taxes? Yes, occasionally someone gets an $80,000 house for $2,000 in back taxes by buying a tax lien. Just don't count on it as a part of your plan.

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