Tax lien certificates can be a safe, collateralized complement to a balanced portfolio — but only if you have time, knowledge and the ability to reinvest your money when short-term certificates are redeemed early.
[Sign up for stock news with our Invested newsletter.]
Tax-lien investing works like this: When property owners fail to pay their property tax bills, the government will eventually place a tax lien, or a note of unpaid debts, on their property. Governments sell tax lien certificates to investors in order to recover money from delinquent property taxes due to them. Homeowners then have an opportunity to pay the delinquent amount due plus interest to prevent the investor from foreclosing on the tax lien he or she holds.
Experts offer up the following top things to know if you’re thinking about getting started with tax lien investing:
— You likely won’t get a property out of it.
— Tax lien investing is active.
— Property value reassessments could benefit investors.
— Your return may surprise you.
— Tyler v. Hennepin changes the game.
— Consider investing with a tax lien servicing professional.
— You can be a property tax lender.
— Get educated about tax lien investing.
You Likely Won’t Get a Property Out Of It
Don’t invest in tax liens with the expectation that you will get a property out of it at a fire-sale price, says Brad Westover, executive director of the National Tax Lien Association, a nonprofit that represents tax lien investors, governments and lenders. More than 95% of homeowners redeem the property before the foreclosure process starts, and once a tax foreclosure starts, all but 0.5% of those homeowners redeem, Westover says. Most tax foreclosures happen on vacant land or vacant and abandoned property.
Tax Lien Investing Is Active
Though investors may see tax lien investing like a certificate of deposit for their short-term, relatively safe nature, they are “different than a CD where you invest and then fall asleep,” Westover says. “Tax liens are a very high-touch business. There’s some servicing and management of a tax lien portfolio.” That’s because you’ll need to check when tax lien certificates are being redeemed, or follow through with any notification requirements with the property owners prior to filing a tax foreclosure.
Property Value Reassessments Could Benefit Investors
“Municipalities have been looking for ways to increase revenues, and one method local governments have used is to reassess property values for property tax purposes,” says Sean P. Salter, assistant dean for assessment and associate professor of finance in Middle Tennessee State University’s Jones College of Business. “As municipalities employ this practice, the likelihood of a property owner being unable to pay the required tax increases, and the likelihood of a tax lien also increases.” This could really ramp up opportunities to participate in tax lien investing.
[READ: What the SEC Names Rule Means for ESG Funds and Greenwashing]
Your Return May Surprise You
State statutes determine interest on tax lien certificates to be as much as 1.5% per month. Florida has a maximum simple interest rate of 18%, while Iowa charges 2% monthly on the unpaid balance. But the ways local jurisdictions structure the sales means you’re not likely to top 9%, Westover says. Some municipalities use a “bid down” auction, where investors win the tax lien based on the lowest interest rate they’re willing to accept. A general rule of thumb is to pay about 3% to 7% of a property’s value for a tax lien certificate.
Tyler v. Hennepin Changes the Game
“In May 2023, the U.S. Supreme Court handed down a decision in Tyler v. Hennepin that could have a significant impact on tax lien foreclosures in states that previously had a practice of allowing the government to retain excess equity following a tax foreclosure sale,” Salter says.
Under the ruling, retention of excess equity over and above the amount owed by the property owner becomes illegal. This means that “municipalities in those states have an even greater incentive to sell the lien rather than retaining the lien and pursuing a foreclosure sale,” Salter says. “Selling the lien at auction will allow the municipality to recover the debt more quickly, and, with the government’s upside potential of a foreclosure sale limited by Tyler, will likely provide a better outcome for the municipality.”
The ruling does not preclude tax lien auctions, though, “so individual investors can still realize significant returns if the property owner doesn’t redeem the property in time, and — for the moment — these states probably don’t have a prohibition against individual investors retaining excess equity,” he says.
However, legislation may be forthcoming in some states that would limit individual investors’ ability to retain property equity above the amount owed in taxes plus interest following a foreclosure, he says. “This type of legislation would obviously reduce the attractiveness of tax lien investing in states that currently allow lienholders to retain 100% of the foreclosure sale price.”
Consider Investing with a Tax Lien Servicing Professional
If you’re new to the game and want a more passive experience, it’s likely easier to invest with a professional. More than 80% of tax liens bought or sold in America are by members of the National Tax Lien Association, many of which are tax lien investing fund managers. Contact NTLA for referrals for funds and managers based on your needs, Westover says.
You Can Be a Property Tax Lender
Texas and Nevada allow private lenders to offer loans to homeowners to pay off their tax bills, though this instrument is complicated and not recommended for individual investors, Westover says. Redemption laws or requirements depend on each state’s statues, and terms of the loans are individually negotiated, Westover says.
Get Educated About Tax Lien Investing
The NTLA certifies tax lien professionals in tax lien investing that prepares them for hands-on industry work, and participants use their knowledge to avoid pitfalls when actively investing for themselves in the field, Westover says. After participation in the courses, students must pass a couple “difficult tests” and meet community service requirements. “You need to know state statutes and also local auction rules and regulations, and demonstrate your expertise in the investment community over time,” Westover says.
More from U.S. News
The 10 Most Valuable Companies in the World by Market Cap
7 of the Best Fidelity Bond Funds to Buy for Steady Income
7 of the Best High-Yield Bond Funds
8 Things to Know About Tax Lien Investing originally appeared on usnews.com
