Are Tax Liens a Worthwhile Real Estate Investment?
Property taxes can be a significant burden on homeowners. They are a major cost that can fluctuate from year to year — and for various reasons, homeowners might not be able to pay.
Still, local governments rely on those taxes to operate, and they want to make sure the money gets collected. One way they do this is through tax liens — a legal instrument that ensures property tax collection and creates a way people can invest in real estate.
Here’s what you need to know about investing in property tax liens.
What is a property tax lien?
A property tax lien is a legal claim against a person’s home to secure the payment of a tax debt. Tax liens are placed on a property by the city or county in which it’s located. The federal government can also place a lien on your property if you neglect to pay the IRS.
A homeowner who has a lien attached to their property won’t be able to refinance their mortgage or sell their home until the tax debt is paid and the lien is removed.
The city or county that places real estate liens does so because it needs money to continue carrying out its various functions, said Chantelle Owens, lead instructor for the GA Tax Lien Bootcamp in Snellville, Ga.
“The county provides services that basically would make our society chaotic without them,” including the police force, libraries, schools, etc., Owens explained.
How property tax lien sales work
Many states have created legislation that allows local governments to sell their property tax liens. There are currently more than 25 states that sell tax liens, according to the National Tax Lien Association.
In order to collect the money owed to them more quickly, counties sell tax liens to the public, typically in an auction where the highest bidder wins. The purchaser receives a tax lien certificate, and that particular lien is superior to most other liens on the property, with the exception of any federal government liens, according to the NTLA.
In Georgia, tax lien auctions start bidding at the amount of taxes owed plus any legal fees incurred to bring the lien to sale, Owens said.
“That presents an opportunity for an investor to actually begin to invest in real estate at a price point that is significantly lower than most other forms of real estate investing,” she said.
Once the investor owns the tax lien, the property owner must pay the tax debt, plus interest and fees, directly to the investor to have the lien removed — a right that can be exercised at any point during the 12 months after the sale.
Tax lien investing pros and cons
- Lower barrier of entry. As previously mentioned, investing in tax liens can often mean investing fewer upfront dollars than you would for other real estate investments. Owens said tax liens can be less costly than wholesaling, flipping, off-market properties, etc.
- Lucrative return on investment. If another lienholder, such as a mortgage company, wants to redeem their claim on the property, they would have to pay the investor for that redemption, which would be the auction purchase price plus the interest rate decided on by the local entity. In Fulton County, Ga., the interest rate is 20% for the first year or fraction of the year. The 12-month redemption period also applies.
- Possibility of owning the property free and clear. If no other lienholder pays the investor what they paid for the tax lien at auction, the investor could eventually end up owning the property after the redemption period via foreclosure, Owens said.
- One-year redemption period. The owner has 12 months to redeem the property, which means your money will sit for that long and you can’t touch it.
- Higher-priority liens. If there are other liens that are superior to your tax lien certificate — such as a homeowner being ordered in a bankruptcy case to satisfy other debts before repaying the tax debt — you could lose your investment.
- Possibility of a bad investment. If it turns out that the property is abandoned and not worth the time or money needed to renovate it to a livable condition, you could be wasting money. The NTLA recommends that investors do their due diligence and research the properties up for sale before making any tax lien purchases.
The bottom line
If you’re a new real estate investor with limited capital, or you’re looking for an investment with a potentially higher return than what the stock market offers on average, you might consider tax liens.
“Tax liens are kind of an anomaly in that they are a high-yield investment with low risk,” Owens said. “Those two usually don’t go together.”
Tax lien investments aren’t risk-free, however, so take the time to get a thorough understanding of how tax lien sales operate in your local area and be sure to vet any properties you’re interested in.
Additionally, keep in mind that in order to realize a consistent return on your investments, you’ll need to attend tax lien auctions on a regular basis, Owens said.