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Tax Lien Certificates
Lien Back and Research - by Joseph Basralian
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Lien Back and Research Investors in tax lien certificates can make a pretty penny. If they're extremely careful. With the return of better times for residential real estate, people are beginning to wonder if there is a way to capture those fabulous Eighties-like returns. There is, if you don't mind doing some legwork and earning interest from people down on their luck. The trick is to pay someone else's delinquent property taxes. You can do that because many counties auction off tax certificates equal in value to each resident's unpaid tax bill. If the resident eventually pays up what he owes, the county collects the money, and turns it over to the certificate holder. In 19 states the maximum annual interest rate the investor earns is between 12% and 50%. The other 31 states either don't sell tax lien certificates or have low maximum rates. "I have a stock that is going to hell," says Allan Garner, a tax certificate investor and book editor in California. "But with my tax liens, every morning I wake up I don't have to check the paper to know I've made good money." The certificates are well suited for small investors such as Garner because delinquent property tax payments usually fall in the $500 to $3,000 range. Buy several and you've diversified your portfolio. Problem is, they're less liquid than most investments because there isn't a big secondary market for the certificates, though they can be freely transferred. The investor doesn't even know when the resident will redeem. States require residents to redeem a maximum of one to four years after the auction. What if the resident doesn't pay? The holder of the certificate can foreclose on the property free of any mortgage obligations the original owner had. After all, the certificate is a tax lien, which is senior to every other obligation except IRS liens. But the investor only gets the deed about 1% of the time. Part of the reason is that the mortgage holders and other creditors would rather pay off the owner of the tax certificate, with interest, than miss out on foreclosing themselves. By law, the certificate investor can't refuse the money. But that's not a problem if you're earning 15% or so. Here's how yields are determined. Counties typically auction off the certificates annually, and investors bid using interest rates, not dollars. Bidding starts at the maximum interest rate allowed by the state. If only one person bids, that's the rate the investor will wind up with. As investors vie for the same certificate, they bid the lower and lower yields they are willing to receive. The more competition, the lower the yield. Each year about $1.5 billion worth of tax certificates are offered. In most counties that's more than enough to outstrip demand and keep interest rates near the maximum allowed, which can be as high as the 50% that is offered in Michigan. So what's the catch? Some investors don't spend enough time figuring out how to avoid mistakes. "We've had one or two people who didn't do their research come and buy a few certificates, but they've fallen by the wayside, never to come back," says Ethyl Martin, a tax collector in Raritan, N.J. To avoid bungling, first call the county treasurer in an area you'd like to get more familiar with and ask for a listing of the tax liens going on the block. Then learn about the properties. If someone isn't paying his property taxes, there's often a good reason why. For one thing, the property may not be worth anything to the owner. If that's the case, odds are it won't be worth anything to you either. The best rule of thumb is to deal only with fairly valuable residential properties, according to Joel Moskowitz, an attorney and author of The 16% Solution, a comprehensive guide to investing in tax liens. Make sure that the building is worth at least 25% of the overall property value, he advises. You can get the breakdown from the local tax assessor's office. Nightmares abound for the unsuspecting investor who doesn't stick to good residential properties. Counties have been known to auction certificates for land on the side of mountains, under water, or in the middle of roads. Says Bob Plantenga, the office manager for the tax collection office in Lafayette County, Ind.: "I've seen counties issue certificates for shabby buildings but not the land underneath them. Then the building is torn down, so the investor is really buying nothing." Fortunately, most counties make it easy to dig up reliable information. Dade County, Fla., makes it especially simple by offering a comprehensive on-line service covering the 600 to 800 certificates it sells every year. But by coddling investors, the county fuels competition at auctions. Last year, says Marsha Williams, a tax official there, a dozen hungry investors drove rates down to 3% to 5% from the 18% state maximum. That's terrific for delinquent Dade County taxpayers who pay the minuscule rate, but investors are starting to look elsewhere for deals. Investors need to do more than find good properties in out-of-the-way counties. Experts say you can't avoid pitfalls unless you study the letter of the law in each state you deal with. For example, states require investors to send formal notices to residents a certain number of months before the foreclosure date. Missing the date usually causes the investor to forfeit the chance at foreclosure. "Some investors think they can buy a few certificates and get a deed in the mail a few months later. Not so," says Williams. Before the auctions, there are ways to anticipate how high the yields will be. In urban areas, bidding is usually competitive. For example, last year in Phoenix the yields fell from a maximum of 16% to an average of 12.6%. Bidders were much more scarce in more rural parts of Arizona. Properties not bought in the county auctions were picked up afterwards at the maximum rate. Bargains remained because "not many people were willing to trek across the desert in their jalopies to look at properties," says Garner. Like other experienced tax certificate investors, Garner does most of his research and bidding without leaving his telephone and fax machine. The large amount of legwork relative to the sums involved is what keeps yields so high. Money managers and very wealthy investors tend to stay away because certificates usually only go for $500 to $3,000, and have to be researched individually. Still, the high rates are attracting the attention of bigger players. Moskowitz thinks it's only a matter of time before brokerage firms create a secondary market for the tax certificates. That would increase their liquidity, entice more people to invest and dampen rates of return. Large investors are also attracted to commercial properties, which have bigger tax bills and higher assessed values. But they are an entirely different animal from residentials. For one thing, they are only fit for investors with a lot of money to spend on legal fees. One frightening possibility: Investors who end up with deeds could be faced with huge bills for hazardous waste cleanups. So it's easy to see why many investors feel tax certificates offer too many ways to get burned. Even if the investor does everything right, there is still a slight chance that a property owner who files for bankruptcy won't end up paying his tax bills until several years after the foreclosure date, if ever. If your scruples are the only reason for not venturing into tax certificates, remember two things. First, the auctions often allow residents to pay a lower interest rate than they would if the locality just demanded the maximum interest rate. And if you dread the thought of facing your neighbor's woes directly, remember the resident sends his delinquent tax payments to the county, not the certificate holder. Adventuresome investors might do well to investigate. by Joseph Basralian |
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