Real Estate is one of the most common investment categories. In fact, real estate has created more millionaires than any other type of investment. It is no surprise then that many individual investors are choosing to roll their funds from 401(k)s into self directed IRAs in an attempt to flee the stock markets and invest in real estate. One of the biggest problems, however, is that most people do not wish to be landlords. It is possible to turn investment properties over to a management company that handles all of the day to day management tasks, but that comes with a cost. There is another way, though, to make a great return investing in real estate, with less risk and responsibility.
Investing in tax liens can produce returns as high as 18% or more. In addition, some property taxes can be very low, which means investors can get started with as little as $3,000. For investors that do not have much money saved up in an existing IRA, the low entry point for tax lien investments makes them extremely attractive.
How Does It Work
A tax lien is a lien the government puts on a property whose owner is delinquent on their property taxes. Property taxes represent a major income stream for the government, and are used to fund various operations. Since the government doesn’t tend to run on a budget surplus, if property owners don’t pay their taxes it would cause all sorts of problems. To combat this, in the event a property owner doesn’t pay their property taxes, the government will sell their lien to an investor. This allows the government to collect the revenue that they were planning for in their budgets – keeping day to day operations humming. In return for the investor providing the upfront cash, the government allows the investor to participate in the ‘upside.’ This upside includes all the various penalties that get charged to property owners for being delinquent. Depending on the state the fees can equal 1% - 2% a month, or a set annual rate.
In the event that a property owner does not pay the taxes - after a certain point - the state will foreclose on the property. Once it is sold through the trustee or judicial sale, the proceeds will go towards paying back the tax lien holder first. That means the tax lien holder gets paid before lenders or any other creditor – tax liens take top priority. An important note here is that liens can be placed on worthless pieces of property. If a property has no value, an investor could potentially lose their entire investment. This is why before investors go to the auction they need to do their homework on the properties they intend to bid on.
How To Get Started
First of all, tax lien investors have to identify whether the state they wish to invest in is a lien or deed state. Washington, for example, is a deed state. This means investors buy the property directly out of foreclosure rather than having a lien on the property prior to foreclosure. The investors are then responsible for selling the property themselves. While there are great opportunities for wealth in deed states that will have to be for a later discussion.
Liens are typically sold at an auction. Investors each have a sign so the auctioneer can identify the highest bidder, or, in this case, the lowest bidder. The property at hand is identified to the bidders and they then start with the highest interest rate and work their way down to the lowest interest rate the investors are willing to take for that property. The investor that is willing to go the lowest is the one that gets the property.
Investing in tax liens can be extremely lucrative for investors that understand how the process works. It is highly advised that anyone unfamiliar with the process locates some sort of mentor to guide them through the process a few times before going out on their own.