Tax lien investing is often promoted by "real estate gurus" as either the perfect fixed-income investment alternative or alternatively as a magical way to buy a house for a fraction of its true value. Buying tax lien certificates is the latest educational gimmick being offered by many of the same "real estate experts" who also brought you the sure-fire no-money down strategies for buying both commercial real estate and homes. In case you don't recall, the gurus showed all of us (who of course are not nearly as well-informed as they are) how to buy properties without worrying about the true value because it is going to continue appreciating and therefore current values do not matter. On top of that, the rental income will cover the mortgage payments while we are waiting on all of that real estate appreciation to keep on happening each and every year.
What could go wrong?
As we now know, real estate can go down in value by substantial amounts and does involve a number of investment risks. Vacancies are also routinely a fact of life for anyone evaluating cash flow and operating expenses. Vacancy rates become more than a theoretical data point when an investor is depending on the cash flow from renters to cover the loan payments. When you buy a property with no money down and suddenly need to sell it because of insufficient cash flow, the final straw becomes apparent when simultaneously the proposed sales price is 40% less than what you paid. That 40% comes out of your own pocket because you had no equity in the property. For those who need to sell and cannot afford a 40% loss, the remaining alternative is to default on the loan and go through a foreclosure process.
Buying tax liens is much more risky than whenever I hear someone explaining it as a salesperson trying to make a sale to an interested customer. I would go so far as to say that except for very unique and specialized circumstances, tax lien purchases should be totally avoided by anyone who is not prepared for the very real possibility that they will lose all or part of their invested funds. This is not the safe and secure financial investment that it is regularly purported to be.
Here is the short list of what can go wrong with tax liens:
- A property owner who cannot make their property tax payments is a high risk for failing to pay their homeowners insurance policy premiums as well. If damage to the property occurs without proper insurance, everyone can lose.
- It is not unusual for those who have fallen behind in their property taxes to consider the possibility of filing for bankruptcy. If they do so, the redemption period can be extended. It is not unusual for a bankruptcy trustee to order a reduction in the interest rate for the tax lien.
- For those wanting to use the tax lien process as a way of acquiring ownership of the property, the odds are against you as about 75% of current owners redeem their property in the period allowed by law in their State.
The entire tax lien certificate scheme is reminiscent of how safe second trust deeds were represented to be during the 1980s. Investing in second mortgages was usually described as "an easy way to make 12% or more." If that sounds similar to how tax liens are being marketing, that is exactly the point I am trying to make.