Tax lien investing is generally regarded as one of the safest real estate strategies out there. But as with any investment, there can be risks. Tax lien foreclosure, low property values, or additional investment requirements can be profitable to investors; however, you cannot ignore potential risks. On the surface, coming away as the highest bidder on a tax lien certificate auction, which is sometimes referred to as a sheriff's sale, may seem like a win-win situation, particularly in states where the auction is for the actual deed of the property. You may ask yourself: What can go wrong if I secure the title of the property? The answer will depend on the circumstances by which the residential structure or the land came to fall into a county auction.
One of the best ways to hedge yourself against tax lien investing risks is to know what you are getting yourself into. It would help if you considered what the worst-case scenarios could be, and you also have to formulate an exit strategy if things do not go your way. In other words, you have to figure out ways to reduce liability and mitigate risk. Let's start with discussing the various investing strategies you can evaluate concerning tax liens; each of them can pose particular problems you will want to avoid.
Tax Lien Foreclosure
For those looking only to collect interest, property acquisition can pose a risk. Many newcomers to the world of tax lien investing believe that they can take over a property by paying off overdue taxes and penalties assessed by a local revenue collection agency. This is what unscrupulous providers of tax lien education conferences will tell you, and it is not always as clear cut as that.
When you obtain a tax lien certificate, you have the right to collect interest from the morose homeowners who may or may not exercise tenancy in the property. The interest rates can be quite attractive because they hover around 5% and 10%, but they are capped by statutes and rules, which also dictate the maximum repayment period. When you think about it, a homeowner whose family occupies the property will probably consider you a suitable business partner in avoiding foreclosure, but think about what can happen if the owner cannot or does not want to play along. Will you be ready to exercise your right to foreclosing on the property and evicting the occupants?
Even with a tax lien certificate in your name, a foreclosure could be a costly affair. You may need to retain a law firm's services, and this is an idea that the homeowner may explore. You will become a plaintiff filing a complaint to the defendant owner. If the owner retains a foreclosure defense firm for some reason, you may be looking at legal headaches. There may also be the likelihood of the property owner being an attorney or having connections to law firms; this is more likely to happen when the property is a lovely beach home or a ripe piece of land for development.
Lack of preparation for foreclosure could potentially lead to lost money on a tax lien certificate. For the investor that is solely focused on interest, we recommend concentrating on single-family homes, properties with a homestead exemption, or properties with liens that are likely to be redeemed.
Tax Lien Property Values
There will always be a chance of acquiring a property that is not desirable or does not hold any real value. This is more likely to occur in states where the deed is auctioned off, but it can also happen in tax lien certificate situations. A deed may be packed with caveats, and one of them is related to the property's market value. For example, an investor could acquire a tax lien certificate on a parcel of land in Arizona's desert, and with an ugly view of the border wall separating the United States and Mexico. The property is undeveloped and is not surrounded by any residential or commercial real estate. An excellent way to avoid this risk would be to get an aerial view of the land. The aerial view will provide an idea of the property's condition and the surrounding area and can prevent this risk to a certain extent.
When real estate markets enter a downturn period, all property owners are bound to be affected, and some will be impacted more than others. This happened mainly in certain Southwest Florida regions between 2004 and 2008, when land buyers went crazy purchasing plots of land that appeared to be located close to residential developments under construction. When the housing market crashed, some of those development projects came to a screeching halt, and those who purchased lots near those construction sites were left holding titles that ended up losing more value than they expected. This is a highly speculative strategy that can happen whenever market conditions are not favorable.
Additional Investment Requirements
Another risk in tax lien investing also comes in acquiring the tax lien property through tax foreclosure. Because you are often buying a tax lien certificate, most likely on a distressed property, it is expected that additional investments need to be made to make the property marketable. A new roof, municipal liens needing to be satisfied, cleaning the yard, changing the locks, etc. There are countless ways additional investments may be required. When purchasing a tax lien certificate, it's crucial to anticipate all exit strategies and set aside extra investment money if repairs are needed.
Properties that are in a severe state of disrepair may end up becoming too expensive to improve. This can happen in California with homes that were never brought up to seismic code; the risk could be cracks in the foundation caused by earthquakes, which would require a complete demolition of the structure. You may still be able to profit from the land value, but only if you commit to paying for the cost of demolition and debris disposal. Yet another risk is related to environmental impact or damage. We should mention the Golden State once again because new stormwater disposal requirements are coming into effect in 2021.
The bottom line of additional investment risk is: Are you willing to shell out extra money to make the acquisition attractive? We may not even call this a risk because it can be an exercise in building equity. If you think about it, real estate investors who are into flipping properties for a quick sell deal with this kind of risk all the time; for them, it is implied, but it has more to do with market conditions. Here we should mention that some house flippers are also tax lien certificate investors.
In some cases, they can see market conditions improving, and they move towards negotiating with the homeowners for a quick exit and amicable foreclosure in exchange for a cash payout. In this example, the advantage would be a summary foreclosure judgment without eviction because you would be paying the occupants to move out.
There Are Risks In Every Investment
Each of the risks mentioned above can be avoided by conducting thorough research. We understand that you may not know all the details you need to pay attention to avoid these risks, but we are dedicated to teaching our members how these processes work.
Proper research doesn't always mean that you will avoid all of the risky situations. In the realm of tax lien investing, some risks can be unpredictable. It would be best if you were prepared to solve problems to make money; nonetheless, it is often in difficult situations where expert investors can thrive and earn the most significant profits. It is important to remember not to be scared of a potentially profitable investment because the property needs some repairs or negotiations. There will be times when you come across information that merits ignoring an auction listing altogether. Seasoned real estate investors will look at title search or abstract to get an idea about mechanic's liens or potential claims to the title that can grow into headaches that are not worth dealing with.
In the end, education, proper training, and a formidable team will help reduce the risk of losing money on an investment. With Marketplace Pro software, you can significantly reduce your risk because you will not be going blind when registering for a tax lien certificate or a property deed auction.
If you are familiar with the Multiple Listing Service (MLS) used by real estate professionals, Marketplace Pro is the closest you will get, and it can give you a distinct advantage over other auction bidders. Whenever you are ready to experience the power of Marketplace Pro, be sure to get in touch with our office so that we can arrange a demonstration.