Basic Investing Insights

19 Risks of Buying Tax Liens

Rachel Seidensticker
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Introduction to the Risks of Buying Tax Liens

Investing in tax liens can be lucrative, but it's not without risks. From illiquidity and inadequate research to title issues and low return rates, navigating the world of tax lien investing requires careful consideration and strategic planning. 

With the potential for competition, property value fluctuations, legal complexities, and unpredictable redemption periods, it's crucial to approach tax lien investments cautiously yet confidently.

Tax Sale Resources has been developing insights in this area for over a decade. 

Our in-depth experience in tax sales across the country and investor services have allowed us to explore every nook and cranny of the realm of tax liens. 

So buckle up, because we're about to navigate the twists and turns of the tax lien investment landscape and equip you with the knowledge to make informed decisions and maximize your returns.

Risk 1: Illiquid Investments

First, tax liens are an illiquid investment. 

In other words, when you buy a tax lien, turning the asset back into cash isn't easy – at least in the short term. 

The typical model is to collect payments on the lien and possibly take the property to foreclosure. 

As a result, investing in tax liens means holding onto assets for months or years and gradually making a profit.

That said, you can buy and sell tax liens on a secondary market. Tax Sale Resources offers a trade service to broker tax liens, whether you have a portfolio you’d like to liquidate or a specific lien that doesn’t fit your investment model. 

The service includes the completion of the transfer paperwork. However, tax liens aren’t guaranteed to sell, so it serves to reiterate that tax liens are less liquid than money in your checking account or a stock purchase.

Risk 2: Inadequate Research

Risks of Buying Tax Liens

Another risk in tax lien investing is the consequence of inadequate research. 

As with any form of investing, due diligence is crucial for tax sales. So, not doing the necessary research can burn an inexperienced investor. 

For example, you might attend an auction without doing prior research on any properties. You bid on an address in a well-to-do neighborhood, only to find out the parcel is a chunk of sidewalk and nothing else. 

Unfortunately, you just paid thousands for a tax lien that isn’t likely to give a return.

You can avoid this risk by thoroughly researching the properties for bid at the next auction. For instance, you’ll want to know the property’s size, boundaries, and estimated market value. 

Depending on your research capabilities, you may be able to gather some of this information from your county. On the other hand, Tax Sale Resources offers a research tool that gives an exhaustive rundown of each property in your region.

Risk 3: Title Issues

Next, title issues can cause issues for tax lien investors

For example, tax sales can come with municipal and HOA liens, adding hundreds or thousands of dollars to the investment cost. 

Because these liens survive the foreclosure process, they can go undetected until the tax lien falls into your hands.

In addition, a common misconception is that a tax sale or tax lien always wipes out a mortgage. But there are exceptions to this rule. For example, Florida’s tax deed foreclosure process requires that the mortgage holder receives a notification about their property. 

In other words, the owner has the right to due process and a chance to redeem the property. 

However, if the owner hasn’t received the proper communication, purchasing the lien means the investor becomes responsible for the second mortgage.

You can offset this risk by researching the properties at the upcoming auction. Tax Sale Resources’ research tools include a municipal lien search product. In addition, we gather HOA lien data, protecting investors from that angle as well.

Risk 4: Surviving Liens

The tax lien redemption process also exposes investors to risk, depending on their investment goals. 

For example, investors often buy tax liens in Florida, intending to make 5% on their investment within a few months. 

However, if the owner doesn’t repay the lien, you are on the hook for a low rate of return – such as two and a half percent or less – over a two-year period. 

Because you bid on the lien with the idea of collecting interest payments instead of taking the long road toward ownership, the lien doesn’t fit your investment model.

Conversely, say you buy a tax lien with the intent to own that real estate eventually. The fact is that the vast majority of tax liens are redeemed. 

So, you’re unlikely to become the owner of multiple properties by solely investing in tax liens.

Tax Sale Resources serves investors in this area through its research functionality, which reveals the habits of various property owners. 

For instance, some owners allow their properties to become delinquent and go to tax auction. These owners repeatedly redeem the properties just a month later when they get their finances together. This situation makes for a profitable model for investors. 

While there's no guarantee that this pattern will continue with any particular property, a multi-year history of this kind can help investors identify better opportunities. 

In other words, focusing on these specific liens increases the chances of quick redemption compared to first-time liens. While some first-time liens may also redeem quickly, it's more difficult to predict without a track record.

Risk 5: HOAs

Tax sales may seem like a lucrative investment opportunity, but it's essential to be aware of potential HOA liens that could significantly increase your costs. 

These liens can remain unnoticed until you acquire the tax lien, as they survive the foreclosure process. 

Understanding these factors is crucial for determining your financial obligations at expiration or during the tax foreclosure process.

Fortunately, we provide resources that help you identify properties associated with HOAs. Our specialized data goes beyond traditional property information, ensuring you have the necessary insights to make informed decisions in the realm of real estate.

Risk 6: Redemption

There are multiple perspectives to consider when assessing the risks and outcomes of tax lien redemption. 

The timing of redemption plays a significant role in determining the level of risk involved. Take Florida, for instance. If your goal is to quickly redeem a property in Florida and achieve a Fast 5% return, there are two scenarios to consider. 

The first is when redemption occurs within the initial few months, allowing you to meet your desired return. However, the redemption rate typically drops significantly over the next two years, resulting in a slow and unsatisfactory 5% return over that extended period.

On the other hand, if your objective is to eventually own the real estate by purchasing liens, the majority of those liens are likely to be redeemed. 

As long as you factor this into your investment model, you can mitigate the associated risks. 

However, if you anticipate purchasing a single lien with the expectation of owning the property in the future, you may be setting yourself up for disappointment. While there's a chance of winning the lottery with your first purchase, the likelihood of repeating that success diminishes with subsequent purchases.

Risk 7: Low Return Rates

Low return rates can ruin an investor’s best efforts. 

While making 5% interest within several months can provide excellent profit and fuel financial growth, investments can also go south and end up costing you money.

For instance, New Jersey has a unique situation in which most tax liens are bid down to 0% interest and have a premium fee. 

So, if the property redeems in six months or less, you break even on the lien at best. Instead, you make money if the property owner prolongs the repayment period and begins paying interest. 

Therefore, understanding tax lien statutes in your state can help you adjust your investment model to fit the assets available.

Because high returns are the essence of tax sale investing, it’s crucial to mitigate the possibility of the opposite. As a result, Tax Sale Resources recently launched a market analysis tool to show investors the average rates of return in their region by property type. 

This way, you can distinguish between shaky properties versus those that fit your investment style. 

Risk 8: Competitive Bidding

Because tax liens are lucrative investments, the competition runs hot at the typical auction. It can be discouraging to do the necessary research, establish the financial position needed for investing, and then lose on every bid to corporate-backed investors and seasoned solo veterans.

The solution is to hyper-focus your investment scope and limit the competition. 

You can achieve the first part by developing parameters for your investments, such as bidding on liens within specific price ranges or property types. The second piece of the solution means forgoing online tax sales and solely attending live auctions. 

In addition, going to remote areas can distance you from the more intense competition. Remember, less dense populations and rural areas don’t mean you can’t find an excellent investment.

Risk 9: Property Values

Likewise, fluctuating property values can hamstring tax lien investments, especially when you buy a lien and want to become the property owner. 

Tax liens usually take multiple years to turn into real estate, and various factors can influence the property value during that time.

For instance, the property could initially appear pristine at the time of purchase, but by the time foreclosure proceedings commence, it may have remained unoccupied for years. 

If this scenario occurs in a tax lien state with freezing temperatures like Vermont, issues such as burst pipes and a flooded basement can damage an otherwise beautiful property.

Unfortunately, this risk comes with every property. 

It isn’t necessarily solvable by research because property conditions can swing widely between the day you bought the lien and the day you become the owner. However, you can reduce the chances of buying a home already in a run-down condition.

For instance, it’s crucial not to rely on a source like Google to research properties. 

Although you might see a picturesque, single-family home in the images, they can be months or years old and not reflect the current reality. Even if your approach is investing in fixer-uppers, it’s best to get an accurate idea of the damage to ensure the property is a suitable investment. So, you can use Tax Sale Resources for its visual inspection services

Risk 10: Economic Factors

Similarly, prevalent economic trends can affect tax lien investments. While a market downturn can diminish property value, it’s a double-edged sword. Although rough economic circumstances impact home prices, more homeowners typically fall behind on their taxes, producing a surplus of liens. 

So, a higher supply alleviates some of the demand on the investor’s end.

However, competition can remain high in these situations, driving down interest rates on devalued properties. 

Plus, economic downswings often diminish the owner’s ability to repay their taxes, reducing your chances of seeing a return on investment. Therefore, in-depth research and adjusting your investment approach are critical.

Risk 11: Property Location

Furthermore, location is vital when considering tax lien risks. Merely having an address is insufficient, as it may not accurately indicate access or reveal that the property is a landlocked strip adjacent to another house.

A pertinent example is Cook County, Illinois, where streets with similar numerical addresses but different identifiers (such as "Street" or "Avenue") can indicate completely distinct parts of town. 

Therefore, it’s imperative to conduct thorough due diligence on tax lien sales and ensure all information aligns. For example, it’s best to confirm if the address matches the latitude and longitude coordinates and aligns with the parcel boundaries.

Another illustrative case involves cities with variations in street names like "8th West Avenue," "8th Avenue West," and "8th Avenue Street West." Search engines struggle to identify the correct property among the numerous iterations. 

The Tax Sale Resources platform utilizes more accurate matching criteria, such as the parcel number or ID. 

This method reduces ambiguity and enhances accuracy. In addition, we bring awareness of the precise partial boundaries and allow investors to distinguish between favorable and unfavorable aspects of a location.

Risk 12: Property Damage

Risks of Buying Tax Liens

Another risk is damage to the property while you’re waiting for it to be redeemed. 

Just like neglect can ruin a home, natural disasters can take their toll on a house. 

For example, a house in good condition might be sitting on a flood plain, introducing the risk while the house sits for a two or three year-long redemption period. 

This scenario can cause other investors to pass by multimillion-dollar homes because of the liability. As a result, it’s crucial to perform sufficient research and understand the asset you’re purchasing at the auction.

Risk 13: Foreclosure Costs

Foreclosure costs can make the difference between a profitable investment and a giant money sink. While the majority of your tax liens will convert, a few will inevitably go into foreclosure, and you’ll become the owner. As a result, it’s best only to buy liens for real estate you’d feel comfortable owning.

When a property fails to redeem and enters foreclosure, you’re responsible for the delinquent taxes, county fees, and attorney payments. 

These can trip up the otherwise well-oiled machine of your investment style because of the demand for additional capital. So, it’s best to set aside capital for foreclosures or use the Tax Sale Resources financing program

It only takes a few weeks to get the capital you need after applying, with no title insurance, personal guarantee, or credit score required.

Risk 14: Legal Complexity

When you buy a tax lien, you take a legal position on an asset. As a result, the legal complexities of tax sales can hinder investing, especially if you want to become the property owner. 

Converting tax liens to real estate involves time, resources, and legal expertise, so an attorney is necessary. Otherwise, you can miss essential county deadlines and conditions for becoming the property owner. Plus, every state has different laws regarding tax lien conversions, so it’s not enough to rely on familiarity with your state when entering another state’s market

In other words, there’s no scenario where you purchase a tax lien, let it sit for two years, and have the home fall into your lap. It bears repeating that an attorney is crucial to your business plan.

Risk 15: Unpredictable Redemption Periods

Unpredictable redemption periods are another risk when buying tax liens. 

Redemption periods affect your cash flow, which in turn decides how quickly you can scale your business. Because redemption periods are uncontrollable, it’s best to model your cash flow based on redemption period averages and stay flexible when your profits don’t go exactly as planned.

For instance, a property might redeem faster than you thought, leaving you with a pile of cash before you prepare for another investment. 

Or, you might experience slow redemption with a property, leaving you in a bind with your lender or funding source breathing down your neck for repayment. 

Therefore, it’s best to retain a rainy-day fund when implementing your investment model to handle fluctuating redemption periods.

Risk 16: Bankruptcy

Owner bankruptcy can also have implications for tax lien investors. 

Bankruptcy is common with properties of decent value that may have a tax lien. When property owners have the means, they may file for bankruptcy, putting everything on pause. Bankruptcy proceedings follow specific rules that can vary from state to state and will disrupt your plans, especially if you expect to obtain ownership through a tax deed after holding the lien for two years.

For example, a property owner can file just before the tax deed date arrives, putting your timeline on hold. Unfortunately, bankruptcy court proceedings can extend over several years

However, if you follow the proper procedures, you should eventually receive the payment owed as the tax lien owner. 

Nonetheless, bankruptcies can throw a wrench in your plans and intentions for the property. So, it's necessary to gain some familiarity with the topic and consult with an attorney experienced in handling such cases.

We always recommend working with an attorney rather than attempting to navigate these situations alone. 

While bankruptcy doesn't affect every tax lien, it occurs frequently enough that it is likely to come across it if you engage in this type of investment at scale. Remember that bankruptcies can be filed under different chapters, each with its distinct process.

Risk 17: Environmental Liabilities

Likewise, unforeseen environmental liabilities can wreck an otherwise perfect investment. 

For example, say you purchase a property that was formerly a gas station. A local environmental agency sees the change of ownership as an opportunity to demand cleanup efforts for the parcel because of a leaky gas tank. 

Or, say you buy vacant land with state wildlife regulations requiring you to remove a protected species safely. These issues can double or triple your initial cost.

Unfortunately, there’s no surefire way to head off environmental problems. Again, due diligence on tax lien sales can help you prepare for numerous eventualities, but a rare type of owl or a chemical spill from twenty years ago might not appear on your radar. 

So, it’s best to see this aspect as an occasional hazard and try to break even if you fall into such a situation.

Risk 18: Law and Statue Changes

Whether nationwide or state-specific, statute changes can interfere with your investment approach. For example, Montana changed its tax lien process in the last several years, and Alabama overhauled its tax lien system as well. Moreover, South Carolina recently extended the redemption period by one year. 

These regulatory shifts can sneak up and force you to adjust your investment model.

Changes to state laws can be unpredictable and affect the validity of the liens you recently purchased. 

So, staying abreast of trends and news in this realm can prevent costly legal battles and help you avoid potentially illegal activity. In addition to hiring a knowledgeable attorney, which is a must for numerous reasons, The Tax Sale Resources podcast informs tax lien investors of upcoming changes and the latest updates. 

For instance, we’ve covered how the current Tyler vs. Hennepin case affects tax sale investing, both in complex legal changes and how counties might handle tax liens in the future.

Risk 19: Extreme Circumstances

Last but not least there is always the possibility of an extreme industry risk like we all experienced in 2020 with the COVID shutdowns.

While this is a tough one to plan for, it's important to remember that if something like this happens we all need to come together as a group/industry so our voices can be heard.

Joining an association like the National Tax Lien Association is a great place to get involved and connect with like minded investors.

Tax Lien Due Diligence Checklist

Here’s a step-by-step guide for safe tax lien investing:

  1. Educate Yourself: Start by gaining knowledge and understanding of tax lien investments. Seek out reputable educators, attend conferences, join groups like the National Tax Lien Association, and listen to informative podcasts like Tax Sale Insiders.
  2. Choose the Right Partners: Building a network of reliable partners is essential. Identify trustworthy attorneys specializing in tax lien investments in each state you plan to operate. In addition, find reliable title insurance partners and data providers, and consider software solutions that can support your efforts. These partners will prove to be invaluable as you scale your investments.
  3. Plan Strategically: Take the time to plan your investment approach. Consider factors like your target market, investment goals, and risk tolerance. Develop a clear strategy that aligns with your objectives and helps guide your decision-making process.
  4. Execute with Flexibility: As you dive into the tax lien investment space, remain flexible and adaptable. Be open to learning and adjusting your approach based on new information and experiences. Stay agile in your execution to capitalize on opportunities and mitigate risks effectively.
  5. Prioritize Due Diligence: We can't emphasize due diligence on tax lien sales enough. Make it a mantra for your investment approach, and thoroughly research and investigate properties before making investment decisions. Scrutinize property details, ownership records, liens, and any other relevant information. Prioritize a comprehensive due diligence process to ensure you make informed and prudent investment choices.
Tax Lien Due Diligence Checklist

Decrease your Risks of Buying Tax Liens with the Best Resources

Reduce Risks of Buying Tax Liens

Tax Sale Resources can help you minimize risks and follow the due diligence checklist. First, our state directory provides attorney contacts, state statute information, and county contact information. In addition, our blog and podcast archives are a treasure trove of information, including state-specific investment case studies and reporting on recent legal changes. Likewise, our newsletter delivers news and insights every week.

Furthermore, our research tool compiles data from over 1.4 million liens, 200,000 deeds, 5,100 jurisdictions, and 8,100 auctions annually

We have spent over a decade building cross-referenced database to kickstart your investing in tax liens and ensure you don’t miss opportunities. You can also manage your tax lien portfolio on our platform, streamlining your reports and gaining insight from your data at speed.

Tax Sale Resources can also finance your business. We offer transparent terms for diverse asset classes, allowing you to scale your operations within days. 

Likewise, we act as a broker for tax sale trading. By using trusted third-party escrow funds and transfer documentation, we decrease transaction risk. Lastly, our transparent fee structure and reconciliation policies will provide clarity as you enter high-value deals, giving you peace of mind.

Conclusion to the Risks of Buying Tax Liens

Managing tax lien investing risks requires careful consideration and proactive strategies. 

Issues like liquidity, cash flow, legal ramifications, and unforeseen property issues can create roadblocks for an otherwise successful venture. 

As a result, investing in tax liens requires thorough research, strategic decision-making, and flexibility to manage the risks involved. 

By understanding and addressing these risks, investors can increase their chances of success in the tax lien market. Plus, Tax Sale Resources is there with you every step of the way, offering our suite of services to mitigate risk and promote growth.

Author - Rachel Seidensticker
Rachel Seidensticker
Chief Operations Officer
In the Tax Sale Industry Since 2010
Rachel is responsible for managing and overseeing the daily operations of Tax Sale Resources, which produces data for approximately 8,000 nationwide tax sales yearly. She started in the tax sale industry originally as an investor but decided to change course and team up with her brother (Brian Seidensticker) to build Tax Sale Resources quickly thereafter.

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