A few days ago on the radio, a pitchman proclaimed that people could make big bucks by buying property tax liens. Just call the 800 number for your free tax lien kit, attend the live training event where you’ll receive a $20 Visa gift card and you’re on your way!

But not so fast! What is a property tax lien and is it a suitable purchase for the individual investor? A property tax lien is generated when a property owner fails to pay his tax bill. Then, the tax collector awaits the expiration of the time period required by his state’s law, issues a tax warrant, which is a legal action against the delinquent property owner, and auctions off the unpaid charges. Thus, the government has a legal claim against the owner’s real property and the lien protects the government’s interest in that property. The unpaid charges (tax plus interest plus any penalties) that appear on the tax lien certificate become matters of public record and are put on the market in a tax lien sale for an investor to purchase. At the time of purchase, the investor immediately pays to the government the amount due and sends written notification to the property owner that the investor is now the lien holder; the debt is now owed to the investor, not to the government.

Who benefits? Local governments conduct these sales in order to immediately receive the tax monies due to them. The investor makes money by collecting interest from the property owner based on the principal amount that the investor paid to purchase the lien. If the owner pays to the investor the overdue taxes plus interest and penalties within the time period allowed by state law, then the investor receives what he paid for the lien plus interest at the rate set by the state. If the investor paid a premium to purchase the lien then the owner might pay that off as well. Statutory interest rates are usually 10 to 20 percent but can be much higher, reportedly up to 36 percent in some states, or much lower, reportedly 3 percent. If the owner does not redeem his/her property within the designated time (usually six months to three years) then the investor can foreclose (just as the government would have done) and can file a lawsuit to obtain title to the property.

Therefore, buying a tax lien means that the investor has purchased only the tax debt, not the deed to the property. Tax liens can be bought and sold at auctions, sometimes online and sometimes even before being placed on the official public tax lien list. The tax lien is sold to the investor who will pay either the highest premium or, in some auctions, accept the lowest rate of interest. If there is a bidding war then the winner will of course realize a lower rate of return.

To purchase a property tax lien, contact the municipality’s or county’s treasurer for the date of the next auction. You will be told the procedural requirements for participating—for example, the legally acceptable form of payment. You can see the list of properties (the current list in The Bronx is 84 pages long). Address, block and lot number, type of lien (for example, property or water/sewer), owner’s name, property’s assessed valuation, property description, structures on the property, property condition and other items will be listed.

Before buying a lien, the careful investor should thoroughly research the property, because he/she is concerned with the property owner’s ability to pay and because there is always the chance that the investor might eventually have to foreclose on the property. Thus, the investor must consider if he/she really wants to. Sometimes you can get a better deal if the house has a lien on it and can afford to, become a property owner. Other important questions: Are there other liens on the property? If so, all liens—not only the tax lien—must be satisfied before the property can be sold. How about environmental hazards and other violations? What is the condition of the structures and of the property? Is the property in a good neighborhood? What is the zoning? What are comparable sales within a one-mile radius and in the same municipality as the property? If the investor has to foreclose, will he/she lose money on his/her investment if the amount of taxes, interest and penalties that he/she paid to purchase the lien exceeds the value of the property? Can the investor afford to invest additional capital in repairs and other expenses to correct violations and to make the property attractive for resale? Have any payments been made that have not yet been applied against the tax lien? Why is the current owner not paying taxes and can the owner afford to pay back the investor, with interest? Will the current owner pay the upcoming new taxes on the property? If not, then an additional tax lien will be created so that, if the investor forecloses then the investor will have to satisfy the new lien before he/she can sell the property. In creating and issuing the lien, did the issuing municipality properly comply with all of the state statutory requirements? Is the current owner likely to file for bankruptcy? If so, then a bankruptcy judge may allow more time to redeem the property and may even lower the debtor’s interest rate to be paid to the investor. And so on!

Investing in tax liens became more popular and competitive after the subprime mortgage crisis unleashed a spate of foreclosures. In addition, investment returns in many categories fell during the recession, prompting large institutions, such as banks, to look for more lucrative investment opportunities. High statutory permissible interest rates on property tax lien investments attracted the interest of these institutions, which sought to purchase portfolios of these liens. The greater purchasing power of these capital-rich institutions enabled them to outbid the small investor. What was the small investor to do? Seek out lien opportunities in small communities with fewer liens that could be purchased for as little as a few hundred dollars apiece—but with the same risks and responsibilities as those described above?

Therefore, any small investor who contemplates buying property tax liens should become very knowledgeable about the process, the risks and about local real estate. He/she should have sufficient financial wherewithal and have patience for a long time frame before making a profit. But there is an easier and less risky way to invest: Find a mutual fund that invests in property tax liens. This allows the small investor to benefit from the research skills of professionals and to avoid being pitted against the superior financial power of large institutional investors in the bidding process. It allows the small investor access to a broader investment portfolio while spreading risk among the many properties in the fund.

By Vivian J. Oleen

 Vivian J. Oleen is an associate broker at Sopher Realty.