Knowing What to Look for
What to Look for when Obtaining a Tax Lien
We buy deeds to acquire properties to sell for immediate profit. Buying a deed means we are buying properties, and buying properties requires careful due diligence; we should know all about the property. After the purchase you need additional efforts to sell the parcel to take your profit.
On the other hand, we buy liens with the purpose of putting capital into circulation to create growth and long-term wealth. It is not that one method of doing this business is better than the other, but one is certainly simpler and takes less work – liens represent an ideal way to gain entry into the business of tax sales.
Guidelines for a Good Lien
Purchasing a lien requires less research that purchasing a property or a deed. We don't have to know everything about the property, because we don’t expect to take possession of the property. To a large degree, it's like selecting apples at the grocery store. They're all apples; you take the ones that don't have bruises or worm damage, otherwise it hardly matters.
Although taking the property is a distant possibility, that is not our thinking as we analyze the lien, any more than a bank expects to someday own your house at the time they lend you the purchase money with a mortgage. That is, after all, the essence of a tax lien purchase, we lend the property owner the money to get the taxes paid for a year at a high rate of interest.
Meanwhile, just like the mortgage lender, we are putting our money to work for us. Taking the property instead of re-circulating would not be our preference; in fact, as with the mortgage lender, it would be our security in the transaction and our final course if necessary.
What to Look for with a Lien
When we analyze a lien, we take two factors into account to make the decision:
- How probable is it that the owner of the property will redeem the property within the redemption period?
- How marketable will the property be if we have to foreclose and take possession of it?
What follows helps you rank properties on these two factors. The higher the rating, the higher the probability of redemption or the easier it would be to market. You can imagine that a big, beautiful home in an exclusive and expensive neighborhood will probably not be neglected to the point of foreclosure. Given your cost to acquire the property through tax foreclosure, it would be easy to sell. On the other hand, an unbuildable parcel will not get redeemed and would impossible to market.
Those investors new to real estate investing are advised to stick to properties that are ranked at 3 or higher, at least early on.
5 – Single family residence, owner occupied: people don't easily give up hearth and home,
especially not for property taxes, which are only a small percentage of property value. They generally find a way eventually, unless they are unable to save their home because of death, incarceration or because they are no longer in the country. Whether this is a single wide manufactured house out in the woods or a 6,000 square foot house with a pool on an acre fronting a lake, it is home for the owner. It further represents the best accomodations the owner can afford. Emotions are powerful forces - everything we do is based of feelings, be it anticipation of pleasure or avoidance of pain. Emotional ties to home are among the most compelling that people have.
4 – Improved property, residential or commercial, not owner occupied: these will most
likely be either rental properties or they might be vacant, which makes them potential rental properties. The decision to save this property is more of a business decision than an emotional decision, but a rational thought process would cause the owner to save a valuable asset.
3 – Building lots or land in developed areas: these are unimproved properties, meaning
that no structure sits on the property, such as a house or other type of building. A manufactured house on a permanent foundation would push this up to a ranking of 4 or 5, but a mobile manufactured home on axels making it easy to move would keep the lot in a grade 3 ranking. The key here is that the area is developed: the street or road is in its finished condition (usually paved, but in some areas you might notice that it is normal for residences to front unpaved roads) and the situation with utilities meets normal local standards. In most cases, this means paved streets and local water, sewer, gas, electricity, telephone and cable service, although what we are looking for is what is normal for the local area. If there is no local sewer, and houses in the area have septic tanks, then we expect that with this parcel. Obviuosly many nice places depend on wells and have no cable. The important consideration is that the property is build-ready. A person could commence construction on the lot as soon as the permit process has been completed, based on local norms and code. Your best bet is just look around the neighborhood. If you see houses around, that indicates that this is a grade 3 property.
2 – Miscelleneous unimproved lots and lands in undeveloped areas: lots in a paper
subdivision would receive this ranking - a paper subdivision has been platted, the plat map has been approved by the county, but nothing has happened on site: land has not been cleared, roads have not been graded. This would also include parcels that are landlocked (although if the owner also owns the property between this property and the road, you can look at that situation closer). This would include rural lots out in the country in non-developed areas.This could also be a buildable parcel that could be sub-divided by a local developer, thus creating multiple grade 3 lots.
1 – Land not ready for development: These parcels could include anything without road
access or where the distance away from civilization requies considerable travel to get there; it might be out in the desert or in the backwoods, but there is limited marketability of the property if someone tried to sell it. These could also be odd shaped lots for which creative thought could come up with a viable use, such as billboard placement, etc.
0 – Unusable lots: narrow strips, land beneath streets, roads or recorded rights of way, lands
within an environmental easement (e.g., wetland, greenbelt), unbuildable parcels due to geography (swamp, frequent flooding, cliff-face, etc.)
Early on in your career, you probably should limit yourself to liens that score 3 or higher – perhaps a 2 ranking if you have an idea of how to market such a property. Those ranked 3 or higher tend to have more appeal to the owner, increasing the probability of redemption, and are more readily marketable in case that becomes necessary. It is not necessary that the lot be improved (i.e., with a structure on it). Building lots that are ready for immediate construction with the streets, utilities and other developed amenities in place are highly desirable.
Clearly, a property that also serves as the owner's home creates an emotional attachment to the owner - extremely high probability of redemption. A non-owner occupied but improved property represents a potential revenue source - it can be rented out - and saving that property would be a business decision for the owner that would give a high probability of redemption. Building lots in an improved neighborhood can offer high probability of redemption, based on how long the owner has had the lot, how much was paid for it and what the pattern of tax payments in the past has been. The latter are also marketable because there will always be small-time builders looking for inexpensive lots to build on.
To simplify your analysis, you should first quickly look at the nature of the property. If it meets the standards of grade 3 or higher you continue by looking into the property owner. If not, you leave that property and go to the next.
Gauging Probability of Redemption
As you look further into the property you will look for three primary indicators that the owner will probably redeem the property and save you from the effort and bother of foreclosure:
- The length of ownership may indicate level of commitment to the property: a long ownership shows the owner has been taking care of things, brief ownership indicates that the owner recently put money out that will be lost if the property is lost to foreclosure.
- The amount the owner paid for the property if within the past few years would testify to potential loss if the owner does not redeem.
- The tax payment history of the property over the term of ownership helps understand whether redemption is forthcoming or not: some people pay their taxes sporadically, skipping a few years and then making it up all at once, perhaps every four years or so. These are good liens to buy. Or this might be the first time the owner has been late in 15 years - likewise, a safe lien.
In summation and to restate what we wrote previously, you buy liens to put your money to work for you. Money at work increases in value. Money that sits loses value to inflation. It seems that causing money to circulate creates friction that causes it to grow. When you put your money into liens, the liens cause your money to work for you in a highly productive way.
Don’t over-think this. Buying a lien should be no more challenging to you than going to the grocery to pick up a loaf of bread – or going to the bank to open up a certificate of deposit (other than the fact that the bread will either be consumed or will spoil, and a bank CD will pay less than 2% instead of 12% - 18%.
That is why we say, you just get liens, then get more liens, and then get still more liens, meanwhile you keep your eyes open for any deeds.