How to Avoid Tax Sale Investment Risks

Tax lien investing is extremely safe because the government has made it that way.  But there are still some risks, if you are aware of them, you can easily avoid them.

Here are a few primary pitfalls to look out for:
  • Liquidity
  • Emotional Bidding
  • Low Value Properties
  • Environmental Issues

Liquidity
Liquidity is the ability to sell an asset and convert it to cash.  This is a risk only if the cash that the investor invests in a tax lien or deed is tied up for an extended period of time.  An investor’s money is tied up in a tax lien until one of the following things happens:
  1. The property owner redeems the lien by paying the county the delinquent taxes, penalties, and fees in full.
  2. The redemption period passes and the certificate holder forecloses and sells the property.
A tax deed investor’s money is tied up until he or she executes their exit strategy.  The investor may want a cash flow property and each month the investor receives a check from the renter, or the investor may want to sell it, then they would exit when the property is sold.

This really isn’t a risk per se, but for some investors it’s something important to consider. 

If an investor needs to exit from a tax lien certificate, it’s possible to sell a tax lien to another investor.  You can even find them listed on eBay.

The main thing to look at is the redemption period for a tax lien investor.  Consider the longest time period that your money will be out of pocket.  If you’re okay with that time period then go for it. The same applies for tax deed and redemption deed investors.

Emotional Bidding
Emotional bidding occurs in an auction setting where a bidder gets caught up emotionally in the bidding to the point where they bid away their returns.

An example would be a tax deed investor that is interested in a $50,000 property and has set a maximum bid limit of $25,000.  There is another bidder in the room that the investor is competing with that continues to bid higher.  The bidding reaches $25,000 and beyond and the investor continues to bid higher and higher until the return is gone.

There are two ways to lose money in tax deed investing - either you bid away your return through emotional bidding (or by bidding too high because of lack of due diligence) or you buy a property with little or no real value.  Researching before attending the auction and sticking to your set bid limits will easily help you avoid making both of those mistakes.

To avoid bidding away your return at the auction, research beforehand, make sure the property values are solid, set a maximum bid limit after considering your exit strategy and after you know the maximum amount you can spend to make a sufficient return, and then stay cool at the auction.

Low Value Properties
This is very simple to avoid, but this is probably the risk that you need to keep in mind more often than the others.

What do we consider low value properties?  Useless land might be considered low value, like a lot in the middle of the desert, far from civilization and access.  It is low value only because your options after purchasing are limited.  Beware of land with easements on it, which could prevent the investor from making any changes to the property.  A good indication of useless land is the assessed value.  If the land has an assessed value of $1,000 then move on to another investment.  However, even if the land has a high assessed value, make sure to check the location of the land.  A piece of land with an assessed value of $500,000 might still be in the middle of the Texas desert where no one can reach it.

Other properties that you may want to avoid are:
  • Flood or swampland. This may come up in Florida or other southern states.
  • Landlocked properties. Landlocked properties are surrounded by other land and do not have public access, so in order to access your land, you have to get permission from another property owner.  You avoid both of those property types just by taking a look through a mapping service in the assessor’s office or Google Maps.

To avoid making a purchase on a property with low to no real value, check the assessed value with the county and take a look at the property using a mapping service.  Don’t buy a property based solely on the legal or property description.  Make sure to do some due diligence so you know exactly what the property is.

Environmental Issues
This is uncommon, but something to be aware of. U.S. Code Title 42 Section 9601 states that property owners are responsible for contamination even if it existed prior to ownership.  This isn’t a problem with tax lien holders because the investor isn’t the property owner unless he or she forecloses on the property, but it is something to consider as a tax deed investor.

This is easy to avoid.  All you have to do is look at county records and in most cases it’s very obvious.  For example, if you’re buying an old gas station that experienced erosion underground then you probably have environmental issues.

One safe way to avoid environmental issues is to stick to residential land and homes.  Residential homes and improved lots tend to not have environmental issues.  If you have any questions about whether a property has environmental issues, check out epa.gov.

Other Risks
Some other risks that you may want to consider are bankruptcy and federal liens.  In both cases, it won’t wipe out a tax lien certificate, but it may postpone your repayment.  In some cases foreclosure won’t wipe out a federal lien, so if buying a tax deed or a tax lien on a property that you would like to own, consider avoiding federal liens.

One way to check for any of the risks discussed above is through the county records.  If you don’t find what you need there, you can also get a title search.  You would do a title search if you have questions about a certain property that you want to buy.  Title searches can cost anywhere from $25 to $150 depending on the detail that you require.

There are links on the resources page on this website to some online title search companies if it comes to that.