Exploring Tax-Defaulted Property Investing: Building a Comprehensive Thesis
In this post, we will explore the intriguing world of tax-defaulted property investing, a lesser-known investment strategy. The goal is twofold:
- Develop an interactive US-level thesis model for tax-defaulted property investing, enabling investors of all sizes to filter risk criteria effectively, devise a strategy, and access a target list of real-time bidding opportunities.
- Share notes on my research process as I venture into this new investment arena.
As a disclaimer, this piece is purely research-based, and I have not executed this investment strategy as of the publish date. My background lies in megafund commercial real estate, making this a novel and different approach to real estate investing compared to my past experiences in Multifamily, M&A, Distressed Loans, and Luxury Retail. This post aims to provide a nuanced outsider's review of the space, its opportunities, and its accessibility to individual investors.
Why Dive into Tax-Defaulted Property Investing
I came across this strategy while discussing with a friend and was intrigued by its novelty and the manageable deal sizes (some can be done in the hundreds of dollars). It appears to be a large enough niche where my proposed thesis work could make a meaningful impact within a reasonable timeframe. Fragmented data and the potential for technology to consolidate information make this investment strategy particularly appealing. Ultimately, I am curious to see if I can create an interactive top-down market model for investors to experiment with, given that the information is freely available but scattered across US county websites.
Important Definitions Up Front
Understanding the different types of tax-defaulted property auctions—tax lien certificate investing, tax deed investing, and redeemable deed investing—is crucial. Here are the definitions for each:
Tax Lien Certificate Investing: When a property owner fails to pay property taxes, the local government places a tax lien on the property. The government auctions off these tax lien certificates to investors, who pay the delinquent taxes in return for a lien on the property with a specified interest rate. The property owner must pay back the taxes, plus interest, to clear the lien. If they fail to do so within the redemption period, the lienholder can foreclose on the property.
Tax Deed Investing: In tax deed states, the local government seizes and auctions off properties when owners fail to pay property taxes. The highest bidder obtains ownership of the property, typically free and clear of any mortgages, liens, or encumbrances. This investment type offers the potential to acquire real estate at significantly discounted prices.
Redeemable Deed Investing: A hybrid between tax lien certificate and tax deed investing. In redeemable deed states, the local government seizes properties with unpaid taxes and auctions them off as redeemable tax deeds. The winning bidder receives a deed but not immediate ownership. The property owner has a redemption period to repay the taxes plus a penalty to regain ownership. If they fail to do so, the redeemable deed holder becomes the owner.
Different states and counties may have variations or additional rules, so research the specific regulations in your target investment area.
Benefits of Tax-Defaulted Property Investing
Tax-defaulted property investing offers several advantages for investors, which include:
- Potential high returns on investment: Tax lien certificates often come with attractive interest rates, which can provide investors with significant returns if the property owner pays back the taxes and interest within the redemption period.
- Diversification: Adding tax-defaulted property investments to your portfolio can help you diversify your assets and reduce the overall risk of your investments. This strategy may appeal to those looking to balance their holdings with a mix of traditional and alternative investments.
- Acquiring properties at a discount: Investing in tax deeds or redeemable deeds can offer the opportunity to acquire real estate at a significantly lower price than its market value. This benefit can be especially attractive to investors looking to flip properties or build a rental portfolio.
Risks and Challenges
Despite the potential benefits, tax-defaulted property investing also comes with its share of risks and challenges:
- Redemption period: In tax lien certificate and redeemable deed investing, property owners have the right to pay back the delinquent taxes and interest within a specified redemption period. This means that investors may not always acquire the property, and their returns depend on the property owner's actions.
- Competition with other investors: Tax-defaulted property auctions can be highly competitive, driving up prices and reducing the potential returns on investment. It is crucial for investors to be well-prepared and strategic when participating in these auctions.
- Property condition: When investing in tax-defaulted properties, you may not have the opportunity to thoroughly inspect the property beforehand. This means you could potentially acquire a property in poor condition, requiring significant repairs and additional investment.
- Due diligence requirements: Investors must thoroughly research each property before bidding at an auction, including verifying the property's title, outstanding debts, and any other liens. Failure to conduct proper due diligence can result in unforeseen complications and financial losses.
By understanding the benefits and risks of tax-defaulted property investing, investors can make informed decisions and develop strategies that maximize their chances of success in this niche market.
Data-Based Questions
Back to my goal of developing an interactive US-level thesis model for tax-defaulted property investing. To move forward, I'll need to answer several data-related questions:
- Can I easily obtain a list of all active tax lien certificate and tax deed auctions and sales? What is the easiest way to transfer information from thousands of county websites into a singular master list?
- Can I easily obtain a list of every US county, whether it is a certificate or deed county, and if it's a certificate county, what is the minimum statutory interest rate? Tax Sale Resources provides a helpful state-level map, but nuances may exist between counties within the same state.
- For redeemable tax deeds and tax lien certificates, what is the probability of redemption? How easily can I determine the historical outcomes of every tax lien certificate auction, including address, certificate cost, whether it was paid back in full with interest, or if the certificate holder received the property?
I plan to create a high-level information architecture representing the above and find the most time-efficient means of populating that architecture.
Next Steps
By pairing this information with demographic data from services like DemographIQ, I can create a targeted thesis model for tax-defaulted property investing, providing valuable insights and actionable investment opportunities. Stay tuned for the development of this comprehensive model and future updates on tax lien and tax deed investing!
Where to go if you're looking to get started
If you're interested in learning more about tax-defaulted property investing, I found two resources particularly informative as I was Googling around: