Tax Lien Certificates (TLCs) arise when property owners don’t pay their ad valorem taxes and the local taxing jurisdiction sells its rights to collect to an investor in order to get cash for operating expenses.
TLCs basically constitute a government-sanctioned loan program to provide financing to delinquent property owners. From a public-policy standpoint, this is generally considered favorable – from everyone’s perspective – to the immediate seizure of land.
Generally, TLCs are first position liens that supercede any other lien already on the books (including mortgages). This is an outgrowth of the taxing entity’s unequivocal statutory right to collect taxes, irrespective of other concerns.
TLCs are issued as interest-earning instruments. The rate is determined by state statute and the interest becomes a part of the lien as it accrues (i.e. the lien can’t be cleared without also paying the interest). The rates are often high (e.g. 10% to 18%) in order to reflect the punitive consequences of tax delinquency. The rate doesn’t have anything to do with the risk associated with the TLCs themselves (which is very low on an individual basis, and almost non-existent on a portfolio basis, due to the superior lien position and invested amount relative to collateral value).
Land owners have a stipulated time in which to repay the original lien plus accrued interest (usually 12 to 36 months, depending on state of issue). Otherwise their property will be forfeited to the lien holder. This is the security provision of the instrument, similar to foreclosure on a mortgage.
In cases where redemption does not occur, the investor can end up becoming the owner of the property, often at a significant discount. Depending on the investor’s goals, they are generally free to re-sell the property, rent it, or occupy it, as they wish.
Forfeitures generally occur about 2% – 5% of the time. However, in many jurisdictions, due to the low investment-to-collateral value ratio, the result of these instances can have a material positive effect on overall portfolio return.
Investors purchase TLCs at auctions held by the local tax office. Traditionally these were live auctions, although many of them are now held online. Each jurisdiction usually has an annual sale. Sales occur in different areas across the country throughout the year.
Competition for liens varies widely from one jurisdiction to the next. In places with heavy institutional buying, investors should expect lower yields and a tougher time deploying their capital. Even in smaller markets, it is not unusual for a handful of locals to have sufficient capital to acquire the majority of the liens.