Over the past 15-20 years, I have had hundreds of conversations with people about money. Their money. And the question always comes up, “What should I invest in?” Stocks? Bonds? Mutual funds? Real estate? Land? Rental houses? The choices are endless. Eventually, the conversations turn to risk, return, the person’s risk tolerance and their time horizon. At some point in these conversations, I find myself talking a little about the options that are available, and painting a picture of risk, reward, and effort. I believe that the reward is closely tied to the amount of effort expended. For example, a person can easily invest in a savings account. The return is extremely low, but it is easy to open the account, the money is always available and they can withdraw it at any time without penalty. Perhaps next on the list would be a certificate of deposit or a money market account. The rate of return is slightly higher, it takes a little more time and effort to investigate which CD to buy, and it is not as liquid. Next up the ladder might be mutual funds. The return could be a little higher yet, but it is a more volatile investment, and requires more work and research to choose the right fund. Next on the list might be individual, publicly traded stocks. Along with a potentially higher return comes more required research and market fluctuations.

At some point in these conversations, I would bring up a seldom known investment called tax lien certificates. Usually, the person I am speaking with gets a slightly confused look on their face because very few people have even heard of tax lien certificates. A very brief overview of my conversation around tax lien certificates goes like this:

“There are two types of states in the United States – “Deed” states and “Lien” states. In a deed state, when a property owner fails to pay the property taxes on their real estate, the county tax collector waits a statutory period of time (let’s call it 5 years), and then the county forecloses on the person’s property. The property is sold at an auction, and the successful bidder/investor receives a deed to the property. It is a very simple, straightforward way for the county to dispose of delinquent properties, and a very easy way for an investor to invest in said real property.
Lien states are very different. In a lien state, the state has decided they do not want to wait that five years to recover the property’s delinquent taxes. They have roads to pave and county services to pay for, so instead of waiting a long period of time to receive all of their money from a given delinquent parcel, they sell a lien on each delinquent parcel each year. In essence, the county tax collector sells the county’s tax lien to an investor. The investor pays the delinquent property taxes for the property owner, and the investor now has a priority lien on the property. The tax lien is superior to any mortgage or loan the property owner may have in place, and the lien bears interest at an interest rate that is determined when the investor buys the lien.”

Tax liens are a very safe, high yield investment. They are superior to nearly all other encumbrances a parcel of real estate may have and the interest rate is guaranteed by the government (to the extent anything is “guaranteed” these days). But if tax lien certificates are so lucrative, why haven’t most people heard of them, and what are the risks? Most investors have never heard of tax lien certificates because they are not publicly traded on a stock or commodities exchange. They are not traded or recommended by well-known brokerage houses like Fidelity or Schwab so there is no incentive for anyone to advertise them in the way that we are all accustomed to seeing investments advertised.

And yes, there are some risks with tax liens. They are certainly not a liquid investment. But the biggest downside to tax liens is the amount of work it takes to purchase the right lien. As we discussed earlier, I believe there is a very real relationship between return and effort. And tax liens are a lot of work. It takes hours, days and weeks to research and identify the right liens, and the wrong ones. And I believe this is the reason very few people ever take the first step and invest in them.

I have always liked business models where the model is tilted in my favor. I want to know that there are multiple ways for me to succeed and very few ways for me to fail. I have also always liked business models that contain a passive income model – a model that generates revenue over and over after the investment has been made. There are multiple profit centers and a passive income model surrounding tax liens.

If a property owner chooses to keep their property and pay their tax lien, then the investor receives their principal back plus interest. If the property owner chooses not to pay their property taxes, then the owner of the tax lien may foreclose on the lien and the investor would then own the property free and clear. Whether the property owner pays their taxes or not is of little concern to the investor because either way the investor wins, either via a high return or through property ownership.