When inflation rises quickly, it erodes the average person’s financial health. This is now happening at an almost-unprecedented speed. This year has seen the biggest increase since January of 1982.
To make matters worse, the Russian invasion of Ukraine has sent prices at the gas pump skyrocketing to new all-time highs. It is no surprise then, that Fidelity’s eMoney Advisor found that the high cost of gas prices were the number one concern for Americans (43%), followed by being able to pay bills (42%) and inflation overall .(40%).
In light of this seemingly bleak state of affairs, is it possible for the average person to stay ahead when inflation rises quickly?
The short answer is yes. This article will discuss a relatively low-risk investment in a unique subset of real estate that is often overlooked. Tax liens and tax deeds – collectively referred to as tax-defaulted property.
When Inflation Rises Quickly, Invest Wisely: What is Tax-defaulted Property?
The entire process begins when homeowners fail to pay their property taxes. Because local governments rely on these taxes to pay for essential services (police, fire, hospitals, libraries, etc), they must take steps to recover the money owed.
To that end, local counties are mandated to either levy a tax lien on the property and issue a tax lien certificate for auction, or seize the property altogether and issue a tax deed for auction.
The tax lien certificates and the tax deeds are auctioned off to the highest bidder at property tax auctions, which are open to the public. Herein lies the opportunity for everyday investors to receive a competitive return on investment (ROI), although in very different ways.
When Inflation Rises Quickly, Invest Wisely: What are Tax Lien Certificates
A tax lien certificate is a lien against a property for unpaid taxes. It prevents the owner from refinancing or selling the property until the taxes are paid, and it guarantees the owner of the certificate the right to collect the back-taxes owing, plus a significant rate of interest and penalties.
Tax lien certificates are sold at an auction, with the starting bid typically at the amount of outstanding taxes owed. For instance, on a property worth $200,000, the annual property tax is likely around $2,000 (1% of the value of the property). If the taxes are three years in arrears, the amount of unpaid taxes will be around $6,000. If the rate of interest charged to the homeowner is 18% (this will depend on where the property is located), then the ROI on this amount will be $1,080.
Owning a tax lien certificate does not mean you own the property, rather it gives you the right to collect the taxes owing on the property. The property owner has a fixed amount of time to redeem the certificate by paying the taxes owed, plus interest and penalties, which the local government then forwards to you, the investor.
What happens when the owner doesn’t redeem the certificate? Your investment is secured by the property itself. This means that you are within your rights to foreclose on the property, at which time you do own the property and can do with it as you like.
Remember in our example that you paid $6,000 for the certificate. The property is worth $200,000. Instead of making $1,080 on your investment, you can sell it and make $194,000. (*these are very loose estimates, as your profit will depend on what the winning bid actually was).
If you’re nervous about being stuck with the property, you may rest easier knowing that over 97% of the time the property owner redeems the certificate.
When Inflation Rises Quickly, Invest Wisely: What are Tax Deeds?
Tax deeds are a different beast altogether and a much less benevolent way for the government to collect their taxes.
In tax deed states, when homeowners fail to pay their property taxes, the government will confiscate the property and sell it at auction to the highest bidder for pennies on the dollar.
As is the case with tax liens, bidding for tax deeds generally starts at the amount of back taxes owing. The highest bid wins the deed to the property – with the mortgage wiped out no less – and is free to do with the property as they wish.
They can fix and flip it, rent it out, live in it, or sell it as-is at a significantly lower price than its market value, while still making a very healthy profit.
Remember the home worth $200,000 with $6,000 of back taxes owing? Imagine winning the bid at $25,000. Even if you took the path of least resistance by selling it as-is for $125,000, you still just made $100,000 on your investment.
When Inflation Rises Quickly, Invest Wisely: Is Tax-defaulted Property a Risk-free Investment?
While investing in tax-defaulted property is a relatively low risk investment due to it being secured by property, it is not entirely without risk.
The biggest risk is that you could be bidding on worthless property. The property could be swamp land, or there could be environmental contaminants that render it uninhabitable.
You may get the property for pennies on the dollar, but unless you can sell it, you are throwing your money away.
Another risk is that there may be other taxes owing on the property that would then become your responsibility. This wouldn’t necessarily stop you from bidding, but it will impact how much you are willing to pay.
The risks associated with tax-defaulting property investing are all easily mitigated by thoroughly understanding the process and doing your homework.
When Inflation Rises Quickly, Invest Wisely: How to Get Started
When inflation rises quickly, a smart investor will counteract the rising cost of living by wisely investing. If tax defaulted investing interests you, how do you get started?
The first step is to assess if tax lien or tax deed investing is right for you, based on your tolerance for risk, and the time you can commit to it. Once you determine that, then educate yourself on what states offer tax liens, and which offer tax deeds (in some states there is a hybrid of the two).
The next step is to research where and when the counties you want to bid in are holding their auctions, and what their particular rules are for participating in the auctions.
This article has discussed tax-defaulted property investing at a very high level, but there is much to learn about the process if you are going to maximize your profits and minimize your risk. Perhaps the best investment you can first make is in a coach or course to guide you along the way.
As a free gift to Duc’s readers, we are delighted to offer a free Insiders Report designed to get you started on your path to tax-defaulted property investing. When inflation rises quickly, as it has done this year especially, a smart investor will preemptively boost their cash flow through their investments in order to bring in greater returns. Tax-defaulted property investing is a preferred way of doing just that.
Guest blogger: The Ted Thomas Team