I belong to a Google group of investors, where we all share ideas, answer each other’s questions, and try to tap into the experience that each of us brings to the table.
The other day, one of the members of the group asked if any of us had experience purchasing tax liens with private money.
Here was my response – I hope you find it as interesting as the group did…
I have a Tax lien course but it doesn’t cover that.
The main question here is really not a Tax lien question but a legal entity structuring question.
A tax lien can be bought by either a natural person (a human) or by a LLC or CORP…
But you can’t put a 1st lien position on a tax lien, so there for the traditional real estate private money way doesn’t work.
Of course you can borrow money to buy liens, but in your documents you basically need to pledge the liens as collateral (however they really can’t record anything against those liens).
Tax lien ownership can be transferred from one person to another, so if the lenders have to act on the loan, they can force you to transfer the ownership of the liens to them. There are county processes in place (which title companies know how to work but which are state specific) that allow for such a transfer.
Probably the better way would be to set up a private placement fund with one or multiple investors investing into an LLC and then you run that LLC and invest for it. The profit arrangements can be managed in the operating agreement (I have seen people do something like the following):
– Investors get a preferred 8% and then X% of what the fund generates in addition to that.
– Or you just to a plan 50/50 with investors
– Or you arrange with them that you get 3% of each lien and they get the rest…. Plus on each foreclosed and flipped property they get X% of profits.
Then when you get a tax lien which you end up foreclosing on, you get the lion’s share of the profits while your investors are still part of the upside.
The main issue with Tax liens are that you NEVER know when you get your money plus interest back.
Tax liens might have interest rates of 16%, 18% or even up to 36%, but you only ACCRUE that interest, you DON’T get it paid on a monthly basis.
That means that if you buy a lien today and if the owner of the property doesn’t pay it off for 3 years (and assuming you can’t foreclose for 3 years) you don’t get a dime for 3 years – and then all at once you get the invested money back plus 3 years’ worth of 16%, 18% or even 36%.
So using private money is a problem because they expect monthly interest payments which you really can’t reliably predict unless you buy a LOT of liens (in that case the assumption is that some people will pay their liens off each month so you can then use some of that money to pay interest)
So I think the way to go is to do a private placement fund with no payouts for a while until you can reasonably count on having cashed out on a bunch of liens and/or foreclosed and flipped a bunch of properties so that you are for sure liquid when you do pay out profits.