This past week, I spent considerable time preparing for a county property tax auction. Unfortunately, none of the properties I was interested in actually made it to the auction. I still learned a lot and wanted to share it with you all!

What is a tax sale?

A tax property auction (a tax lien auction or tax foreclosure auction) is a public sale of properties with unpaid property taxes. This lien serves as a claim against the property for the unpaid taxes. Layman's Definition: you are buying debt on the property and have the potential to foreclosure if the debt is unpaid.

These sales vary by county. Here are the rules from my county tax sale:

Buyers have to be state residents and have to register prior to the auction. I have a local friend who was going to bid for me, and then I’d transfer the lien into an LLC with me and my investors. More on that later.
Property owners have one year to pay off their lien plus interest. This is important because you are not guaranteed the property and need to factor this into your underwriting.
- Owners have to pay 10% interest on owed taxes, 8% interest on future paid taxes, and there is no interest paid on the difference between your bid and the delinquent taxes. If they owe $6k and you pay $10k at the auction, you will only receive interest payments on the $6k if they choose to pay you off.
- After that one-year period, you receive a “Collector’s Deed” and then need to go through a legal process to get a clean deed and title.

Tax sale rules differ based on the jurisdiction holding the auction. What I went through may be different than your situation, but I still hope this helps!

Why You Should and Shouldn’t Buy at a Tax Auction.

Tax auctions are a mystery box. Price of admission is much cheaper than a traditional purchase, but you are restricted on how much due diligence you can do…

Pros:

Much cheaper than a traditional purchase! The starting bid for a property we wanted was $6500 (three years of back taxes), and the property ARV was ~$250,000.
There are multiple exit strategies since your entry price is so low. You can sell the tax lien, take possession of the property and immediately sell the property, repair the property and sell, or repair the property and rent it.

Cons and Risks:

The property significantly deteriorates in the next 12-18 months (natural disasters, lack of upkeep, etc.). You essentially own debt collateralized by the property and have no control over what happens to the property until you take control.
You are buying site unseen. You can’t knock on the door and ask for a property tour. The owners most likely won’t be too friendly since you are potentially buying their house and may have to evict them.
The property incurs more liens before you take possession. Like I said, you have no control of the property during the repayment period and the ensuing legal battle to get the deed. During that time, the tenant could get multiple mechanics liens placed on the property that you would be responsible for paying if you want clean possession.
You may have to evict the current owner. After the legal battle to obtain the property, you will still need to part ways with the current owner. This could mean “cash for keys” or a full eviction.
Good old market risk (rates, lending drying up, etc.).

Step-by-Step Guide

My plan was to bring a few close investors in on the deal. I only had $10,000 free to invest and I felt that the margins were so good that I could have investors and we all make money. (This is a lie. I accepted defeat that we couldn’t bid and Kim recommended we open it up to investors). I split up this guide by “Before the Auction” and “After the Auction.”

Before the Auction.

Review all properties on the auction list. Owners can pay their debt any time before the auction so this list will change up until the auction starts. Our county’s list started with 8 pages and ended with 3 pages. The goal of this step is to narrow down your buy list. We don’t buy trailers, farmland, or commercial so we wanted to eliminate those properties.
Confirm Property List. I sent my list of six target properties to my agent who drove by them to confirm what I saw on Google Streetview. She called out that a few properties were in flood plains which elimated them from our list.
Title Search. I sent the two remaining properties to our Title Company. They offered three search: a free property profile, a $75 one owner/3 year title search, or a $200 three owner/45-year search. I opted for the free property profile because I could tell from county records that the properties hadn’t been sold in 10+ years. All I really wanted to know was if there were any ownership disputes or mortgages/liens on the property. One property had a mortgage and muddied ownership from a divorce. This didn’t take the property off our list, but we had to adjust our underwriting.
Underwriting. I’ll jump into that later.

After the Auction.

Begin Legal Process. I spoke with a local title company that specializes in tax sale possession. There are certain notices that need to be sent to the current owner throughout the 12-month grace period.
Entity Creation and Transfer. This step would transfer the certificate from my local contact to the entity with my investors, and I couldn’t do this before the auction since the equity breakdown depended on the bid results.
Wait The Payback Period.
Take Legal Possession. I would have tried to pay the owner outright for the property, but if that failed, our lawyer would have initiated a Quiet Title Suit ($ 3,000)

Underwriting a tax sale.

Underwriting these was actually kind of fun. Our goal was to find our max bid amount and the resulting ROIs based on different exit strategies. You also need to factor in the different legal fees associated with different exits. With an investment this risky, we want at least a 20% ROI and the most conservative exit strategy is converting the property into a rental. Let’s go through each exit strategy and its underwriting variables.

No Possession - The owner pays the note within that year’s timeframe.

This scenario has a low ROI since we wouldn’t receive interest on our entire bid.

Interest Payment [Revenue]: 10% interest on owed taxes and 8% interest on future paid taxes
Legal Fees [Expense]: $300. These are for the lawyer to notify the owner through the year grace period.
Friend Fee [Expense]: $150. I’ve got to pay the person going to the auction for me.

Possession - Flip The Property.

90% ARV [Revenue]: This is to bake in some conservatism into our underwriting.
Rehab at $10/sqft [Expense]: This was just a shot in the dark. In hindsight, I wish I would have assumed $15-20/sqft. $10/sqft would cover a cosmetic renovation, but we would be over budget if we needed to replace a roof or AC system.
Friend Fee [Expense]: I would pay the person who went to the auction 2% of the sale price. You have to incentives good help!
Holding Costs [Expense]: I assumed the rehab would take 3 months during which time I’d have to pay utilities, taxes, and interest if I financed the renovation.
7% Closing Costs [Expense]: If we sold, we would have to pay our agent, the buyer’s agent, plus some random closing costs.

Possession - Rent the Property.

This scenario is very similar to flipping except for the following inputs.

2% Closing Costs [Expense]: Bank fees and title costs.
Rent [Revenue]

Investing with Others

This is what I pitched to a few select investors. I only wanted investors who were eager to invest and didn’t need a lot of explanation since this was a short turnaround (48 hours until I needed funds).

General Partner Compensation:

10% Equity and cash flow
Upfront costs reimbursed first.

Limited Partners Compensation: Equity percentages will be determined based on the final bid amount.

We plan on investing $10,000.
If we win the bid at $15,000, we will put in $7500 a,nd you will put in $7500 an,d we will be 50/50 equity partners of the 90% Limited Partner pool.
If we win the bid at $25,000, we will put in $10,000 an,d you will put in $15,000, and we will be 40/60 equity partners of the 90% Limited Partner pool.

Here’s what I was going to send to those investors: