By JAY ROMANO

Published: August 15, 1999

ANYONE who has seriously contemplated making money in real estate has probably encountered the arcane but potentially profitable practice of investing in tax liens at public sales — the legal process through which municipalities obtain payment of delinquent property taxes.

Real estate experts say it is possible to make a secure investment with a high rate of return in property tax liens, even for unsophisticated investors. And savvier, more careful and more knowledgeable investors can even obtain title to real estate for a small fraction of its market value by buying property at a tax foreclosure sale, the experts say.

»Tax liens can be a great investment,» said Saul M. Simon, a certified financial planner for Allmerica Investments in Edison, N.J. »as long as you know what you’re doing.»

Mr. Simon said that investors must normally seek out these sales independently. Tax lien investments are generally not marketed like securities by brokerage houses. The investors must be aware that states have different procedures for handling properties on which the owner has failed to pay property taxes. In New Jersey, for example, municipalities are allowed to »sell» their tax liens — or their right to foreclose on a property when the owner has failed to pay taxes — at public auction. Mr. Simon said he has realized a 16 percent rate of return on tax lien certificates he has purchased in these sales.

So what is a municipal tax lien certificate?

»It’s a memorialization of a town’s lien for unpaid taxes on a property,» said Hugh McGuire, a Jersey City real estate lawyer. When a property owner in New Jersey fails to pay local property taxes, he said, the municipality acquires an automatic lien against the property. That lien gives the municipality the right to force the sale of the property to raise the money necessary to pay the overdue taxes.

Usually, however, instead of foreclosing, most municipalities take advantage of a provision in state law that allows the tax collector to sell the municipality’s lien in exchange for the payment of overdue taxes, Mr. McGuire said. To make it worthwhile for investors to buy those liens, the law also allows the buyer to collect interest on the amount he paid when he redeems the lien.

Mr. McGuire said that the interest rate that applies to a particular lien is determined at the time the lien is sold by the municipality. The maximum interest rate permitted by New Jersey law — and the rate offered at the time of sale — is 18 percent. Accordingly, when a tax collector holds a tax lien sale, investors will »bid» for liens on particular properties, Mr. McGuire said. Since the municipality is interested in obtaining payment of all of the unpaid taxes, however, all bidders must bid the entire amount of unpaid taxes. The successful bidder is the one who is willing to accept the lowest interest rate.

So, for example, if only one bidder is present, he will obtain the highest interest rate permitted by state law — 18 percent. If a rival bidder is present, however, he may »bid down» to 17 percent, meaning that he is willing to pay the overdue taxes in exchange for a 17 percent rate of return.

»Most people purchase tax lien certificates with the hope that at some point in time, someone will come forward» and reimburse the investor for his outlay, paying any interest charges that have accrued, Mr. McGuire said. That is what happens in most cases, he added.

For example, if the original owner tries to sell the property, the buyer will require that all back taxes and tax liens — as well as interest due any lienholders — be paid in full. And when it appears that the lien might not be satisfied, either because the owner cannot be located or cannot or will not sell the property, the law gives the lienholder the right to foreclose after holding the lien for at least two years, Mr. McGuire explained.

»If your ultimate intention is to foreclose,» Mr. McGuire said, »it is usually wise to continue paying taxes for the two-year period to prevent someone else from picking up a subsequent year’s lien.» Generally speaking, he said, it makes sense for investors to pay taxes that accrue during the waiting period because when they redeem a lien, they are allowed to collect interest on any additional taxes paid at the same rate established at the tax sale.

In Connecticut, similar procedures are used, but in New York State, the procedures for handling tax-delinquent property depend upon where it is located.

Eric Davis, a Manhattan real estate lawyer, said New York City sells tax liens similar to the liens sold in New Jersey. However, he said, in recent years the city has adopted procedures for the sale of such liens that have resulted in the liens being sold »in bulk» to large institutional investors.

In other areas of the state, Mr. Davis said, individuals can invest in tax-delinquent properties, but the procedure is somewhat riskier than the city’s.

Outside New York City, a county tax collector is allowed to hold a tax sale for any property that has accrued three years’ back taxes, Mr. Davis said. Before holding such a sale the tax collector must notify the property owner of the time and date of the sale and the amount of taxes that are due. If the taxes have not been paid by the date of the sale, the tax collector has the right to sell the property to the highest bidder. But buying property from a tax collector is not the same as buying it from the owner.

»What you get from the county is what is known as a quitclaim deed,» Mr. Davis said. Such a deed transfers to the successful bidder all of the county’s rights to the property.

And while the county’s tax lien takes precedence over all other liens except Federal claims, a quitclaim deed from the county tax collector may not always be the safest investment.

»If the county didn’t provide proper notice of the tax sale, the sale could be subject to challenge,» Mr. Davis said. For example, he said, if the county notifies the property owner at the address on the deed, but the property owner had properly notified the county of a change of address, the sale could be defective.

Moreover, Mr. Davis said, properties sold at tax sale can be occupied by tenants, squatters or even the property owner himself — a complication that could require lengthy legal proceedings to rectify.

Accordingly, Mr. Davis said, investors considering purchasing New York State property at a tax sale should inspect it before the sale. It is also wise to conduct a title search to determine the chain of title and to find out whether the person the tax collector has identified as the owner is the current owner of record, he said.

»This is not something you would want to just jump into,» said Mr. Davis, who has purchased about 120 acres of upstate property at tax sales. »The risks can be significant. But that’s not to say you can’t get lucky.»