How much of a $4M allocation do I have to keep idle for subs?

Question

Sizing a first allocation and the reserve line is where my model falls apart. Plan is roughly $4M across three or four states, average certificate around $4,400 face, so call it 900 positions. I penciled subsequent taxes at 10% of face per year and a 24 to 30 month average redemption horizon, which gives me about $180k a year of reserve and lets me put 95% of the money to work.

Two things are bothering me. First, the reserve number feels too clean, like I've mis-specified what a sub actually is. Second, the timing. If redemptions arrive lumpily and my sub deadlines are fixed calendar dates by county, I could be short cash on a date I can't move while sitting on paper I can't sell quickly. Anyone who has run a book of a few hundred positions across multiple states: what percentage of committed capital never gets deployed, and does that drag get charged against the statutory rate in your reporting or held above the line?

Rena Expert · Accepted Answer

Your reserve is mis-specified, and the size of the error matters more than the timing question. A subsequent tax payment isn't a percentage of face, it's the next tax year's full bill on that parcel. If your original certificate represents one year of delinquent taxes, then each sub is roughly the same order of magnitude as the certificate itself. On a 30 month horizon you're funding one to two additional full-year bills per unredeemed position, so the exposure sits closer to 60 to 100% of deployed face on the positions that go the distance, not 10% a year. Redemptions returning capital offset that, which is why the working number people land on is a reserve of 25 to 40% of the allocation rather than 5%, with the exact figure driven by your assumed redemption curve in year one.

Keystone's read is county-specific and dangerous to generalize. Whether unpaid subsequent taxes get resold to a new certificate holder, and where that holder sits relative to you in priority or in the right to foreclose, is set by state statute and varies substantially. Some states let you add subs to your certificate at the statutory rate. Some run a separate sale. Some effectively force you to keep paying to protect your position. Confirm the specific statute and the county's practice with counsel licensed in that state before you model any of it.

On deployment drag, hold it above the line and report it. A gross statutory rate on deployed capital with a footnote about idle cash is the presentation that gets picked apart in diligence.

The fixed calendar dates are the part I'd stress-test hardest. Sub deadlines in four states won't align, and none of them care that you're waiting on a redemption check from a fifth county.

megan_doyle15 · Answer

What is a sub? I've read the auction pages for two counties now and neither used the word. Is it a fee the county charges you for holding the certificate, or something the owner pays?

samantha_ruiz · Answer

In the county I've looked at hardest, paying the following year's taxes is optional. You just don't, and the lien you already hold still sits there earning. So I'd argue the reserve is a choice, not a requirement, and if cash is tight you skip a year and take the smaller position. That's how I read the treasurer's FAQ anyway. Where it hurts is that whoever does pay that year gets their own certificate and now you're sharing the property with a stranger.

tonyv88 · Answer

Whatever your reserve number is, add the cost of finding out what's standing on the parcel. We get calls from lien holders asking us to drive a property because they discovered at year two that it's a burned-out shell and they've been paying taxes on ash. A drive-by with photos runs $75 to $150 around here. On 900 positions you won't do all of them, but you should be doing the ones where you're about to write another tax check.

gregpowell66 · Answer

And if the lien actually runs to a deed you've got a second reserve nobody budgets. I price rehabs for a living and the properties that sit through a full redemption period unredeemed are usually unredeemed for a reason. Roof, systems, sometimes a hole in the floor. Even a hold-and-flip-as-is exit costs you a cleanout, a lock change, taxes going forward and a broker. Call it $8k to $12k before you touch anything structural. On 900 positions with even a 2% deed rate that's 18 properties and real money.

aaron_fitz10 · Answer

Does any of this get easier at a smaller size? If I'm buying 20 certificates a year in one county with one sub deadline, I can just keep the sub money in the same account and never think about it. The whole reserve problem seems to be a multi-state problem you're volunteering for.

marcus_hale41 · Answer

The two funds whose materials I've read both carry a named reserve line and both state it as a percentage of committed capital, one at 30% and one at 22%, so rena-expert's range matches what's actually in the documents. What I'd want in your model, meridian, is the redemption curve split by year rather than an average. A 30 month average could be 60% redeeming inside 12 months and a long tail, or a flat bleed, and those two shapes need very different cash on hand.

Over-the-counter certificates are worth a look for the smoothing problem, since you can buy them off-cycle instead of only on auction dates. Availability and pricing rules differ by state.

sonia_alvarez · Answer

Why is the reserve cash rather than a line? A revolver secured by the certificate portfolio solves the fixed-date problem without parking 30% of the fund at money market yields. I'd ask what a lender thinks certificates are worth as collateral, though. Perfecting a security interest in a book of tax certificates across four states sounds like the kind of thing that eats legal fees before it produces a term sheet, and you'd want the borrowing rate well under the statutory rate or you're just renting your own yield.

raj_mehta14 · Answer

So a sub is functionally like a servicer advancing taxes on a mortgage to protect the lien position? That's the first thing in this whole area that's clicked for me.

tylerbrooks9 · Answer

Reading this, the reserve, four sets of statutes, calendar dates that don't line up, the drive-by photos. I came in wondering whether to buy certificates directly and I'm leaving fairly sure I'd rather pay someone a management fee to do it and read their reserve line once a year. Though if their reserve is 22% and the other one's is 30%, I now have no idea which of them is being honest about the redemption curve.

How much of a $4M allocation do I have to keep idle for subs?

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