Choosing a Discount Rate for Tax Lien Cash Flows
Summary
The document frames the valuation of tax liens as a bond-like cash flow problem. An investor pays delinquent property taxes, may advance later tax bills, and earns interest if the owner redeems the lien; prolonged nonpayment can instead lead to foreclosure. Because additional advances occur before redemption, the cash flows can include outflows after the initial investment, complicating conventional yield calculations.
The question focuses on selecting a discount rate when auction prices are poor evidence: artificial price ceilings reportedly bind in many sales, limiting the usefulness of observed prices for inferring yields. It considers Treasury yields as a possible alternative but does not resolve whether they are appropriate or how to estimate a risk-adjusted rate. The document supplies no valuation formula or empirical comparison. Its useful lesson is to distinguish the cash flow model from the rate used to discount it, and to recognize that capped auction prices and nonstandard cash flow timing limit simple yield-based approaches.
Key ideas
- Tax liens can involve later investor advances as well as an initial purchase payment.
- Redemption timing determines when principal advances and accrued interest are recovered.
- Possible foreclosure makes the eventual cash flow depend on more than a fixed maturity date.
- Artificial auction price ceilings can make observed prices unreliable for estimating a yield.
- The document raises, but does not answer, whether Treasury yields can serve as a suitable discount rate.
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Full text
# How to calculate the discount rate from yield when adequate price data does not exist # How to calculate the discount rate from yield when adequate price data does not exist I'm creating a pricing model for an asset that is similar to a bond, for which I need a discount rate. Using yield to calculate this discount rate was my first thought, but this seems impossible for reasons I will outline. The asset is a tax lien, in which delinquent tax bills (usually on property taxes) are sold at auction to private investors, who then pay the subsequent tax bills on the property, charging interest to the tax payer, until the tax payer "redeems" their tax lien by paying the delinquent bills pluss that interest to the tax buyer. Let's say Jane's tax lien made up of USD 3000 in delinquent taxes is sold to Harry for that amount. When the next tax bill of USD 1500 comes due and Jane still hasn't redeemed her tax lien, then Harry will pay that tax bill for Jane, and then charge her 12% interest on that USD 1500. This continues until Jane redeems her tax bill including all the subsequent payments and all the interest due on them (or until Harry forecloses upon Jane's house because she hasn't paid for long enough). In this way, a tax lien should be similar to a bond in terms of modelling, but with negative cashflows until the point of maturity. Regarding the calculation of a discount rate, the auctions for these tax liens typically work in such a way that price data isn't really accurate, as they have artificial price ceilings which are reached in a majority of cases. I'm thus unsure if calculating yield through price data is the correct approach. Should I perhaps use yields from US treasury bonds for my discount rate, or should I calculate yield using the likely flawed price data? An additional (more open ended) question is whether the presence of negative cash flows has any effect on how I should perform the necessary calculations.
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