Public Auctions Can Maximize Real Estate Sales Prices

Readers of the real estate section of the Sunday newspaper cannot avoid noticing frequent ads for real estate that is being offered for sale "at public auction," real estate "to be sold absolute, regardless of price." The properties being auctioned often include well-located commercial, industrial, investment, and residential properties Why do owners elect to sell their property at an uncertain auction rather than via the traditional method of private negotiations? Can a real estate auction really maximize ownership's investment yield? What are the logistics for successfully accomplishing the sale of real estate at public auction? Most people think of an auction as a method of selling distressed or problem property. This common perception is partly based on fact, but it is largely a misconception

Ever since there has been farmland, there have been public real estate auctions of farmland. In fact, in farm communities the auction method is the prevalent method of selling property. Farmland has been sold consistently at public auction rather than via private negotiations because the market for the product is narrow or "thin." In thin markets, the auction vehicle was proved to be an effective selling tool.

The other situation in which the auction has been a consistent selling technique involves the sale of either government property or property whose sale is conducted under governmental or judicial authority. Examples include sealed-bid sales, sheriffs' sales and tax sales. The fact that these types of properties are generally sold at auction is probably the basis for the misconception that the public real estate auction usually produces "fire sale" prices.

The generally poor results of the auctions that are conducted pursuant to governmental authority are probably due to the fact that the governmental or court officials who conduct these sales are often unsophisticated about real estate and about selling. Furthermore, the purposes of many government-ordered auction sales may be other than to obtain the highest price for the property. For example, in a sealed bid sale, the seller's primary objective is to avoid collusion among buyers and to maintain the integrity of the sale. In a tax or sheriffs' sale, the seller is primarily interested in effecting a speedy and orderly transfer of ownership, and not necessarily in price maximization.

Despite the poor reputation that these activities have given to the auction method of property sale, many properties are sold at public auction because this technique, when used properly, can result in profits far greater than those produced by conventional sales.

What are the factors in a selling situation that lead a seller to select an auction, rather than a conventional sale? The existence of any of the following conditions may create an auction situation:

• High carrying costs
• Need for an arm's-length transfer
• Need for a quick sale
• A "thin" market

High Carrying Costs

Probably the first and foremost "auction situation" arises when there are unusually high carrying costs incident to the ownership of the real estate When an owner recognizes that holding the property for an extended period of time will erode his equity despite the best possible price upon sale, he may conclude that speedy sale of the property is his best strategy

Examples of owners who may benefit from inducing rapid sales are single-family home developers or condominium converters who have built modest projects, have sold (say) 80 percent of the units, and are having difficulties selling the remaining units. Often a developer's profits are represented by these last units, and the longer he must carry these units, the more troubling become the costs of debt service, real estate taxes, insurance, and marketing. These expenses may ultimately erode the profitability of the project. This reality coupled with either stagnant or declining prices, suggests that if the remaining units can be sold immediately or in a relatively short period of time, the developer will net significantly more than he otherwise would because time is working against him

Owners of vacant land encounter similar high carrying costs, and they may also decide to undertake auction sales. They conclude that high carrying costs and significant loss opportunity costs will not be recouped by the higher selling prices that they may achieve at a later date.