Real estate investor Justin Pierce writes an occasional column on the art of buying and selling houses for profit.
Many think that real estate auctions are the best way to get a good deal on a home. There are certainly deals to be had but auctions can be very dangerous for buyers. There are many traps and pitfalls that the buyer needs to navigate in order to win an auction.
I attended a real estate auction recently. I don’t often take the time to go to auctions because I just haven’t had much luck in the past. But I was hoping the crowds would be smaller this time since it was so close to Christmas. I was wrong. There must have been at least a 100 people there. For those of you who have sold or bought a home recently, could you imagine having 100 bidders competing for your home? If you can, then you probably have an idea of where I’m going.
One of my best real estate brokers accompanied me. It was his first auction. We toured the house. We pulled the comparable sales and re-pulled the comparable sales. I did a scope of work and estimated repair costs. As usual, the comparable sales were spread out over a wide price range. There was a lot of gray area. But I settled on what I figured the home would be worth after a good remodeling and from that I determined how much I could pay for the home.
This is critical for every auction-goer. You have to do some realistic math. Many people think they’re going to get a steal of a deal at auction and they don’t do their math beforehand. They often figure on some unrealistically low price. When the price starts escalating then they are forced to do quick calculations in their head while under pressure and in the middle of all the excitement.
Warning: Auctions are extremely exciting. It is easy to get carried away. Even with the math that I did beforehand I still bid slightly higher than my max number and I still didn’t win. Not even close. I decided on a $115,000 max sales price. The home sold for $141,500.
Auctioneers’ job is to generate as much excitement about a property as possible. They advertise extremely low starting bid prices. They send out thousands of flyers and e-mails. They post signs and they network with real estate brokers to get the word out. Any buyers who show up to the auction are automatically vested. They often already have previewed the property. They’ve gone to the bank to get certified funds or large amounts of cash. Buyers are required to do most of their due diligence prior to the auction so many already have put a lot of effort into an auction home before the bidding even starts and losing means all that time was wasted.
I rarely see any kind of deal at an auction. I remember going to one auction where a property was bid up to $85,000 when an almost identical property right around the corner was listed on the MLS for $65,000. And don’t forget the buyer’s premium. Every auction that I know of has a buyer’s premium of 5 percent. You have to tack on 5 percent to the final bid. So this winning bidder’s actual price was $89,250.
After the gavel falls, all the leverage goes to the seller. There are no contingencies with most auctions. The buyer is required to put up a 10 percent deposit right away. And that deposit will be forfeited if the buyer fails to close for any reason. It doesn’t matter if the home does not appraise. It doesn’t matter if the buyer fails to get financing. It doesn’t matter if the home inspector finds a major deficiency. The buyers will forfeit their their deposit to the seller if they do not close.
And what is that buyer’s premium? That buyer’s premium means that the buyer pays all of the broker and marketing fees. Normally the seller pays the broker. In an auction, your buyer’s premium will be the same whether you are represented by an agent realtor or not, so you might want to at least ask a broker to help you determine the home’s value.
If you’re planning to attend an auction, here are six critical rules that you must follow:
●Do your homework. Know what the property is worth. Remember there is no appraisal contingency.
●Know what repairs are needed and what it will cost to make the home livable.
●Know your max price and stick to it and don’t forget to include the buyer’s premium.
●Make sure you can close on the home. Cash or at least a large down payment is best. You’ll find many lenders and appraisers will not be friendly if your home needs a lot of work.
●Remember that the effort required by rules 1 to 4 is a sunk cost. Don’t let this prior effort become a factor in your bidding during the heat of the moment. You have to let it go and be willing to start over.
●Most important, maintain control. Many auctions turn into feeding frenzies. The excitement of the moment leads to bidders getting carried away. I still get nervous and intoxicated by the high roller feeling I get when I increase the bid.
Justin Pierce is a real estate investor in Northern Virginia. In his occasional column, he will write about investing in real estate.