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COVER STORY, APRIL 2004
THE AUCTION OPTION
To sell properties, commercial real estate owners jump
on the auction bandwagon.
John Johnson
In one of the most active investment markets in years, commercial
properties of virtually all types are being successfully sold
using accelerated marketing or auction techniques. Fading
is the stigma that auctions are only for distressed properties
or to be used as a last resort. By 2010, one in every three
properties will be sold using an auction method of marketing,
according to a National Association of Realtors study.
During the past two decades, the auction has evolved from
a tool primarily used to dispose of distressed properties
to today’s accelerated marketing method — a way
to sell quickly and still maximize the return to the seller.
Savvy owners of all types of properties — high-rise Class
A office buildings, retail centers, multifamily properties,
hotels, industrial buildings and land parcels — are using
accelerated marketing to achieve the highest value for their
property. Vacant or partially vacant properties and developed
commercial building sites and pads are also being sold by
auction in order to attract potential buyers.
Real estate owners first observed auction successes in other
areas of the economy. Sellers of high-value assets, such as
thoroughbred racehorses, antiques, art and fine wines, have
fetched top dollar at auction. For the longest time, commodities
and stock shares have been sold to the top bidder at the Chicago
Mercantile Exchange and the New York Stock Exchange. Following
this lead, several top companies, including Wal-Mart, McDonald’s,
Hewlett-Packard Development Company, Chevron and ExxonMobil,
are now auctioning off excess real estate holdings through
the accelerated marketing approach. Even Donald Trump, who
sold at auction his Trump Plaza Condominiums in West Palm
Beach, Florida, has extolled the merits of this method.
In a successful auction, the commercial real estate investment
market, like the very strong one we’re experiencing now,
determines the worth of the property, not the seller. An auction
is the best avenue in which to sell a property in order to
achieve the highest value because buyers may come from anywhere
and be willing to pay nearly anything. Additionally, a commercial
real estate auction is completed in a much shorter timeframe
than a conventionally brokered sale. With an auction, the
entire process of gathering property and market information,
marketing and selling the asset, and settling the contract
normally occurs in less than 3 months. Because of this, the
auction process can save the seller months, or even years,
of carrying costs.
SPEED OF SALE
The most obvious auction benefit is the ability to achieve
a quick sale — the typical commercial real estate auction
process goes from list to close in less than 90 days. A traditional
property listing might take many months to go under contract.
Then the seller has to wait through an inspection or due diligence
period, during which the buyer can walk away. At a commercial
real estate auction, all of the due diligence is completed
beforehand, allowing the auction sale to close quickly, usually
within 30 days.
SELLER SETS THE TERMS
The seller, not the buyer, draws up the contract used at a
commercial real estate auction. The terms usually include:
no contingencies for the buyer; substantial earnest money
— often 10 percent or more — that goes “hard”
immediately; selling “as is, where is” with no warranties;
closing within 30 or 45 days; and no modification of contract
terms. As a result, more than 99 percent of real estate auction
contracts result in a closing.
With a traditional listing — especially in today’s
active investment market — the seller must, at times,
deal with multiple offers and choose with whom to negotiate.
Since the seller has pre-set the terms of the auction contract,
all buyers must compete with each other for the right to submit
the top offer. Instead of the seller having to negotiate with
multiple buyers, the buyers at an auction negotiate among
themselves by bidding to determine which makes the top offer
on the seller’s terms.
MARKET VALUE vs. CURRENT MARKET VALUE
The IRS defines fair market value as “the price that
property would sell for in the open market. It is a price
that would be agreed on between a willing buyer and a willing
seller, with neither reign required to act and both having
reasonable knowledge of the relevant facts.” If a seller
has an unlimited timeframe for the sale of his commercial
real estate, then a conventional marketing program with a
commercial real estate broker will probably produce the results
most desired by the seller, at fair market value.
Current market value is the price realized by a seller whose
motivation is to sell his property in a very short time frame.
A properly marketed auction may exclude certain types of buyers
due to the abbreviated marketing period and the seller’s
more restrictive terms. However, the seller will still achieve
current market value if his auction has been properly marketed
and enough potential buyers are thus made aware of the property.
TIME IS MONEY
Even though current market value may be somewhat less than
fair market value, sellers often opt for the accelerated marketing
program, believing that a certain sale today is worth more
than a possible sale tomorrow. Factors involved in the seller’s
decision to go to auction include holding costs (debt service,
taxes, insurance, utilities, maintenance, management fees,
etc.), lost opportunity costs (the return that could be realized
if the property is sold and the proceeds invested in earning
assets), competing properties on the market (an auction makes
the property stand out from the rest) and management time.
In October 2003, Jim Saxton, managing partner of Levitz Plaza
LLC, decided to auction the 144,350-square-foot Levitz Plaza
I and II in Las Vegas. After an extensive accelerated marketing
campaign had been conducted, the property sold for $14.2 million
to a buyer who agreed to a quick escrow. The transaction went
from list to close in 40 days.
“I had a very limited timeframe with which to market
and sell our $14 million retail property,” says Saxton.
“The buyer was qualified and assumed an existing conduit
mortgage within a 2-week time period. You can’t ask for
better results than that.”
AUCTION TYPES
There are three general types of commercial real estate auctions
for the seller to use. The right method depends upon the seller’s
circumstances and objectives.
At an absolute auction, the property is sold to the highest
bidder without a minimum or reserve price. In other words,
it is sold to the highest bidder regardless of price. Many
sellers are fearful of the possibility that their property
might be sold at a ridiculously low amount. However, absolute
auctions usually bring the maximum response from the buying
pool because many prospective buyers will not attend an auction
if they feel there is a possibility that the property will
not be sold. Regardless of price, if a sale is assured, buyers
will take the time to do their homework and participate in
the process. The irony is that the prospect of a low selling
price raises the probability of much greater buyer participation,
and therefore a higher end price.
A variation of the absolute auction is a minimum bid auction.
Once the minimum bid is reached, the auction automatically
becomes an absolute auction. This type of auction works best
when the published minimum bid amount is well below market
value, signaling to prospective bidders that there still is
a great buying opportunity. If the minimum is set too high,
many potential buyers will not take the time to become involved.
Another type of auction involves selling subject to the seller’s
confirmation. Through this method, the owner and auctioneer
determine a confidential minimum or benchmark, after which
the owner agrees to sell. If the auction price does not reach
the minimum value, the owner has the right to accept, reject
or negotiate the highest bid. This method is often used when
the properties are in high demand, fresh to the market, located
in a rising market or have a high debt-to-value ratio.
Rather than selling subject to confirmation, more sophisticated
sellers, and those sellers with greater financial resources,
choose absolute auctions or a minimum-bid setup with a relatively
low minimum amount. They know that, while there might be an
element of risk, an absolute auction will generate much more
excitement and participation, usually resulting in a higher
price to the seller. The absolute auction approach is the
best way for the seller to establish his credibility as a
committed seller, maximize attention and exposure, and, as
a result, maximize his price.
AUCTION FORMAT
Once the type of auction has been selected, the format must
be chosen. The two formats are open outcry and sealed bid.
The most dominant type is the open outcry, at which the auctioneer
stands in front of the bidding audience and asks for ever-increasing
bids. This format is best suited when potential buyers would
similarly value the property being sold or when the seller
wants to capitalize on the illusion of a bargain.
Sealed-bid format auctions require that written offers be
submitted by a certain date and time. The sealed-bid format
is best when it is believed that no two buyers would value
a property in the same manner or value. The high bid in a
sealed-bid auction might be significantly more than the next
highest bid. Thus, the seller receives a greater price, whereas
the high bidder at an open-outcry auction would only bid incrementally
more than the second highest bidder. A combination of sealed-bid
followed by open-outcry auction formats are sometimes used
for unique or high-value properties.
John Johnson is a national auctioneer for Sperry Van
Ness/Interstate Auction Company. Louis Fisher of Sperry Van
Ness/Fisher Auction Company, David Gilmore of Sperry Van Ness/Gilmore
Auction & Realty Company and Paul McInnis of Sperry Van
Ness/Paul McInnis Inc. also contributed to the article.
©2004 France Publications, Inc. Duplication
or reproduction of this article not permitted without authorization
from France Publications, Inc. For information on reprints
of this article contact Barbara
Sherer at (630) 554-6054.
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