Valuation

The Auction Alternative

Discover How the Bidding Process Can Generate Profitable Deals.

Each year, auctions are used to sell billions of dollars of commercial real estate. Once thought useful only for disposing of problem and hard-to-sell properties, auctions are gaining popularity as an effective sales strategy for all types of commercial real estate.

Current market activity shows that auctions are on the rise nationwide. For instance, the number of industrial property auctions is increasing as companies divest themselves of surplus space resulting from the volatile economy. Regional malls, big boxes, and strip centers also are hitting the auction block as a shakeout continues in the highly competitive retail sector. Even multifamily real estate is garnering record sales prices at auctions as investment yield rates fall and condominium conversions drive up selling prices.

Auctions offer commercial real estate professionals a viable alternative to traditional sales methods that can benefit their clients and themselves. For example, brokers who register prospects that prevail in the bidding process can earn substantial fees, especially as the trend in traditional commercial brokerage moves away from fee sharing. Referring specific properties to auction companies results in immediate sales and subleases for clients and referral fees for brokers. Also, by aligning with an auction company, a brokerage gains professionally executed auctions without having to develop its own auction division.

While methodologies vary slightly for different property types, some general principles apply to all auctions. By understanding auction fundamentals — including how and when to use them — commercial real estate practitioners can reap the benefits of this potentially lucrative sales method.

When Do Auctions Make Sense?

Common situational themes often portend when auctions are preferable to more-traditional sales methods.

Specifically, auctions help define the market for hard-to-value properties. The competitive bidding process garners premium sales prices for such properties. In addition, if a property's market is thin, an auction can accelerate the sale.

Auctions also are useful when a property owner wants to control the deal structure. In an auction, the owner sets the specific sales terms, and the market bids based on those terms. The auction company prepares all of the financial, legal, and other materials beforehand, including the real estate sales contract that the prevailing bidder must sign. This valuable aspect of auction programming is reassuring, particularly to owners who have had negative experiences with contingency-laden contracts. Most auction deals are made on an as-is, where-is basis and require potential buyers to complete due diligence prior to bidding.

Another benefit of the seller controlling the deal structure is that bidders have the opportunity to offer alternative deals, including conditional bids versus as-is bids. For instance, many times owners of vacant land must choose between accepting a deal with zoning contingencies, which may fall through, and only looking at deals offered on an as-is basis. However, an auction company can structure the process so bidders can bid both ways. Then the seller can choose between the bidder's offer subject to zoning contingencies or a lesser, as-is, non-contingent offer.

Auctions also allow owners to set and control a deal's time line. This is a key advantage for owners who want to defer taxes by selling a property and buying a replacement property in an Internal Revenue Code Section 1031 exchange. Other times, owners seeking to sell properties before year's end to offset gains and losses find the ability to set the sale date and the transaction's closing date very important.

Owners of properties with negative cash flows also benefit from controlling the deal's time line, especially if they cannot recoup carrying costs incurred during a prolonged marketing campaign by selling at a higher price. Most commercial property auctions take place within 45 days to 75 days, with closings ranging from 10 days to 60 days thereafter. The speed of these transactions can translate into huge savings. For example, a property has a negative cash flow of $20,000 per month and is expected to take six months to 18 months to sell. By using an auction, the owner can afford to discount the sales price between $120,000 and $360,000 and still come out ahead.

Auctions also are used for vacant commercial real estate space and surplus leases. Through portfolio sales, surplus properties are sold individually and simultaneously, thereby maximizing each property's sales price.

For example, an insurance company wanted to sell a portfolio of 29 commercial properties located across the country. Several auctions were held during a five-day span, and the bids on each property remained irrevocable for three business days following the final auction. This deal structure allowed the owner to review all bids before selecting the buyers. Thus, if a particular property achieved a higher price than expected, the owner had the latitude to accept a lower bid on another property. All 29 properties were sold for $30 million — with about 70 percent of the properties selling on the spot at their respective auctions.

Choosing the Format

Stand-alone, portfolio sales, and multiple owner/multiple property are the three basic types of auction forums.

Stand-alone auctions are simply one property, one auction. All of the pre-auction marketing is designed specifically for the property involved. The main benefit of stand-alone auctions is that they can take place at any time, but this is the most costly approach, since one property bears all promotional expenses.

In portfolio sales, one owner offers a number of properties for sale individually but at the same time. The key to a successful portfolio sale is to treat each property as if it is being marketed on a stand-alone basis to take advantage of economics of scale that result from overlapping marketing opportunities.

For instance, for a 300-property portfolio sale that spanned several Northeastern and Midwestern states, many of the properties were promoted jointly in local, regional, and national publications as well as in two brochures that presented each of the properties individually. These economies of scale offered significant cost savings and nearly all of the properties sold as a result of these marketing efforts.

Portfolio sales also allow owners to have the buyers in a given market bid for each property simultaneously without giving a bulk sale discount; avoid carrying costs that cause equity erosion; capture the market's attention at the expense of competing properties; and control the sales time line. The main drawback is the amount of cost savings achieved depends on economies of scale that may or may not occur in marketing the properties. Product type, geography, and scope of the market for the variety of properties involved all affect the potential savings.

Multiple-owner/multiple-property auc- tions are a hybrid of stand-alone and portfolio sales. In this forum, an auction company assembles a portfolio of properties from various owners to take advantage of economies of scale. The primary benefit for properties in this forum is the large-scale marketing opportunities at a significant discount. However, since the forum is shared, sellers must accept a flexible time line determined by how long it takes to assemble the properties.

Depending upon the specific situation, any given property that fits an auction profile can be a candidate for any combination of auction programs.

Types of Auctions

The two types of auctions — open outcry and sealed bid — have several subsets within them, and auction companies often mix and match the methods.

Open outcry is commonly associated with auctions: An auctioneer calls for bids in a public forum until the highest bidder prevails. Open outcry auctions typically are used in the following situations:

  • The owner wants to sell the property on predetermined terms, usually on an as-is basis with no contingencies other than standard title, survey, and environmental matters.
  • There are many potential buyers and the competitive bidding process most likely will yield a fair-market price or even a premium in the case of a highly desirable property.
  • The property does not require lengthy evaluation to determine its value.

On the other hand, sealed-bid auctions are preferable for situations that combine the following characteristics:

  • one bidder is superior to all others;
  • a great disparity exists between the highest bidder's offer and second-highest bidder's offer;
  • deal flexibility adds value;
  • alternative bids are desirable; and
  • price is not the sole consideration for accepting a bid, such as a case where the second-highest bidder has more desirable credit than the highest bidder.

Several different methods within each category can handle these unique situations. They include:

  • without reserve with no-minimum-bid auctions, for very desirable properties as well as portfolio sales where establishing the owner's legal commitment to sell the properties at potentially low prices may be necessary to attract buyers in the marketplace;
  • without reserve with a stated-minimum bid, to limit potential bidders to only those bidding at the top of the property's valuation range; and
  • with reserve, when the owner either is unwilling or unable to offer the property with a binding minimum bid that is significantly below the target price. An unstated reserve is when the seller's acceptable price is not made public and generally is used when the owner's price expectation is a range of value; if the bidding is in the range, the owner accepts the bid. In a stated reserve, the seller publicly states the property's price. This approach differs greatly from the minimum-bid approach in that a stated reserve informs the public where the owner expects to end, rather than start, the bidding.

Commercial real estate auctions are gaining acceptance as useful sales tools in the brokerage arena. The competitive bidding processes vary, but all have proven remarkably effective in capturing markets and yielding premium results. By participating in auctions, commercial real estate practitioners can earn significant dollars for their clients and themselves.

Steven L. Good, JD

Steven L. Good, JD, is chairman and chief executive officer of Chicago-based Sheldon Good & Co., Auctions LLC, one of America's largest real estate auction companies. Contact him at (312) 346-1500 or stevengood@sheldongood.com.

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