Big Money: Have Gavel, Will Travel

With no clear end of housing's downturn in sight, home builders and developers are eager to move their standing inventory–now. Many turn to residential auctions in an effort to minimize their losses and stay afloat. Since we conducted our first developer auction of the current cycle in October 2006, demand for auction services, mostly in California, has grown. We expect demand to continue through 2009. Builders and developers considering moving forward with an auction should carefully consider the following.

Rhett Winchell A big difference between the current cycle and the last one in the early 1990s is that lenders are making it tougher on borrowers. They have tightened their lending standards and are seeking larger down payments, as well as demanding fully-documented loan applications. They're being more cautious about appraisals. Banks can demand an extra 5 percent down payment if appraisers report that a property is in an area with declining property values. What's more, aggressive loan products, such as subprime, are unavailable. So, we recommend having a preferred lender on site to pre-qualify bidders.

For home builders and developers, we normally recommend published minimum bid auctions. Potential buyers know that if they bid on a property and offer the highest bid at or above the published minimum bid, their offer will win. In addition to giving the auction more credibility, a published minimum bid auction requires buyers to pre-qualify in specific price ranges.

The goal is to sell 100 percent of the homes offered for sale. Advertising published minimum bids is a powerful tool to generate interest and can help the builder achieve that goal. While there is no question that buyers can get substantial savings, the developer also wins because it can quickly move inventory. Incurring ongoing carrying costs while waiting for the market to turn around will only erode existing equity.

Builders should consider an auction when they have a completed project where sale rates have persisted in trending downward, especially if the project is in close proximity to competing communities. Most of our clients are developers with projects in the 20- to 100-unit range. If their sales slow to less than five per month, we advise them to select an accelerated auction marketing program. The builder pays the marketing costs of an auction. As a rule, the auction company receives a commission based on the size of the auction and the total value of the sales.

We recommend that sellers select a variety of floor plans and locations within the project in order to offer potential buyers a range of choices. All of the homes being auctioned should be ready for buyers to tour and move into–carpeted, appliances in place, etc. It is important that the prior asking price listed in the auction brochure is realistic. Buyers know values and are possibly aware of the last asking price. Further, developers should withdraw homes that have low buyer demand prior to the auction. It's also critical to create the right atmosphere. In the right environment, buyers who don't get the first property that they bid on are likely to raise their bids on subsequent units. Higher bids for less desirable homes may actually occur toward the end.

It's a myth that an auction makes it difficult to resume conventional sales. After auctions, several home builder/developer clients with future phases of homes went on to sell homes by conventional means, sometimes at increased prices.

Attrition rates vary by market and property type. We anticipate that 5 to 10 percent of buyers will fall out, but many of these homes will sell the next day to back-up bidders. Bottom line: Builders should expect to obtain 80 to 85 percent of last asking prices, minus previous incentives.

In today's environment, that's a win.

Rhett Winchell is president of Beverly Hills, Calif.-based Kennedy Wilson Auction Group. Winchell may be reached via e-mail at [email protected].