August 01, 1998
By John McCloud - a freelance writer based in San Francisco
As seen in The Commercial Investment Real Estate Journal
Commercial real estate brokers and auctioneers long have considered themselves rivals for the same prize; each group believes the other wants to steal potential clients from their grasp.
The rivalry has abated in recent years, but it definitely has not disappeared. Some brokers now look at auctioneers as allies in the quest to attain the best deal for their clients. They routinely bring clients to auctions as both buyers and sellers, and work closely with select auction houses to market clients' properties. Other brokers, however, regard auctions as a generally inferior method of selling.
"I love auctions," says Edward Herbert, president of Herbert Company Realtors in Nashville. "It is the purest form of arm's-length transaction you can have. You've got a willing buyer and willing seller. The price is the purest price you can have, regardless of what the tax assessor or appraiser says."
But Gary Willard, CCIM, a first vice president with CB Commercial Real Estate Group in Foster City, California, disagrees. "The goal of auction houses is to move a lot of property out quickly. That's not important in today's environment. To get top dollar, you need a broker who's fully versed in the local market and very good at negotiating," he argues.
Auctions work well in some cases, says Kevin Van Voorhis, CCIM, director of the Financial Services Group in Cushman & Wakefield's Walnut Creek, California, office, but calls them an inefficient way to handle most transactions.
"When you auction a Rembrandt, you can see it. You know what you're getting. But real estate is extremely complicated. There are a lot of issues that don't necessarily get understood or disclosed in an auction environment," he says.
For their part, auctioneers appear to welcome broker participation. William Z. Fox, chairman of Michael Fox International, Inc., in Baltimore, says his firm has had a formal working arrangement for nine years with brokers in New America International's network.
And some say the old animosities rapidly are breaking down. "Over the years it had been an us-against-them situation, but it's been proven true [that] we work better together than separately," says Jerome J. Manning, president of Jerome J. Manning & Company, Inc., in Boston.
It is need, not benevolence, Manning admits, that prompts him to work closely with brokers. As he puts it, "From an auctioneer's viewpoint, listings are the most important asset. It doesn't take a rocket scientist to figure where all the listings are - they're in the real estate brokers' offices."
The experience of Hanley Auction Company in Fort Worth, Texas, bears this out. More than half of the firm's business last year came from broker referrals, reports company president Tom Hanley, CCIM.
Brokers benefit equally from the relationship, says Gary Watson, CCIM, a broker for Beck Property Company, Inc., in Pensacola, Florida, who has participated in five or six auctions with Fisher Auction Company of nearby Pompano Beach. "The sale is essentially assured and it is assured to happen by a certain date. That takes a lot of anxiety out of the business," he says.
Advantages for Brokers
Auctioneers say auctions offer brokers many benefits, particularly now that most auction houses provide more evenly split commissions. Manning's firm splits commissions 50-50 with brokers who bring in a property, he says. If the buyer also uses a broker, the split becomes 40-40, with the buyer's broker getting 20 percent. Other auctioneers and brokers report similar splits.
Auctions can have several advantages, users say:
- A property listed at auction is almost certain to sell. "We sell 85 percent of all our properties," says Steven Good, chief executive officer of Sheldon Good & Company International, a Chicago-based commercial real estate firm with its own auction division. "No brokerage can match that."
- Properties sell quickly. "Most brokerage listings go six months to a year or longer before selling. The entire auction process typically runs 60 to 90 days," Fox points out.
- Sales are final. Sellers cannot back out of deals once their bids are accepted. "At auction, you have 95 percent certainty the deal will close," Good says. That level of certainty is rare in private treaty transactions."
- The price is set. The winning bid is the selling price, although it can be adjusted in reserved auctions.
- The purchaser has the money. Participants must show proof of ability to pay before bidding. The deal will not fall through because the buyer cannot obtain financing.
- Brokers have to do less work. 'Typically, the auction house handles all marketing. Because deals are final, the broker does not have to spend time and effort in negotiations.
However, some brokers might dispute the last claim, for auctions add as many tasks as they take away. In a standard sale, the seller's broker does some basic due diligence work, but the buyer and his representative do the bulk of it once an offer has been accepted. For an auction, the seller's representative has to perform virtually all due diligence in order to have a proper ready for prospective buyers to inspect prior to bidding.
What Sells Best at Auctions?
Auctioneers and brokers differ about which types of property make the best candidates for auction. In general, auctioneers insist that auctions work well for almost every property type. But, according to Ernest Brown, CCIM, a broker with Grubb & Ellis in San Antonio, Texas, if that really were true, all properties would be sold at auction. Instead, brokers, and some auctioneers, see more limited applications. Situations in which auctions make more sense include:
- Properties that have not sold through standard marketing. "Anything we can't sell within 120 days, we recommend taking to auction," Herbert says.
- Properties that are difficult to value. Good gives unimproved development sites as an example. "Until you know who wants the site and what it will be used for, you can't set an accurate value," he comments. "If someone makes an offer, how do you know it's the best you can get? At an auction, all the potential buyers show their cards."
- Properties with strong emotional appeal. Good Points to the case of a single-tenant retail building in Chicago housing Michael Jordan's restaurant. It sold at auction for $2 million. A standard sales approach, he says, likely would have brought less because most brokerage clients think in terms of profit. The auction produced additional prospects who cared more about prestige than profit.
- One-of-a-kind or "oddball" properties. Herbert gives the example of a high-quality Nashville building with laboratories interspersed among offices. In California, such buildings are common because of the large number of high-technology and biotechnology companies-but not in Tennessee. By offering it at auction and marketing it internationally, the seller found several potential takers, he says.
- Properties that must be sold in a limited time frame. Good handled a $30 million portfolio of properties in November for a Canadian insurance company that wanted all sales closed by December 31. An auction made the request possible.
When Auctions Work Best
Auctioneers say that auctions work as well in up markets as in down. Brokers agree that sealed bid sales can work extremely well in up markets. Willard and Van Voorhis call auctions superior to the traditional approach for high demand properties. "Where you know demand for the product far exceeds supply and you know there will be a number of highly qualified investors bidding, [sealed bid] auctions produce the best prices," Van Voorhis says.
But according to most brokers, open bid auctions usually are not necessary in a strong market. They say properties rarely sell much above appraised value, and during up periods, few sellers have trouble selling at or near appraisal through standard brokering.
In down periods, however, auctions have two Primary attractions, according to Michael Hardiman, chief executive officer of Commercial Property, & Development Corporation in Baton Rouge, Louisiana. First, when a slow market makes it difficult to price properties due to the lack of comparable, auctions let demand determine the price. Second, auctions ferret out more buyers When investors are scarce.
In both bad times and good, Herbert notes, auctions put a greater burden on sellers because they have to put money up front for marketing and advertising and they have to refuse any offers that come in while the auction is being planned.
And rightly or wrongly, auctions still may have a certain stigma. Even Watson, who generally gives auctions high marks, says his clients resist them. "It's so difficult to convince sellers [that] they aren't going to take a beating. They see auctions as a last resort," he remarks.
Those attitudes are changing, Manning contends. "You're seeing more and more brokers participating in the auction process," he says. "They're becoming more familiar with it."
Auctions on Increase?
Most auctioneers maintain that the number, quality, and value of properties sold through auctions are increasing steadily. But, while many auction houses can show quantifiable evidence of increases in numbers and values for their own businesses, no overall industry statistics are available.
However, a report from the Gwent Group in Bloomington, Indiana, commissioned by the National Auctioneers Association (NAA) in Overland Park, Kansas, indicates that $40 billion of commercial and residential real estate-sold at auction in 1994, compared to $34.7 billion in 1992. The ratio of residential to commercial sales for the earlier year, according to Joseph G. Keefhauver, NAA executive vice president, was approximately three to one. Later figures are not available.
It would be a mistake to interpret any reported increases as definitive signs of the growing acceptance of auctions. Comparatively few commercial properties came to market in the early '90s, values were severely depressed, and a sizable proportion of properties sold at auction were those with the most problems. The values, if not necessarily the numbers, of properties should be much higher today.
Consequently, without in-depth analysis, increases at a few individual auction houses mean little. Nonetheless, auctioneers are confident that the numbers are rising.
"There is an increasing trend of owners going to auction first, rather than a brokerage, particularly with desirable properties," Fox asserts. "They would rather the market set the price through bidding than create the artificial ceiling of an asking price. We're seeing all types of properties from top class A office buildings to successful shopping centers. We're even seeing institutional investors."
Others claim the reverse is true. "I'm seeing a decline in auctions because it's a seller's market," says Hardiman, who worked for the Federal Deposit Insurance Corporation (FDIC) from 1989 to 1997. He says the widespread use of auctions during that period largely was a response to financial institutions' need to dispose of large real estate inventories quickly. With that need gone, there is less need for auctions as well, he says.
The Auction Process
Auctions typically are classified into two categories: open outcry or sealed bid. Some say only the former qualifies as a true auction, but for practical purposes virtually everyone accepts the use of the term "auction" for both formats.
Auctioneers express a preference for open bidding, claiming that the excitement and competitive atmosphere result in a higher price for the seller. Fox refers to the process as "putting bidders into the competitive pressure cooker of immediacy."
The fear of loss created by the process drives people to bid more than they would under less pressured circumstances, Watson says. "If you've got the right property, it's amazing what people will do," he says.
Open bidding itself breaks into two categories: reserved, where the seller can accept or reject a final offer, and unreserved, where the seller only can accept it.
Nearly 70 percent of Hanley's firm's auctions are reserved because sellers worry that they will be stuck having to accept too low an offer, he says. Fox, however, discourages reserved auctions because he says that buyers tend to hold back due to the uncertainly of the outcome.
Reserved auctions work best for properties with complications, Brown says. These could include properties with unresolved environmental issues, a single large tenant on short-term lease, a land lease, or another type of encumbrance.
Auctioneers tend not to like sealed bid sales, but they recognize that many of their clients prefer them because they feel uncomfortable with the more freewheeling atmosphere that is typical of an open auction.
Sealed bids are preferable only when the seller attaches contingencies to the sale, a property has too many unknowns, or issues are unusually complex, Good says. "If prior due diligence can't clear everything up and it appears the sale is too complicated to consummate without negotiation, then it should go to sealed bid," he says.
Sealed bids also might be advantageous, Fox says, when the seller wants to control and limit the marketing of the property.
Many people dislike sealed bidding because the competition is not revealed, Fox says. Knowing who plans to bid can make a difference in how much others are prepared to offer, he says.
The actual auction process is simple:
- A property owner - with or without a broker - gives the auction house complete physical, financial, and prior sale information, as well as permission to inspect the property.
- The auctioneer provides a written report detailing the proposed marketing program, including cost, recommended auction format, and suggested time frame.
- The parties sign a contract and set an auction date (usually 30 to 90 days forward). When a broker is involved, the contract specifies the commission breakdown (and the brochure prominently displays the broker's name).
- Marketing begins, including advertisements and announcements to investors, brokerages, and former auction participants.
- The seller or broker completes full due diligence and prepares a report.
- Potential bidders register for the auction. For open outcry, they show up at the appointed time; for sealed bid, they submit a written bid by the announced deadline. Brokers may participate with or in place of bidding clients, but they also must register ahead of time. If the client is absent, the broker must provide proof of the right to act for the client.
Getting the Best Price
The question of whether auctions or standard brokerage techniques bring the highest price remains unanswered, though it's actually a question of open bid auctions versus both sealed bid auctions and conventional marketing.
Certainly, open bid auctions produce higher prices in some situations. Properties that have not sold through conventional methods probably will bring more at auction than by remaining on the market, Watson says. "Most people think auctions bring low numbers. But if you have a piece of property you haven't been able to sell, the opposite is true," he says.
On the other hand, Watson reports that the most impressive returns he has encountered came with sealed, not open, bid sales. A sealed bid sale of branch bank buildings in his area generated prices twice as high as anticipated, he says.
Properties sold through open bidding at Manning's company average 85 percent to 110 percent of appraised value, Manning estimates. Prices achieved through open bid while Hardiman worked for the FDIC averaged 88 percent to 94 percent of appraised value, he says. Traditional sales at the time achieved about the same, but had a much longer holding period.
A shorter holding period makes a great deal of difference in calculating total value, according to auctioneers. Even if a property were to Produce less at auction, Hanley says, the broker would be better off with a commission on, say $900,000 for two months of work than on $1 million for six months of work.
The client could be better off, too. Herbert advises brokers not to dismiss the possibility of working with auctioneers. As investment brokers, we need everybody. It's not a situation where we should be fighting one another. Both traditional methods and auctions have a legitimate place in commercial real estate."