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FORBES MAGAZINE - Before You Bid

December 08, 2003

Luisa Kroll, 12.08.03
As seen in Forbes Magazine

Keith Ferrari, an entrepreneur who owns companies in Tennessee and Illinois, wanted a bigger house for his growing family. So he attended an auction of country singer Barbara Mandrell's 27,000-square-foot log house in Nashville, Tenn. He bowed out when the bidding passed his self-imposed limit of $2 million (it sold for $2.1 million). Next, in Franklin, Tenn., he bid on a 13,000-square-foot replica of former President Andrew Jackson's home. This time, his $1.5 million was the winning bid. "You have to set a limit," says Ferrari. "A lot of people who attend auctions get whipped into a frenzy. The key is to make sure you don't get too emotionally invested."

Real estate auctions are on the rise: Sales exceeded $60 billion in 2002, up from $10 billion in 1980, according to consultants Gwent Group in Bloomington, Ind. That takes them to less than 3% of total real estate sales. From the seller's perspective, auction is best suited to homes that are hard to value. These include estate sales, waterfront homes, ranches and homes with historical significance, such as the Andrew Jackson replica that Ferrari bought. "Half the homes we auction have never been on the market before," says Craig King, president of J. P. King, one of the oldest real estate auction firms in the U.S.

For buyers the biggest risk is overpaying. Retired Blockbuster executive Thomas Gruber set himself a $3 million limit when he went to the auction of Alamo Car Rental founder Michael Egan's Fort Lauderdale estate in May 2001. Competing against 27 registered bidders, including pro baseball player Mike Piazza, Gruber ended up paying $5.6 million. "I got carried away." he says, "My wife was playing tennis. I thought it would be fun to go down[to the auction], but we already had three homes and I had no business buying it."

Rule number one for potential buyers: do your homework ahead of time. First, find a reputable auction house. There are 6,500 auctioneers selling real estate in the U.S., 100 of whom handle the majority of the sales. Find one with a good track record of closing sales. Check the Dun & Bradstreet report. Most of the top ones are a Certified Auctioneers Institute graduate or an Accredited Auctioneer of Real Estate (www.auctioneers.org has a directory). Also, speak to former customers and check with the state real estate commission for lawsuits and complaints.

Better auction houses often provide Property Information Packets (PIPs). These include details of the land survey, title and lien search, radon and termite inspections, zoning, taxes and a contract. You're unlikely to get a PIP in a foreclosure sale. These are risky. Most individual buyers should avoid them.

A PIP is no substitute for due diligence. After almost a year of looking for a single-family home in Chicago, interior designer Shelly Barrad found the house she wanted being offered at auction. She spent the weeks leading up to the auction learning all she could about the 5,000-square-foot structure. Her lawyer reviewed the PIP. She hired her own inspector, attended all four open houses and spoke to city officials about zoning. She then lined up her mortgage (the bank's appraisal helped her value the home). She even brought her mortgage broker along to the auction to keep her within her spending range.

That range has to include the "Buyer's Premium." In brokered real estate sales the seller pays the entire commission. At auctions the buyer pays a 4% to 10% surcharge, and the seller is in some cases liable for a small additional percentage.

Potential buyers must write a check or put up a line of credit (the amount varies depending on auction firm but can run as high as $100,000) before the auction begins. All but the winning bidder's checks are returned after the hammer falls; the winner often has to stump up an additional deposit on the spot, to cover the difference between the initial payment and 10% to 20% of the final price. The deposit is nonrefundable and contingency free. Most sales then close within 15 to 45 days, as predetermined by the auction contract.

Buying at auction means buying as is. Hilton Smith bought a waterfront house in South Carolina for $1.9 million. Because he was a real estate developer and the home was new, he didn't expect problems. Instead, he and his wife have spent an additional $400,000 on such things as a new central heating and air-conditioning unit. "We love the home. I am a busy guy, and closing the deal quickly made a lot of sense," says Smith, "But I am happy that I have very deep pockets."

For sellers, time is often the big motivator: An auction almost guarantees a sale within 90 days. When Barbara Crouchley's husband died, he left her with a costly Rhode Island waterfront estate. Rather than list with a broker, she hired auctioneer Jerome J. Manning & Co. "I thought auctions were for distressed or bankrupt properties, and I didn't want it perceived that way," says Crouchley. "But after all I'd gone through, I didn't want the uncertainty of listing the home." She sold it for $1.7 million, $500,000 above its appraised value.

Another reason to consider an auction is for the buzz a good auction firm can generate. To publicize the sale of a remote 90-acre Montana ranch this summer, the Redfield Group mailed brochures to 10,000 multimillionaires and plane owners. Broadcom's chief executive, Alan E. (Lanny) Ross, flew in and made a preemptive bid the day of the auction.

Auctioneers often prod sellers to use absolute (no reserve) auctions, where bids start at $1. This, they say, whips up crowds and money. But it is nerve-racking for a seller who has, say, to clear a mortgage. "We rarely use absolute auctions on behalf of individual sellers of residential homes," says Steven Good, chief executive of Sheldon Good, a large real estate auction firm. "They can't handle the mental risk." Good suggests using a minimum bid to start the auction, or setting a reserve price, which means a seller can accept or reject the final bid. Sellers may have to pay a fee to the auctioneer if the reserve isn't met.

Real estate auctions aren't as risky as they seem. Nor are they a bargain hunter's paradise. Typically houses are auctioned off at somewhere between 85% and 105% of estimated fair market value. Says interior designer Barrad, who ended up spending more than she wanted but less than the original list price on her Chicago home: "Nothing is cheap. If it's a good property, it will go for something reasonable."

Luisa Kroll, 12/08/03