Affordable Housing Institute : US

By: David A. Smith

  

Many are the ways to sell things:

 

Bargaining, one-on-one, as in used cars and Arabian bazaars.

 

Everything for a price, and every price negotiable

 

Shelf pricing, as in grocery or department stores.

 

Bargaining not involved

 

Flea markets and yard sales, where searching and a little haggling are part of the experience, because both you and the seller have plenty of time.

 

Nothing essential here

 

Time-limited discounts, otherwise known as coupons:

 

The modern coupon: something you don’t want, at a great bargain price

 

And then there are auctions, which in many ways are the most curious of all, especially when applied to real estate, as illuminated (at least tangentially) in this otherwise unremarkable New York Times piece:

 

For a Few Developers, It’s Hammer Time

 

Louis Foundos didn’t think he would have a problem selling out his new condominium project last fall. It was a renovated building in East Harlem with everything a first-time buyer might want, including granite countertops, dishwashers and washing machines in every unit. It was just a few blocks from the subway, and plenty of new development was under way in the neighborhood.

Five months later, when not a single one of his 12 condos had sold, he decided it was time for drastic measures. He would break his long-held vow and follow his bank’s advice. He would try an auction.

 

Buying and selling – or at least, the contra dancing around price inherent in buying and selling – is a curious mixture of posturing and uncertainty.  Some transactions, like those in a grocery store, benefit from certainty on both sides.  If both the store and I know the price will stay constant, then we both can have a very brisk and comfortable transaction: I know what I will pay, the store knows I am ready to pay it, and between us we do the business swiftly and amicably. 

 

Even then, sellers use discounts to move buyers

 

In shelf pricing, transaction efficiency speeds up at the expense of reducing the potential for isolated price optimization.  Shelf pricing is thus useful when the thing being bought is a commodity or has readily comparable attributes (like size, weight, or horsepower), and when it is either a necessity or a commonplace, something where we will all make dozens if not hundreds of similar purchases, often from the same or similar vendors. 

 

In short, shelf pricing is the Prisoner’s-Dilemma cooperative solution for effective scalable markets.

 

No honor among thieves?

 

On the other hand, there are transactions where the thing being sold are unique – say, works of art – or at least highly distinctive, with more elements of variability than there are objects for sale (rare coins, antique furniture). 

 

With few sales, developers like Mr. Foundos, tired of seeing loan payments, taxes and maintenance costs consume the bottom line –

 

Remember, holding unsold real estate isn’t just a problem of illiquidity, it actually costs money (management, security).

 

– are resorting to auctions, in a gamble that selling units at a discount now will be better than sitting on unsold property for another year. In some cases they are trying to sell a building’s last remaining units; in others, to prod moribund sales or introduce a property.

 

If speed is not an object, these are usually sold in negotiation-friendly environments – consignment stores, second-hand stores, on-line catalogues – but when speed really matters, then it comes time for the auction.

 

The majority of homes put up for auction in New York are foreclosures sold in city courthouses or through Auction.com, formerly the Real Estate Disposition Corporation. Foreclosure auctions disposed of 6,621 apartments, single- and two-family homes last year in New York City, according to PropertyShark.com.  (Most auction houses avoid foreclosed properties because they don’t want the accompanying hassles and uncertainty.)

 

Auctions have long made sense for lenders seeking to foreclose, not because they want to maximize the price but rather because auctions are mandated by law as a means of proving genuine effort to sell the property.

 

Nobody can say the public didn’t have a chance to buy

 

A lender will hold a foreclosure auction with every expectation not of actually selling but rather simply as the means of securing clean title and wiping out the delinquent debtor.  Having attended one of these, I think of them as ‘semi-real’ auctions, because everybody involved knows the lender will be high bidder.  Far more intriguing, and more rare, is the form of sale that most stiffens the sinews, summons up the blood, and excites the uncertainty of both sellers and buyers – the live non-foreclosure auction.

 

“It’s not an easy decision,” said Mr. Foundos, the managing partner of FFS Realty of East Meadow, N.Y. “No one likes to roll the dice when you don’t know where they’ll go.”

 

Do you know where you’re going?

 

Auctions are risky because they are negotiating without a net.  Neither the seller nor the buyers knows for certain where the price will end up.  That sudden-death uncertainty renders the pure auction a rare bird:

 

Yet, for all the interest, fewer than 10 live, in-person auctions have taken place in New York City since the housing bubble burst three years ago. Only about 75 units have changed hands in this way.

 

Because auctions bring people face to face, they stir the emotions and that adds an element of pressure among the bidders.  Some evolutionary wiring within human beings makes us compete for prizes, even if the prizes are seemingly not worth winning.

 

We don’t know if we want her, but we know we want her to want us

 

To get the competitive juices flowing, therefore, it’s important to have a lot of suitors vying for the fair title deed’s hand:

 

Come on, pick one of us!

 

Auctions seek to couple that competitive urge with our natural (if base) desire to steal a bargain, by getting something really cheap. 

 

Last weekend Mr. Foundos’s building, the Winfield, went on the block.

 

The competitive dynamic work if the seller can attract enough prospects into the room, and for that, a good seller offers the promise of consummation – of sales being gaveled down.

 

Sold!

 

But sellers also want to cheat fate by having a reserve price – a minimum below which they will cancel the sale.  As one can imagine, that demotivates prospective buyers, so the seller can try to prime the pump by putting some units in play with no minimum price.  Or the seller can cheat:

 

Some sellers don’t disclose the reserve, so the highest bidder may have to wait until after the auction to see if his bid has been accepted.

 

In this wrinkle, the seller states that there is a reserve, but keeps it a secret.

 

For me to know and you to find out

 

Since I as a buyer know nothing about you, the seller, I have no reason to believe you’ll keep your word (whatever it might be) about your reserve price, so as far as I would be concerned, a hidden reserve renders the whole auction meaningless.

 

“Most auctions I’ve been aware of are faux auctions because they don’t have a disclosed reserve,” said Jonathan J. Miller, the president of the appraisal company Miller Samuel. “The developer decides whether to sell.”

 

Having a reserve, especially an undisclosed reserve, changes the emotional anticipation, and can be counterproductive:

 

At the Solaria in the Riverdale section of the Bronx, only 10 apartments sold in the year after the 64-unit tower went on the market at the start of 2008. Joseph Korff, the developer, decided on an auction.

 

But there were few in attendance when it took place in November 2009. Most bids came in below the reserve — the minimum price that the seller will accept.

 

Not only did the seller use a reserve, evidently he set the reserve high enough to demotivate many prospects who might otherwise have attended the auction if only out of curiosity.

 

Only eight units sold at the auction and in post-auction negotiations.

 

“On this particular property, I wouldn’t do it again,” said Mr. Korff, the principal at ARC Development in Manhattan. “I’d want to see a greater public acceptance of a model of marketing inventory, and I’d like to see some successes in Manhattan.”

 

Perhaps so; or perhaps you conducted a poorly designed auction?

 

Sit down and think it over until tomorrow

 

[Continued tomorrow in Part 2.]