Bringing down the gavel

Times are turbulent in the real estate world, thanks to the triple whammy of a subprime lending spree that ended in delinquencies, foreclosures and bankruptcies, prompting tighter credit standards in a sluggish economy.

173

But opportunities present themselves in all times and these days residential auction companies are seeing growing demand for their services.

A few years ago, when buyers camped outside yet-to-be-built home and condo projects hoping to snag a unit, no incentives were needed to sell out quickly and builders scrambled to deliver new product. Today, more rigid lending terms are shrinking the pool of qualified buyers and residential developers and home builders have little choice but to slash prices and offer a bevy of giveaways to move product in the overbuilt markets.

But marketing gimmicks like Hovnanian Enterprises’ three-day Deal of the Century extravaganza, with buyer incentives of up to $100,000 in free upgrades, and Pulte Homes’ nationwide Halloween-themed Monster Sale, with offers like no house payments for a year and/or a year’s pre-paid HOA dues, have been too little too late, especially in areas where excess supply was caused by speculative overbuilding.

“Sellers today are looking to move standing inventory much more quickly,” said Rhett Winchell, president of Kennedy Wilson Auction Group, a division of Beverly Hills-based Kennedy Wilson that has handled thousands of successful auctions in its 30-year history. “Our accelerated marketing program can provide them with that service. We typically sell out anywhere from 30 to 50 homes in a one-day auction event,” he said.

Auctions can be a last, but welcome, resort for home builders staggering under the marketing and capital costs associated with large unsold inventories that cut deeper into company profits the longer they remain on the balance sheet.

Home builders, especially over-leveraged regional players, are in danger of going under. Some already have. Levitt and Sons, the 79- year-old company that created the first planned suburb in the U.S., called Levittown, for returning soldiers after World War II, filed for Chapter 11 bankruptcy protection in November. Neumann Homes Inc., which operates mainly in Colorado and the Midwest, did the same. National players also are at risk. Last month, Standard & Poor’s downgraded the credit ratings of three of the nation’s largest home builders–D.R. Horton, Lennar and Pulte. Of the three, only D.R. Horton managed to beat out its own dismal guidance in the company’s fiscal fourth quarter, which ended September 30.

While home builders struggle to keep their heads above water, Randy Wells, in-coming president of the National Auctioneers Association (NAA) and principal of Post Falls, Idaho-based Realty Auction Services “NationWide,” is having his best year ever. “I’m doing more and more auctions for homebuilders, largely working through the banks who give them my contact information,” said Wells, who has charged owners anywhere from $1,500 to $50,000 for marketing fees to conduct and market their real estate auction He credits much of his company’s growth this past year to membership in MarkNet Alliance, an auction- marketing franchise.

Business is booming
Residential real estate is the fastest growing segment of the auction business, said Chris Longly, NAA public affairs manager. More than $16 billion of for-sale housing was sold by auction in 2006, a 12.5 percent increase over the previous year, but still just a small percentage of the $1.74 trillion of single-family home sales that closed last year, according to the National Association of Realtors.

The home auction business, however, is so brisk that some auction companies are franchising. The Pacific Auction Exchange has 55 such arrangements and hopes to triple that number to 150 nationwide by the end of 2008.

“Based on different cycles that happen within the real estate market, our auction division takes off when the housing market slows down,” said Winchell, who was involved with previous down cycles in 1984, 1990 and a small slowdown in 1994 and saw the residential auction business skyrocket again about 16 months ago.

Kennedy Wilson’s first auction event of the current cycle was held in October 2006 when the company sold 34 units at Canyon Villas, a former apartment community in Aliso Viejo, Calif. that was converted to condos by Sares Regis in 2005. Minimum bids for the homes that include wood-burning fireplaces, double master suites and nine-foot or vaulted ceilings began at $295,000, a 38 percent reduction from the last asking prices. “Since then, the demand has been building over time and next year we see even more interest in the auction program,” said Winchell. Most of his company’s auctions this year have been in Southern and Northern California, but bookings are coming up in Colorado and Arizona and could include Texas, Florida and possibly Las Vegas next year.

Win-win or lose
With minimum bids at Kennedy Wilson’s builder auctions typically starting at 40 percent of the last asking price, there’s no question sellers may sell at a discount by putting their properties under the gavel. But it makes sense for a builder or developer to move inventory off the books rather than hold on and wait for the market to turn, said Winchell.

“Those minimum bids typically generate a lot of interest and allow the builder to sell out the entire inventory at auction and, at the end of the day, the buyers do get a substantial savings. What the sellers save is the carrying cost factor, which, if they continued with a conventional program selling two units a month, could take them a year or two to sell out and their carrying costs could run into 20 percent or more a year trying to sell the remaining inventory,” he said, adding that one alternative is for the home builder to rent out the properties. “But, since product in most areas where we conduct auctions is priced between $300,000 and $600,000, the rent they are going to receive is far less than those carrying costs,” he said.

Winchell’s ideal auction client is the home builder or condo converter that delivered large amounts of inventory all at one time. His advice for those sellers is to pick a professional auction company with a proven marketing program.

There are three types of auctions–an absolute auction in which the property sells to the highest bidder, regardless of price, an advertised minimum bid reserve auction, where sellers advertise starting bids but are under no obligation to sell unless a bid reaches the published reserve price, and an auction with reserve, which gives the seller the right to accept or reject an undisclosed reserve amount. This is also known as a sale subject to seller confirmation.

“Different auctioneers have differing philosophies, but typically we publish minimum bids so that, when the buying public comes, they are guaranteed that if they are the first, last and only bidder they get the property. Our goal is to sell out 100 percent and that method will give you the higher success ratio,” Winchell said, adding that published minimum bids also give a sale more credibility.

The unpublished reserve bid is used most frequently in Real Estate Owned (REO) auctions, or, in other words, auctions of properties that were repossessed and now owned by the lender. “With an unpublished reserve, there is an advertised starting bid, but if the bidding doesn’t reach the unpublished reserve set by the seller, the highest bidder could walk away empty-handed unless the seller accepts the lower-than-reserve offer. That’s one aspect of lender-owned auctions– they are conducted in that way because the banks have certain guidelines and regulations they must adhere to,” said Winchell.

Around 80 to 90 percent of Kennedy Wilson’s auctions currently are for builder-owned properties, but he expects to see more lender auctions next year. “That’s the cycle. The builders that are being pro-active now are selling at auction. The builders that aren’t selling will lose their projects to the lenders next year,” Winchell cautioned.

Kennedy Wilson will conduct an REO auction at the Colorado Convention Center this month, bringing 100 bank-owned homes in 34 Colorado cities under the gavel at starting bids that range from $5,500 to $375,000. Those homes previously were priced up to $883,900.

All residential properties brought to auction are held open for inspection days and even weeks prior to the sales event and bidders are encouraged to begin their due diligence way in advance. Kennedy Wilson even offers how-to-buy seminars, where potential bidders can participate in a live practice auction with an auctioneer and learn about the process, including how to register, how to pre-qualify for financing, bidding strategies and auction terms and conditions. “Seminars are especially helpful for buyers who have never purchased a home at auction and a nice refresher for those who have,” Winchell said.

Kennedy Wilson likes to have preferred lenders onsite before the event to pre-qualify bidders. “We also suggest that the seller offer an incentive to buyers, and that could vary from $2,500 to $10,000 on closing costs, if the buyer goes with the preferred lender and closes within 30 days,” said Winchell.

Realty Auction Services doesn’t pre-qualify bidders. Instead, the firm accepts non-refundable earnest money down payments. “If a person has good credit, it’s an excellent time to buy,” said Wells. Most of the bidders he sees these days are end-users who are happy to realize the dream of becoming a homeowner.

Investors are holding out because they don’t know where the bottom of the market is.

Wells predicts that bottom is years out and home prices won’t rise again until the industry works through the large and increasing supply of standing inventory. “It will be between two-and-a-half to maybe six years. This real estate downturn will be larger and longer than the crisis during the savings and loan scandal of the 1980s,” he said.

Moody’s.com Chief Economist and co-founder Mark Zandi thinks prices will begin to recover a few years earlier, in late 2009 or early 2010. David Seiders, chief economist of the National Association of Home builders, is more optimistic. “Home sales should bottom out by the end of the first quarter of 2008,” he said, adding that he foresees an increase in starts in the third quarter of next year, assuming the inventory overhang stabilizes.

Meanwhile, single-family home prices that peaked in July 2006 across the 20 metros tracked by the S&P Case/Shiller index have since fallen five percent, with their greatest decline (1.7 percent) last quarter.

There’s no doubt more pain is in store for both the home builder and the homeowner, and not just those who purchased houses that were unaffordable without the use of exotic mortgages and financing packages, artificially low interest rates and easily obtainable credit. Even President Bush’s proposed interest rate freeze, which would offer a modicum of relief to some homeowners who financed their purchases with subprime mortgages, won’t stem the tide of foreclosures. And the product flooding the market at bargain basement prices will further erode all home values.

It may be the auction industry that provides more assistance than even the President’s proposed band-aids. “The auction industry helped out during other crises and made the recoveries that much faster and will do so during this one,” said Wells.

Winchell agrees. “The auction process benefits the real estate industry because when you have product on the market, say 30 unsold homes in a subdivision where 30 already have sold, the people who already live there can’t sell their homes because of the standing inventory. The builder or lender typically can sell for less than the homeowner, so, once we go into a project and sell that inventory all of a sudden the builder or lender no longer is competing with the homeowners, who now could sell using a conventional-type sale program where they are only competing with other re-sales,” said Winchell.

The news today is filled with angry comments from homeowners bemoaning the low prices builders have received at auction for homes just like theirs, squeezing the comparables. But auctioneers point out that the market is the market and auctions are particularly helpful in determining just where the market is.

“The market fluctuates, and if we sell a number of homes prices will drop initially, but eventually will level out to what the demand is for that area and that unit model,” said Winchell, using the condos at Canyon Villas as an example. “After we went through the auction and sold out 34 homes, there was still demand from people who didn’t get a home at the auction. So Sares Regis, which still was in the process of converting units, continued after the auction to sell 10 homes a month for the next 12 months and, in most every phase, they were able to raise the prices,” said Winchell.