Buy smart at real estate auction

Q: I want to buy a house at auction. Do you have any advice?

A: In days of old, like before 2005, most real estate auctions were trustee sales that took place before a home was repossessed. We Realtors had a standard set of admonishments we used to make about those auctions: You might get a deal, but you have to pay in cash and in full; you'll have no opportunity to have inspections; you may have to evict the former owners; and you could end up buying a place with a bunch of liens and other mortgages on it. These typical trustee sale characteristics barred all but the hardiest of cash-flush investors from participating.

Fast forward a couple of years, and the recent spate of foreclosures has spawned a diverse new landscape of property auctions, each type with its own new-and-improved (maybe!) set of pros, cons and cautions.

Before we get to what you need to know to be a smart buyer at auction, let's get clear on a couple of things. Why are you set on buying at auction? Are you looking for a great bargain? A great home? Investment property(ies)? All of these aims can be met with the properties available at auction, but virtually all of them can also be met doing a standard house hunt of properties listed on a multiple listing service, without having to leap some of the many auction hurdles. I would caution you against limiting your house-hunt methodology narrowly to auctions, unless a particular home you love happens to be up for auction or you are an investor seeking bargain-basement pricing with little concern for the condition, location and other characteristics of the properties you purchase.

Need-to-Knows

These days, the foreclosing mortgage bank is the only bidder in the vast majority of old-school county courthouse trustee sales, and it buys the home from the owner. This leaves the lender with a new real estate-owned (also known as bank-owned or REO) property. Often, the lender will list this REO with a real estate agent who markets and sells it per usual. The REO property may be placed up for auction if the listing goes unsold for a long period of time or if the lender chooses to do so before listing it with a Realtor. Most of the auction-property buyers these days ask me about auctions of bank-owned properties.

These auctions of lender-foreclosed homes go down in one of three ways:

 

• Mass REO auctions. These are held by real estate liquidation companies in a warehouse or convention center and usually involve hundreds or even thousands of homes being sold on the same day. On the West Coast, one of the most well-known organizers of these massive auctions is Real Estate Disposition Corp., which operates the USHomeAuction.comWeb site.
• Onsite/on-location REO auction. These auctions are much less circus-like in atmosphere, and take place at the actual property being sold. (Some companies will sell two or three nearby properties onsite in one of the homes.) One of the largest national auctioneers of this sort is Williams & Williams, which operates the WilliamsAuction.comWeb site.
• Online auction. Both lender-foreclosed homes and homes being sold due to back taxes owed are auctioned online, at RealtyBid.com and Bid4Assets.com. These online auctions can last hours or days, eBay-style.

There are a handful of specifics that buyers need to watch out for at any of these types of auction -- those who participate unawares can end up really unhappy. In fact, some of these items comprise the grounds for a couple of currently pending class-action suits by successful bidders against auction companies:

 

• Cash in hand. You need to show up and prove that you have a certain amount of cash (cashier's check, actually) in hand just to participate. Sometimes it is a flat amount, like $5,000, and in other cases it is a percentage of the starting bid. You also need to be able to increase that amount, in cash, to whatever earnest money deposit amount the seller has set, usually 3-5 percent of the successful bid amount.
• Pre-inspections. Most auctions will not allow you to inspect the property after you win the bidding. If you care about the condition of the property, you need to have your pest, property, roof, etc., inspections conducted before the day of the auction -- at your own expense. Yes, this means you could shell out hundreds and not get the property.
• Mortgage. Unlike prior generations of auctions, most auctions these days will allow you to use mortgage financing. However, most will not allow you to have a loan contingency (i.e., the ability to back out of the deal if you cannot get financed) unless you work with their lender, which could limit the options available to you in terms of down payment, interest rates and other mortgage terms.
• Reserve price. Here's the kicker: The seller often sets a reserve price -- a minimum price below which the property will not be sold -- that is greater than the starting bid but is not made known to bidders. So, for example, a property could be listed with a $75,000 starting bid but have an undisclosed reserve price of $250,000. So if you are thinking you will bid up to $200,000 you have no chance of getting it -- even if you are the highest bid. And you have no way to know this until after bidding is completed.
• Buyer's premium. OK, so here's the other kicker: Many auction houses charge a buyer's premium of 5-6 percent of the high bid to pay their fees and marketing expenses. So, if you are the successful bidder at $300,000, the buyer's premium would add $15,000 (5 percent) to $18,000 (6 percent) to that cost.
• Contingency limitations. With many REO auctions, if your bid is the high bid, you are on the hook to buy the place or lose your deposit money, period. There are no contingencies, and there's no right to bail if you change your mind, lose your loan or the place turns out to have condition issues.
• Agent representation. The good news for those of you who take my advice not to limit yourself to house hunting in the auction arena is that many auction companies will now pay your Realtor's commission, just like a regular seller of a home on the multiple listing service. It may not be a full commission, though, so if you have signed a buyer-broker agreement that your Realtor will make "X" amount to represent you, even if you have to pay the difference, you should investigate the amount of commission the auction company is offering.

Action Plan

1. Get preapproved. Make sure that you are shopping for homes with starting bids much lower than your maximum purchase price. If you are going to bid on a home where there will be no loan contingency unless you work with the auction company's preferred lender, either get preapproved by them and compare the rates and terms to what you can qualify for elsewhere or get confirmation that your preapproval from your own mortgage professional is sufficiently sturdy that you would be willing to stake your deposit on it.

2. Read the fine print. Get educated about the specific guidelines and rules of the specific auction you plan to participate in. Virtually every auction company has a detailed set of guidelines online, and they will make their contracts, etc., available to you ahead of the auction on request. Read everything you can before you decide to participate -- that fine print may hold some dealmakers or deal-breakers for you.

3. Involve your agent or broker. Here's where you are going to get the best advice about whether the auction opportunity is sufficiently attractive -- compared to what is available on the rest of the market -- for you to put up with the negatives, like "no contingency period." Also, if you want the auction company to pay your Realtor to represent you throughout your transaction, the Realtor may need to register by a certain date. Your buyer's premium is going to be the same whether you have your own adviser or not so you'd do best to have one. In addition to managing your pre-inspections, they can help you do a starting-bid-to-closing-bid analysis of similar, past auctions to project where you should be prepared to come in.

4. Pre-inspections and due diligence. "No contingencies" means you had better show up to that auction with every single iota of information you will want to have about the property before purchasing it. Most auction companies will open the property on certain dates and times for inspections. Consider obtaining pest, property and roof inspections -- at a minimum -- unless one of your inspectors advises you that fewer or more are necessary. Check out the neighborhood, the property taxes and assessments -- anything and everything that will impact your decision about the place -- before the day of the auction.

5. Decide on your price and stick with it. Understand this: Auctions are like houses staged with Pottery Barn products. You can get caught up in the vortex of energy and overspend. With a staged home, you can back out. With an auction, you cannot. When you show up to bid, have a firm maximum price in your head and stick with it. You might need to manage your mindset some about how this house is just a building, and how many others are out there, and how if it's meant for you it will be yours, etc., but be hardcore about it. I've seen even seasoned investors blow their bankroll in an auction atmosphere. Don't let it happen to you.

Tara-Nicholle Nelson is author of "The Savvy Woman's Homebuying Handbook," and "Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions." Ask her a real estate question online [5].

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