REQUIRED READING: Auctions: No Longer A Last Resort

Written by John Clapp
on December 12, 2008 No Comments
Categories : Required Reading

Not that long ago, auctioning real estate was considered by sellers to be a last-resort option. They attracted the wrong buyers and gave an inaccurate impression of the property's value, critics argued. Or, as one person involved in the real estate owned (REO) space says, ‘Ultimately, that's where properties went to die.’

With the meteoric rise in foreclosures, however, came an equally precipitous uptick in REO volume, and asset managers are now leveraging the timeline-condensing ways – not to mention, much-improved technology – of the auction process with greater regularity. Properties are spending less time on the market before heading to auction, according to Tom Gordon, executive vice president of business solutions for DepotPoint, a default management solution provider.

He observes that properties in some parts of the country are considered aged when they've been on the market for 90 days. (The former norm was closer to 120 days.) This factor, combined with a bank's level of liquidity (which, in a growing number of instances, is low), is causing servicers to become more acceptant of a process that was once thought to be nothing short of a death knell.

"If you're looking for a visual representation of REO inventory, think of a boa constrictor that's just swallowed a large warthog," says RealtyTrac's senior vice president, Rick Sharga. "They're just trying desperately to process it."

Public awareness of foreclosure auctions has also grown greatly in the past year and a half, and as all asset managers know, the REO categorization is no longer limited to low-end properties. As a result of the overvaluations that plagued the boom period, many bank-owned homes are almost brand-new; some are in gated communities. Moreover, with a myriad of new players in the auction space, servicers enjoy a wider array of potential partners with which to team.

The increased use of auctions also provides insight on servicers' pricing strategies, not to mention the many challenges that exist. Auction advocates will almost invariably mention that a bidding process reveals an asset's true market value, which typically falls somewhere between the value expected by the buyers and desired by the sellers.

"When you do auction a property, that certainly gives you some information about where the market sees the value of properties in a particular area," says Lisa Lauroesch, vice president of business development and REO sales for Bid4Homes, an online auction platform that recently entered a partnership with RealtyTrac. "If things are priced right, they seem to be moving quickly. If they're not priced right, then I think buyers are staying away."

Misperceptions
Despite the variety of property types that banks own nowadays, buyers still assume that purchasing REOs comes at a discount. Add in the down-market characteristics of real estate today, and it shouldn't be surprising that a large disparity still exists between the asking price and the selling price.

"The fear that a lot of folks have is if they do start auctioning off properties, especially online, they're going to start stamping these as blue-light specials and drive prices down," says Sharga.

But embracing a counterintuitive attitude – one that involves setting a low initial asking price – may, in fact, be the most effective route for asset sellers to take.

Auction is "intrinsically difficult," notes Chris Saitta, president of REO sales and managing software provider REOTrans, because the best way to attract interest in an auction is to have low-priced assets. Inexpensive homes mean more people, which, in turn, means improved likelihood of a better sale price. "It's hard for a seller to start low, even though it's in their best interest," Saitta says.

Of course, servicers' fiduciary responsibilities to investors prevent them from starting low in many cases. Investors want to "keep the blinders on and not face the music," observes Ryan Knott, CEO of REO marketing company RES Locators. Reluctance on the part of the investor to lower prices can prove detrimental in the long term, however. As properties sit on the market and carrying costs balloon, eventual price reductions are inevitable. And when those reductions come late in the game, they're likely to be significant.

RealtyBid president and CEO Tony Isbell sees areas in Florida and California where this stubborn mindset is most prevalent. Many homes in the two coastal states exemplified the overvalued-asset piece of the meltdown puzzle, and as such, the loss severities that are realized there are often huge.

"Those [states] are the last to see any real price reductions, so when they do start coming, it's really painful, because the banks have waited so long to reduce prices that the reductions must be severe to have an impact on sales," he says. "In Michigan, Ohio and Indiana, they seem to be much more willing to reduce the prices."

RealtyTrac's Sharga notes that in the hardest-hit California cities, the selling prices of some REOs are 60% to 70% less than the properties' last sale prices, and such drastic cuts are the kind of discounts that it takes to "get people off the sidelines and back into buying mode."

Still, there are signs that the California market, for one, is stabilizing. Dave Webb, principal of Hudson & Marshall, which auctioned Fannie Mae properties in the late 1980s and today has a hybrid online platform (in which homes can be sold prior to auction), says a recent Southern California auction saw close to 30% of the properties pre-sell. The company's most recent effort in Detroit, by contrast, pre-sold less than 6%.

"That tells us that market's stabilizing a little bit, because the offers were pretty high," Webb says. "The sellers are pleased, because even before we leave the office, they've already got 30% of their inventory sold."

Accompanying the difficulty of correct pricing is the problem of justifying the price to investors. Although servicers are getting "much more aggressive" with pricing strategies, Webb says, "it's a matter of justifying that price and getting it reduced timely."

Saitta agrees, noting markets often move by the time a price reduction is justified. REOTrans provides sellers with comparables for properties that are sold on its platform.

"If I want to do a $10,000 price reduction, when I send that up the chain, I better have some validation of why I'm doing that," Saitta says.

The comfort levels among servicers is also increasing, because the online auction process no longer precludes the presence of real estate brokers and agents. Webb says keeping brokers in play is a necessary consideration. Agents are "very hungry for REOs, because that's the majority of what's selling these days," says DepotPoint's Gordon, and his company has an agent-screening process that enables servicers to select those agents located near their listed property.

Sharga sums it up by noting the relationship between online auctions and disposition companies and real estate brokers can be beneficial for the latter group, even if it equates to less money per transaction.

"The new model incorporates the agent and the broker as part of the transaction. While in a lot of cases, they're not making the same commission, they're doing far less work," he says. "I think the marrying of the two disciplines is going to change a lot of mindsets that have prevented auctions from becoming a more prevalent part of the industry.

Elusive financing
While buyer appetite for REO is growing, that's not to say marketing a bank-owned property is as easy as posting a sign in the front yard. Auctioneers have identified buyer financing as a major hurdle in moving REO, as credit has tightened almost to the point of strangulation, and lending standards are far more stringent than they have been in the recent past. Zoning in on qualified buyers who can obtain loans is important, notes RealtyBid's Tony Isbell.

"We're not concerned there's buyers out there, because there's a tremendous amount of demand," Isbell says. "It's just making sure that we find qualified buyers. That's becoming a little bit of a challenge."

In light of this consideration, some disposition companies are exploring the possibility of linking sellers with finance partners. The RT Marketplace platform offered by REOTrans provides an arena for servicers, vendors and real estate agents to connect. The company tracks the back-on-market (BOM) rate of properties transacted on its system (i.e., the number of properties that close but then fall out, often due to lack of financing), and Saitta estimates the BOM to be in the teens.

"There's a big difference between selling the property and enabling the buyer," says Saitta. "To enable the buyer is what really needs to happen in this market. You need to make sure the buyer has the financing available and that they can buy the property."

Similarly, RES Locators' Knott says even conservative borrowers are having a hard time qualifying for credit. The problem led, in part, to RES Locators creating lending relationships with Chase and Nationstar/Champion. The relationships allow the company to pre-qualify potential buyers, which Knott says decreases the chance of them falling out after submitting a winning bid.

The coexistence for the first time of a strong REO market and Web-based auctions allows servicers numerous benefits. View-tracking tools – a powerful device for Web advertisers – can give sellers a fairly accurate idea of what type of interest their properties attract. Bid4Homes makes page-view metrics available to servicers, allowing them to examine the traffic for a particular home's listing – a method that Lauroesch says holds a distinct advantage over traditional disposition efforts.

"It's very easy to track in an online venue what the volume is, as opposed to the offline world, where it's a little harder to know who's actually reading your ads or previewing your property," she notes.

Most REO marketers agree it may be some time before auctions are leveraged as routinely as real estate brokers, but the shift is coming.

"For those who have been in the industry for a long, long time, the mindset's never going to change," says Sharga. "With the next generation of people coming up in the industry, there's really no reason why auction should be any worse a transaction model than a traditional sign-in-the-ground MLS listing.’

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