Matthew Ferrara, Philosopher
 

Out from Under with an Idea from Down Under

For all the efforts to clear the U.S. housing market, the sheer scale of the real estate crash defies even the most aggressive approaches like short selling. What’s needed to get the country out from under a crushing debt crisis and inventory glut is an idea that’s been keeping markets healthy and wealthy for decades, Down Under.

In Australia and New Zealand, homes sell weeks, not months. In some areas, more than 60% sell in four weeks – with cash non-contingent offers and 10% non-refundable down. That’s just about the time it takes the average U.S. agent to finagle their first “price reduction” from their irrational sellers. How can this be the case, in a country where mortgage interest isn’t tax-deductible and the 30-year fixed financing is unheard of?

Simple. Down Under, they sell homes just like any other commodity: They auction them.

Beautiful in its simplicity, the Down Under auctioneering approach to selling homes is the product of clear economic thinking. The auction is the oldest and most stable form of transaction. It maximizes the best features of free market: real-time pricing between interested parties who close and pay immediately. It’s the approach used to sell at the small0town flea market or on a global electronic commodity system.

And it’s exactly what the United States needs to clear out the excess and distressed inventory.

Auctions let market forces bear upon the process of trading those “special” commodities we call houses. From a high level there appear significant advantages to auctions in comparison to more traditional “list, wait and hope” approaches. To keep it simple, let’s focus on the  benefits that could be applied to the problem of restoring balance to America’s distorted housing market:

  1. Auctions communicate better pricing information. In traditional listing practices, the seller makes the “first offer” and then spends days or weeks rejecting lower offers. If offers are close to their first-offer, a negotiation might occur, usually lasting days. Auctions, on the other hand, provide immediate and real-time pricing data to the seller and broker. After a previewing and marketing period of two or three weeks, buyers appear for a short amount of time and communicate what they would actually pay for the home by bidding. This pricing data is better for sellers because it relies upon actual offers to purchase, not historical data in a database (which represent others’ offers to purchase others’ homes). Bids represent the only realistic pricing data that accounts for comparable homes on the market as well. Buyers are likely to have previewed all of the relevant alternative homes that interest them, and take their options into account when bidding. Auctions therefore provide the clearest and cleanest appraisal of what a home is worth to the only person who cares: an actual interested buyer. Even in cases where bids do not reach the minimum requirement of the seller, auctions still provide the best pricing guidance in the least amount of time. Traditional MLS “sold data” cannot compare because sold prices only reflect what a home was worth to other buyers at a time in the past that no longer exists, whereas auction pricing is more “meaningful” to all parties because it represents the actual current market.
  2. Auctions use resources better. The auction is an extremely efficient use of everyone’s most valuable asset: time. Sellers can complete a deal within a few short weeks, possibly faster. and agents, selling on commission for a living, can move inventory rapidly and get paid more frequently. Auction are focused on the proper goal: selling the home, not marketing it. Nor showing it, staging it, repairing it, or anything else. It also eliminates the “testing the market” ploy by which sellers consume brokerage resources with no real intention to sell at a market-price. In an auction, everyone is focused on closing the deal as efficiently as possible, especially sellers who often pay up-front for the marketing campaign (see below). Auctions work for even more complex transactions than a house sale – like fine works of art -so they make perfect sense for real estate. Taken to a logical conclusion, auctioning homes would eliminate the traditional six or twelve-month listing agreement. What an insane by-product of real estate industry inefficiency! No other traders of commodities – cars, computers, stocks – contractually hopes to hold their inventory for months. The goal with auctions, as broker Tony Jenkins of Harcourts Holmwood in Christchurch, NZ might say is: Next!
  3. Significant cost savings. Much of the U.S. real estate industry’s structure is built around heavy “carrying costs” necessitated by inefficiently-lengthy listing periods. As a result, everyone pays more: Sellers contribute higher percentages of equity to pay for months of marketing and showings. Buyers ultimately pay those costs in their offers. Brokers and agents carry higher operating costs such as time, technology, marketing, fuel, (showings take gas) and so on. Even finance and closing periods are inefficiently long, driving up borrowing and closing costs. It’s little wonder that few brokers turn a profit in classic U.S. real estate – even in good times.With auctions, the costs are reduced for everyone. More importantly, they are laid at the doorstep of the appropriately responsible party. Buyers have been assumed to have previewed and pre-inspected at their own cost, the property before the auction, since they must place an immediate 10% down on their winning bid. Closing occurs faster, since there are no contingencies at auction. The cost savings are passed along to everyone: Sellers – who are aptly called “vendors” – typically pay less in commissions in Australia and New Zealand than their American counterparts. Even brokers and agents turn profits because they have lower length carrying costs. When one third or more of inventory moves monthly, it’s called cash flow, which can be used to finance further investment, expansion, training and technology to drive down costs further. Compare that to the typical “run-up-the-debt-then-pay-it-off-and-back-to-zero” cyclical trap that forces 60% of new agents out of the business within months in the U.S and the advantage seems clear.
  4. Caveat Actor for All. In an auctioning process, everyone has skin in the game. Likewise, moral hazard is placed squarely where it belongs, on sellers and buyers. Price-setting mechanisms rest on the shoulders of only parties who actually bid and pay for what they want. Either can act sanely, or emotionally. Yet neither can blame financiers, inspectors or even their brokers. Buyers spend according to their personal worthiness; lenders assess the consumer’s credit, not the property’s current market value. Sellers frequently pay for marketing services up-front, increasing willingness to act within market forces, not personal agenda. Best of all, auctions let the most-interested parties determine for themselves how much the home is worth at any moment in time.

And in the U.S., that might have meant the moral hazard didn’t rest on one’s neighbors – i.e., the taxpayers left bailing out the bad decisions of so many other parties to whom caveat actor didn’t apply.

It’s likely that there are other benefits of auctioning homes. While Australia and New Zealand have unique factors contributing to the success of the process, auctioning does occurs in some rare segments of land and commercial in the United States today. Yet it remains an exception, not even an option, for most sellers (vendors). The dominant system of “wait and see” selling permitting seller-sided pricing practices results in heavy carrying costs for brokers, with burden and hazard dragging down everyone. At the bottom of most deals in the U.S., there’s barely $170 in profit margin. The system becomes one in which brokers lose money on each deal, but try to make it up in volume. It’s clear there’s not enough equity left in America’s housing to support this system much longer.

Unlike other industries in the modern American economy, real estate costs to have risen not declined over time. Today’s typical commissions remain at much the same percentage as they did two decades ago, despite heavy investment in technology, training and marketing. Somewhere, at the center of the transaction, more effort, knowledge or skill isn’t required. What’s needed is perhaps a better idea – one based upon market forces, not mercantalism. We might even innovate on the approach – applying some EBay technology perhaps – to make it more like apple pie. If America wants to get its housing market out from under water, it might do well to take a lesson from its friends Down Under.

  • Matthew
    this is a very interesting analysis of the auction marketing method – as an advocate of the system here in NZ it worth seeing an “outsiders” view of the benefits – do you think that the US will consider it?

  • I think there are two possibilities: One is that in some markets, it's going to happen as sellers have less equity to part with in traditional sales approaches and the second option is that someone very “innovative” is going to come and introduce it to the public as a very sensible alternative to For-Sale-By-Owner without all the traditional costs…. not to mention the amazing benefits to agents and brokers!

  • I am sure it will be embraced by the industry with as much vigor as a hound dog on a porcupine. The NAR is like a dinosaur that never got the memo and didn't realize it was supposed to be extinct.
    But hey, “it's a great time to buy.”

  • Doug – funny metaphor!! :> One thing I'm noticing around the country is that now is the time for fresh thinking and many in the industry are shedding old thoughts – and old Associations, if you take my meaning – and going forward in new directions. There's always a chance this could be a future avenue of growth for the industry!

  • Matthew,
    One would think that the lending institutions would find this the perfect outlet for all the REO properties they find themselves holding. In fact I'm suprised we don't see the established auctioneers handling more of their real estate.

    Then again there was a public foreclosure auction and the lenders chose at that time to “invest” in the real estate (perhaps re-invest is a better term), rather than let a market driven auction determine the value of the asset they have found themselves saddled with.

  • Tom Gaddis

    Why is it that a group of auction bidders most resembles a pack of circling sharks? The auction is indeed a fine opportunity for buyers…..and auctioneers. Unfortunately, not so for the hapless seller who has consigned his property to sell to the highest momentary bidder. The fine orchestration of “marketing” that we do for the property cannot be for nothing. It is to make sure that the seller gets a fair and decent price out of their propertywhen exposed to the “whole” market. Auction bidders do not constitute the “whole” market. They consist of the few fortunate and informed individuals who have the knowledge and the financial means to buy with confidence by that method. The bulk of residential buyers are people who have no clue how to put together the simultaneous sale of their present property and acquisition of another one. They need help…..lots of help….expert help. And we give it to them. I have no doubt that the RE Business model in the US is going to face a drastic overhaul, but I don't see the traditional auction as the vehicle for it. Real estate negotiations are by nature complex. A simple swing of the gavel just doesnt quite cut it.

  • Hi Tom:
    Thanks for your comments; I'm not sure I agree, but some of it might be a matter of information. For example, sellers do NOT have to sell at the auction if the price does not meet a certain “reserve” or minimum. So they are STILL and ALWAYS in control. Alternately, most sales are MOST in favor of the seller, not the buyer, because a) the emotional competition causes buyers to bid higher and b) the time-to-sell is dramatically reduced – to weeks, rather than months. Auction bidders don't have to constitute the “whole” market – just the market that wants to pay for the home today. Lastly, as for “simultaneous” sale, that's not an issue either – possession/closing usually doesn't happen after an auction “immediately” but within 4-6 weeks – just like a traditional closing. So while I appreciate your concerns, I'm thinking that they are certainly handled by the process….. Hope that helps!

  • Tom Gaddis

    Matt,
    Most of the residential auction sales that I have witnessed have not been what I would consider to be a “success”. A high percentage of the time, I felt that we could have gotten the seller more out of a private sale. That is because there were not many bona fide bidders at the auction, and definitely none that were emotionally charged. They are there to get a bargain. If they can’t get it, they aren’t interested. It is also because ordinary buyers are not comfortable with having to put down a large non-refundable deposit the day of sale, and having to come up with the balance within a few weeks. They are also not comfortable with having to buy a house without having the opportunity to have it inspected or appraised. Under these circumstances, you have to get a real buy on the property for absorbing all the risk. And, it’s bad for the seller when a property is exposed to auction unsuccessfully. It is a very good thing that appraisers are not allowed to use auction sales of repo’s in their appraisals……otherwise our appraisal situation would be far worse than it is. You seem to want to gloss over the technicalities of arranging for the sale of one property while preparing for the purchase of another. This is not an easy thing for the average real estate owner. Usually they depend on their Realtor to make sure everything happens the way it should. Not everyone is a candidate for a “swing loan”. Things have to happen in a certain order, and ordinary people are usually not in a position to make that happen. Saving a few months on market might cost big bucks to the seller, and put them in a position where they couldn’t fill the financial gap with the proceeds of their sale when their auction didn’t produce enough to cover it.
    I wish I lived in a world where the market was so efficient that all properties could sell by auction. It is fast, and it is certain…..if you want to gamble. For those who need more time to maneuver and a safety net, I’m your man.

  • Tom: This is why I highlighted the auction process as used in Australia and New Zealand; it WORKS. First, all of the bidders are “bona fide” because they are pre-registered and they put 10% NONREFUNDABLE down. And their offers are NOT finance-contingent but binding contracts. Also, the property is only SOLD if the “minimum” price set by the seller (and known only to the auctioneer) is met; otherwise the property is held and still marketed. I encourage you not to compare the process to what you HAVE seen in American but consider how it works well for thousands of properties – in some markets more than 60% – in other countries every day. It works; it’s certainly possible the existing American process isn’t yet arranged or capable of doing it “right” yet – but I just spent three weeks with a company in Australia and New Zealand where they sell homes MONTHLY; they get the asking price OR BETTER; they get PAID for marketing up front in a high percentage of cases; they don’t hold properties for MONTHS with all the advertising costs; and agents get paid REGULARLY not periodically like in the U.S. The market IS efficient; it works well and has for years. That’s the idea; not that it can’t work because it “hasn’t” bit because it HAS and does every day.

    I appreciate your comments; thanks for adding to the discussion.

  • Tom: This is why I highlighted the auction process as used in Australia and New Zealand; it WORKS. First, all of the bidders are “bona fide” because they are pre-registered and they put 10% NONREFUNDABLE down. And their offers are NOT finance-contingent but binding contracts. Also, the property is only SOLD if the “minimum” price set by the seller (and known only to the auctioneer) is met; otherwise the property is held and still marketed. I encourage you not to compare the process to what you HAVE seen in American but consider how it works well for thousands of properties – in some markets more than 60% – in other countries every day. It works; it's certainly possible the existing American process isn't yet arranged or capable of doing it “right” yet – but I just spent three weeks with a company in Australia and New Zealand where they sell homes MONTHLY; they get the asking price OR BETTER; they get PAID for marketing up front in a high percentage of cases; they don't hold properties for MONTHS with all the advertising costs; and agents get paid REGULARLY not periodically like in the U.S. The market IS efficient; it works well and has for years. That's the idea; not that it can't work because it “hasn't” bit because it HAS and does every day.

    I appreciate your comments; thanks for adding to the discussion.