Guest column by Mark Phelan, Cassidy Turley
In today’s commercial real estate market, the three “T”s join the proverbial three “L”s as important elements in the sale of assets. While the old axiom of location, location and location still holds water, timing, timing and timing have become increasingly important, especially for assets that are treading water or have sunk into financial difficulties.
As the credit crisis continues and hangs a dark cloud over many assets, an old-fashioned yet time-proven technique is gaining traction: Auctions for commercial real estate have become more common to move properties in a timely fashion.
Banks currently hold some $176 billion of souring commercial-real-estate loans, according to an estimate by research firm Foresight Analytics. In the first quarter, 9.1 percent of commercial property loans held by banks were delinquent, compared with 7 percent a year earlier and just 1.5 percent in the first quarter of 2007, according to Foresight.
Coupled with this, an estimated $1.4 trillion of commercial real estate debt will mature over the course of the next four to five years. Two-thirds of bank commercial real-estate loans maturing between now and 2014 are underwater, meaning the property is worth less than the loan on it, Foresight data shows.
U.S. commercial-real-estate values remain 42 percent below their October 2007 peak and only slightly above the low they hit in October of 2009, according to Moody’s Investors Service.
Much remains to be seen as the federal government works to ensure such debt can be refinanced without sending further shockwaves into the economy’s recovery efforts. Banks are also working feverishly to restructure loans when possible. In the meantime, though, many sellers are turning to auctions to move properties in a timely manner.
“It’s a confusing time in the marketplace,” says Zane Fry, an associate broker in Cassidy Turley’s Columbus, Ohio, office. “Comparables are down so you often have a difficult time putting a fair price on a property.”
Auctions help establish a fair valuation, Fry notes.
Auctions are by no means a new way to sell assets. They’ve been used since the Mayflower landed in the United States, and date back to the Romans. In fact, many other asset classes – agricultural land and used cars sold to dealers, for example – use auctions as much as traditional sales methods.
In the late 1980s when the S&Ls failed, the auction method was utilized to dispose of the real estate assets of lenders. During the next 20 years, auctions primarily were utilized in distressed situations but also for specialty properties – difficult-to-value assets or assets that might be considered very desirable. In these situations, the value of the asset was in question. In order to get the highest price, the auction was used.
In the distressed asset market, the same general principal of trying to get the best price applies. However, generally speaking the auction is being used not because the asset is highly desired but because there is no other way to get rid of it.
Commercial real estate has seen increasing interest in this method over the past several years. Between 2003 and 2008, auctions for commercial properties increased more than 30 percent from $11.8 billion in 2003 to $15.5 billion in 2008, according to the National Auctioneers Association.
Part of the growing interest today centers on market volatility and distressed assets. While sellers still want the best price, it has become more difficult to determine this. Sellers also are starting to realize that asset value today may be higher than the value of the same asset tomorrow. Obtaining market value quickly is beneficial rather than risking decline by holding the property longer or taking the time and risk of selling it in the general brokerage model.
Besides the risk of market decline, holding costs can further diminish the overall sales price, says Tom McGarity, a senior vice president in Cassidy Turley’s Columbus office. “Insurance, utilities and taxes are hard costs that sellers must continue to pay each day they own the property. They also must cover any further deterioration in the property – roof, parking lot, plumbing and more – and vandalism is a major concern, especially for vacant properties.”
McGarity has used the auction route for three properties, including one that was highly desirable. “This gave us the opportunity to get several people involved immediately. You create a sense of urgency,” he said.
That’s particularly important with properties that are distressed, McGarity adds. The auction method establishes both a set time frame and control over the sales process for the seller. Buyers often look at auctions as a value play, as well.
In today’s market, properties may face many challenges: financing, valuation and lack of comparable sales. These concerns often favor the auction method by giving more control to the seller, McGarity says. The auction process allows sellers to:
• Time the sale, typically 30 to 90 days.
• Structure the offering.
• Set all conditions in advance so there are no negotiations.
• Sell the property with no contingencies, including property on an as-is, where-is basis with no or limited warranties.
• Pre-qualify buyers, especially on financing.
• Receive multiple offers before and during the auction.
• Realize the property’s true market value, with no limit to upside potential.
• Some of the transaction costs also may be offset with a buyer’s premium, which can range from 3 percent to 10 percent of the bid price.
• Usually close within 30 to 45 days from date contract is signed.
The expedited process looms as a huge advantage for sellers, Fry says.
“In today’s environment, days on the market continue to increase for many properties. This process really breaks that barrier down. If you’re the seller, you have the ability to get rid of the property,” Fry says. “You know exactly when you’ll be out of the asset.”
“If you’re the buyer, you go to an open forum and the market decides what the property is worth,” McGarity notes. In fact, bids for the three properties that he helped auction all fell within a tight range.
Finding The Right Fit
Despite its advantages, sellers need to determine if the auction method is suitable for their asset or assets. A sense of urgency certainly is a crucial factor in determining if a seller’s property is a good fit.
A local broker also can play a big role in helping determine a property’s suitability for auction. Local market conditions vary greatly and by product sector. As an example, office buildings that may be ripe for auction in one city may not be the best approach in another city.
Many brokers also are engaging the expertise of auction professionals who specialize in commercial real estate. Auctioning commercial real estate is far different from residential real estate and agricultural land. Sellers should check the credentials and experience of the selected auction professional.
“This really is the best of both worlds,” Fry notes. “The seller receives the expertise of a professional auction company well-versed in commercial real estate and marketing such properties locally and nationally. As brokers, we understand the local market – its property sectors, conditions, competitive product and more. We also put together the sales package, hold open houses and provide tours of the property for interested bidders.”
Understanding The Risks
The auction process doesn’t come without some risks.
Buyers must accept the property on as-is, where-is basis typically without any warranty or limited warranties. The buyer also puts up a non-refundable deposit. The old caveat holds true: Let the buyer beware. This requires careful due diligence before the auction. Once the contract is signed, buyers lose their deposit if they fail to close.
A seller must pay for the upfront marketing costs. These funds allow an accelerated marketing and public relations campaign to promote the property and auction. Costs vary on this, running from $5,000 to $20,000, McGarity says, or between 0.5 percent and 1.5 percent of the property’s value. This expense also may be shared when a number of sellers with small properties can be combined into multi-property, multi-owner auctions.
The sellers’ risk then is that they may not be willing to accept what the market is going to tell them via the bids on auction day. If the property is offered with a reserve or minimum price, the seller is only risking their marketing funds. If the property is offered without reserve or “absolute,” then the seller risks the marketing money and is obligated to accept the highest price on auction day regardless of the bid level.
All things considered, though, auctions may be the best option to sell a property on a timely basis and to find its true market value in today’s challenging environment. It comes down to the three Ts in today’s commercial real estate market – timing, timing and timing.
Mark Phelan is managing principal of Cassidy Turley’s Columbus, Ohio, office. He can be reached at 614-827-1896 or by e-mail at firstname.lastname@example.org.
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