In dissecting the real estate and liquidity collapse of the last twelve months, the media has focused almost exclusively on the residential arena, where admittedly the pain stretches “from sea to shining sea.” But commercial real estate buyers also took advantage of the era of soft lending, and in most states the number of foreclosures are heading higher. Eager to find the most efficient way to get bad debt off their books, according to a recent article in The Wall Street Journal, banks are turning increasingly to auctions for unloading their commercial properties.
Whereas most residential properties, if auctioned, are sold on site with bidders present and competing openly against one another—the quaint term for this is “public outcry”—commercial properties are often handled by sealed bid, and for several compelling reasons.
First, commercial real estate is mostly about income and cap rates and appreciation. Because you don’t have to invest where you live, banks will cast their nets far and wide for suitable buyers, and not depend on local traffic. Many commercial real estate buyers don’t even bother with a visit to the prospective property. A bank, or commercial real estate auction broker (many of them operating exclusively online) will send out photos and information along with a deadline for submitting a bid.
Second, the highest bid does not necessarily determine the most suitable buyer, if the bid has contingencies. A commercial property, which can be as varied as a half empty apartment complex, waste disposal site, race track, or an investor’s entire real estate portfolio, requires of potential buyers serious due diligence, from reviewing rent rolls and tenants’ credit histories for an apartment building, to environmental issues for a landfill, to researching tax liens on abandoned property. A detailed and knowledgeable bid from a buyer who’s completed his due diligence and has his financing in line is more desirable than a shoot-from-the-hip offer. Buyers submitting a bid with complicated contingencies will be ignored or asked to resubmit with a cleaner offer.
Third, not all commercial real estate auctions are brick and mortar. According to the WSJ article, auctions also work well for contractual agreements such as secured mortgages and leases. As more commercial mortgages underperform, banks are happy to sell the notes at auction, a quick, efficient way to get them off their balance sheets without incurring the cost of foreclosure. However, because the debt may require a “structured workout,” (restructuring a nonperforming loan in order to extract as much money as possible) a bidder can present a lender with several options correlated to the discount he seeks on the note.
Sometimes banks and auction companies will combine the sealed bidding process with an “outcry” auction—putting the top bidders in the same room and encouraging a final round—particularly if the property is highly desirable. While the number of “Monets” and “Pollacks” are relatively few, the majority of auctioned properties still present compelling opportunities for astute buyers, many of whom are looking for replacement properties in a 1031 tax-deferred transaction. The beauty is all in the numbers.
