How The ‘Auction Effect’ Hurts Property Investors

Q: My wife and I have been trying unsuccessfully to buy a rental property for a while. Do you think we should try bidding at the sheriff sale auction? Dwayne, Leonia, NJ

A: Most people assume that real estate auctions are a great place to buy properties at bargain prices. Auctions are convenient for sure—especially for the seller. Auctions purposely create a feeding-frenzy environment where potential buyers get caught up in a very public, competitive spectacle that ideally for the seller results in the property selling for the highest possible price. The objective of a bank foreclosure sale for example is to create an auction effect. An auction effect occurs when buyers get into a “gotta have it” mindset that can pressure them into paying more than they should or normally would. People who attend an auction normally get very excited because they want to win. For an investor trying to maximize his return on investment, winning at an auction means buying property cheap enough to achieve his desired return. Winning doesn’t mean winning the auction bid—anyone can win the auction bid by increasing their offer price. If you win the auction bid by paying too much, you’ve only won a Pyrrhic victory.

It’s a good idea to attend an auction to see the process before you actually sign up and participate in one. You should set your financial boundaries for each property you plan to bid on at the auction long before you attend. Analyze properties you want to bid on to determine their current market value. Then calculate a price ceiling also known as a maximum allowable offer (MAO) that you are willing to pay for each property before you attend the auction. Preparing before the auction removes much of the emotion from the situation and protects you from getting too excited and overpaying in the heat of the moment. One omnipresent danger that lurks at auctions are other bidders who may be dumb enough to pay too much for a property—compete with these people at your own peril.

Buyers overpay for real estate at auctions all the time. The fundamental problem with auctions is that anybody who attends can win by paying too much—that’s not winning, that’s losing! Thanks for your question, Dwayne.

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