Stuart Gruendl began developing Eight Orchids in the fourth quarter of 2005—when the market was still booming. At the time, it seemed like a great condo project, one with the right mix of location and demand. Geared to the area's large Asian-American population, it is the only high-rise in the Chinatown section of Oakland, Calif. But by the time pre-sales began in June 2007, the home buying market had already begun to tank—leaving Gruendl faced with a scenario that would make any developer nauseated. Despite steady traffic at the 157-unit site, he had sold only 21 units.
With Eight Orchids' grand opening r rapidly approaching, Gruendl, founding partner of Oakland-based BayRock Residential, discovered that one of his competitors was planning an auction at a property half a mile away. So he made a bold move. As part of his March grand opening, he chose to auction off 41 units in the building.
“The pre-sales are nonexistent,” Gruendl said a week before his auction. “We're doing two times to three times the traffic in a normalized pattern. I believe I've got pent-up demand, and I think the auction is the right event to drive that traffic to the table and do deals.”
Gruendl's foray into the auction business proved to be the right strategy. The auction lured 183 bidders, and Gruendl reports selling all 41 units at 93 percent of his last asking price. But that might be the best part. “We sold most of the inferior units, leaving 95; we essentially sold the dogs,” he says. Since then, another 12 units have been sold.
What's more, Gruendl now has up-to-date comps to help sell the remaining units. He also has a fresh list of more than 2,500 people to whom he can market these units over the next six months. “We feel like were going to gain traction [in pricing] because now we're left with premium units,” he says.
Unlike many of his colleagues around the country, Gruendl didn't use the auction as a last-gasp attempt to keep his business above water. Though they are often used as a way to get rid of excess units in a hurry, auctions can also generate excitement around a property that has stagnant sales. Still, there's a lot to consider before calling up your local auction company. Before you do decide to take to the field and risk the auction game, experts say there's a definite path you must follow to achieve success.
STAGE 1 Know the players—and the game.
Condo developers andand converters who putut their units on the market are not alone in making the decision—there is often a lender helping to make that call.
“Today, there is good communication betweenn lenders and borrowers,” says Frank Diliberto, president and CEO of Inland Real Estate Auctions in Oak Brook, Ill. “They're always talking and meeting about exit strategies, but we're not seeing a tremendous amount of lender activity yet.”
Right now, many lenders are doing everything in their power to keep their builders affloat. But there's potential for a lot of real estate, including single-family, townhome, and condo projects, to boomerang back to them.
“Many of the lenders have been extending loan periods to try to give developers and condo converters additional time to make sales, especially in markets such as Florida and Phoenix.” says Jack McCabe, CEO and managing partner of McCabe Research & Consulting in Deerfield Beach, Fla.
But if things continue to sour, condo developers may not be able to make any payments. Then, the banks will begin cutting off life support. “As soon as [developers] are out of money, they won't have a say,” says Ken Stevens, co-founder and West Coast partner for Boston and San Francisco-based Accelerated Marketing Partners, a firm that specializes in the sale of real estate. “They'll hand the keys back to the bank.”
But the banks can't really hold onto the condos for long, either. For one thing, banks aren't equipped to hold large real estate portfolios. “The banks are being inundated with real estate,” says Robert Roggeveen, president of Auction Services Group in Chicago. “When they take property on REO [real estate owned], they have to include it in loan loss reserves.”
Even if the banks want to hold onto foreclosed real estate, there's speculation that federal regulators wouldn't allow them to do so. That's another incentive to auction off foreclosed real estate. “Their [lenders'] books keep getting bigger and bigger with REO properties and no accrual loans,” McCabe says. “Examiners will tell them they can't do business until they move them off their book. That's when we'll see the real flood gates open.”
Once that does happen, there's a feeling among most—especially those who lived through the real estate downturn of the early '90s—that lenders will put a lot of these units on the auction block. “It's probably going to get to the point where the bank will be hiring the auction company, not the developer,” says Dan Gumbiner, president and CEO of Orion Residential, a multifamily investment firm based in Chicago. “I think you're starting see that pop up around the country.”
STAGE 2 Make a decision, for better or worse.
Unfortunately, some developers and builders have been forced to auction units. One of those people was Ken Neumann, CEO and owner of Warrenville, Ill.-based Neumann Homes. Although Neumann made his mark in single-family homes, he also built for-sale multifamily product. In November 2006, soon after the ill-fated purchase of Tadian Homes in Detroit, Neumann auctioned off 23 single-family homes, 24 condos, and 40 home sites at about 80 percent of list price.
In late July 2007, Neumann was back at the auction block in Detroit shedding the last of his inventory in struggling Motor City. A little less than three months later, he declared bankruptcy.
“It's not uncommon for someone to use an auction to save themselves as a last-ditch effort,” Stevens says. “All you're doing is throwing a raft at someone who has already drowned.”
More developers are choosing not to wait for their bank to force an auction, though. Gruendl didn't have any pressure from his lender. Gumbiner says the same thing. After seeing one of the competitors to his EOS Twenty-One project, a 344-unit condo conversion in Alexandria, Va., hold a successful auction last fall, he decided it was time to follow suit this past March.
“We had no debt on the property and no lender pressure,” Gumbiner says. “[The auction] was purely a means to reintroduce the property, create some excitement for it, and offer a chance to jump start closing out the project.”
Gruendl, too, looked at auctions as both a marketing tool and a way to set accurate prices for the units. “There was no pressure,” he says. “We [had] standing inventory. Rather than write interest checks, we wanted to move units. I'm going to throw away some margin, but I'm going to book sales, pay off debt, and put some money in our pocket.”
If developers don't move early, they can continue to sell into a stagnant market. Or they could rent their units. Gumbiner pursued that route at his La Terraza property in Phoenix.
“Given the location and quality, we think our best interests are served as a rental,” Gumbiner says. “In Phoenix, an auction symbolizes deep distress and the need to liquidate on a forced basis.”
As such, converting to a rental was the wiser choice. If a developer thinks the condo market will come back in the near future—or they can tap into a solid revenue stream by renting—they won't plan an auction.
STAGE 3 Set a game plan, and stick to it.
Once you've committed to an auction—whether with your lender's gentle nudge or as a marketing tactic—the process is critical. First, you must decide on a timeline.
If he had waited longer to auction his units, Gumbiner doesn't think he would have been as successful. “We didn't want to be the fifth, sixth, or seventh guy because the market has limited depth, especially at the price points we were targeting,” he says. “We took a long hard look and tried to get out as quickly as we could relative to any other project in our immediate vicinity inside the beltway for the first time home buyer.”
Then there's picking an auction partner. Gruendl interviewed a number of auction firms. He says their approaches varied—some gave professional presentations, while one national firm took no time to study his market and came in with numbers written on a yellow, 8-1/2-by-11-inch piece of paper. (For more information on five reputable auction houses, see “On the Block” on page 52.)
“We selected the auction company that did their homework and understood the market,” Gruendl says. “They tried to understand the market better than we did. Everything in their world becomes [about] driving traffic and pre-registration.”
Once the partnership is sealed, the auction company and developer must decide whether to have an absolute auction or a minimum-reserve auction. In an absolute auction, the unit goes to the highest bidder, no matter what the bid; in a minimum-reserve auction, the buyer has to meet or exceed a minimum bid.
In general, developers who aren't under the gun prefer a minimum-reserve auction in order to retain control over the price they get. That makes setting the minimum bid price pivotal. Conventional wisdom would dictate that developers go with the highest minimum bid possible, but Gruendl says that shouldn't be the case. He set his at 60 percent of the last asking price for a particular unit. During pre-sales, times were better, and the units were selling at $450 per square foot. During the auction, he got $370 per square foot, and afterward, he pushed it to $400 per square foot.
“You have to be aggressive on minimum bids so that you can drive velocity,” Gruendl says. “The incremental increases were less or flatter when we had a higher minimum bid. The gross results were higher with lower minimum bid.”
Some auction houses recommend setting the –price at a level that will attract investors. “If they can break even and can carry through as a rental, then they'll hang on for five to eight years, they'll accumulate wealth, they'll sell them, and they'll make a lot of money,” says Stephen Karbelk, vice president of premiere properties for Williams & Williams Worldwide Real Estate Auction, a large residential auction firm based in Tulsa, Okla.
Gumbiner disagrees. “We set minimums that were intended to attract those who wanted quality, affordable for-sale housing,” he says. “We wanted owner occupants.”
Finally, developers must determine the exact number of units that should go on the market. Gruendl put less than half of his units on the block. Gumbiner didn't go all out either, putting only 23 of the units on the block; he sold 20 at 20 percent of his last asking price for them. At the EOS auction, units sold for $224 per square foot. Beforehand, they were going for $259 per square foot.
“The idea is try to balance the market between the buyer and seller by not offering too many units,” Karbelk says. “You get concerned about saturating the market.”
Regardless of whether you want to shed excess inventory or you're looking for a life raft, condo auctions are only likely to grow in the next year or two. “I think its going to take a good couple of years to clear out inventory,” Stevens says.
And in markets such as Miami, McCabe says the worst is yet to come. So far, he has seen a limited number of conversions hit the auction block, but as more new developments reach completion over the next year, he expects the pace of auctions to increase significantly. Add that to the banks that will either force their developers to auction or just take over properties and auction them themselves, and it's pretty obvious we'll see more auctions over the next 12 to 24 months.
That may not be a bad thing, McCabe says. “You can make the point that the auctions serve a healthy purpose in that they may help in determining where the bottom lies in many markets,” he says. And, once people determine where the pit ends, only then can the recovery begin.
BUYER'S REMORSE Take care when dealing with existing condo owners at a project with units slated for auction.
Say you bought a condo a year ago. You open the paper and see that your developer is now auctioning off the remaining unsold units in your complex for a fraction of the price you paid. You wouldn't be happy.
“An “An auction drives down all of thea pric prices for the people remaining,” says Jack McCabe, CEO and managing partner of McCabe Research & Consulting in Deerfield Beach, Fla. “In many cases, they're losing downpayments, and they're upside-down in the units—their mortgage am amount is greater than what their their u unit is now valued at.” Stuart Gruendl, founding partner of Oakland, Calif.-based BayRock Residential, recognized the potential for disaster during an auction at his Eight Orchids condo project. So he chose “to t take care of existing residents.” The first step? Convince them that units sitting empty wouldn't help their property values. He relied on his auction company to help educate the existing owners.
“The auction company walked them through the process,” Gruendl says. “They tell them how having sales velocity and residents here will support their values.”
Gruendl says the strategy worked. He received no negative responses from the 20 pre-sold units in Eight Orchids during the auction. Dan Gumbiner, president and CEO of Orion Residential, a multifamily firm based in Chicago, had a similar experience with his auction of EOS Twenty-One, a conversion in Alexandria, Va.
“The auction company did a nice job of contacting all of the residents with a letter [and] explaining the process,” Gumbiner says. “They held a series of meetings [and] explained that having people who would be owners would have a positive impact on value rather than having empty units and investors who would eventually rent at lower rates.”
But in the long run, despite lots of educational outreach, existing owners must realize the realities of today's real estate market. “Most people understand the market today is not what it was two years ago,” Gumbiner says.
STEP BY STEP Looking to auction off units in your stagnant condo project? It can work, but keep these thoughts in mind before you jump in.
- Find a reputable auction company. You need to know the track record of the company you choose, as well as their market expertise. Make sure they've worked with companies in your situation. “I would be very careful and very diligent about who your auction company is,” says Dan Gumbiner, president and CEO of Orion Residential, a multifamily firm based in Chicago.
- Hold your ground. The auction company's job is to help determine the right auction price, but Gumbiner cautions that it shouldn't get full power. “Make sure you have absolute, total control over what happens that day,” Gumbiner says.
- Know the market. To determine how many units you're going to put on the block and at what price, you need to know what's happening in your submarket. “You need to understand the depth of your market and try to figure out where your product fits in,” Gumbiner says.
- Enlist the reserves. The auction company will put effort into marketing your product, but Gumbiner says you can't rest on its laurels. “You need to have your top salespeople on the site,” he says. “You want your best people involved in the process.”
- Lead the way. If the market worsens, more companies are likely to pursue auctions. If an auction hasn't happened yet in your market, try to be the first. “The key to doing this [our auction] was to be first in the submarket because so many people are going to be doing this soon,” says Stuart Gruendl, founding partner of Oakland, Calif.-based BayRock Residential, a multifamily investment firm.
ON THE BLOCK Have a troubled condo project and need to pick up the sales process? An auction is a good way to go, but you'll need to find a reputable auction company. Here are five firms with experience in residential real estate.
1 Accelerated Marketing Partners Headquarters: Boston, San Francisco
Top Executive: Jon Gollinger and Ken Stevens, co-founders & co-CEOs
Contact info: 617-523-6100 or 925-362-1442
www.acceleratedmp.com
2 Auction Services Group Headquarters: Chicago
Top Executive: Robert Roggeveen, president
Contact info: 312-223-8331
3 Inland Real Estate Auctions Headquarters: Oak Brook, Ill.
Top Executive: Frank Diliberto, president & CEO
Contact info: 630-990-5353
www.inlandgroup.com/ireac
4 Sheldon Good & Company International Headquarters: Chicago
Top Executive: Steven L. Good, chairman & CEO
Contact info: 800-962-0931
www.sheldongood.com
5 Williams & Williams Worldwide Real Estate Auction Headquarters: Tulsa, Okla.
Top Executive: Dean C. Williams, chairman & CEO
Contact info: 800-801-8003
www.williamsauction.com