My seller wants me to consider selling a property through an auction. What are some of the considerations?
Last month’s article identified some of the major issues associated with an auction and defined some auction terminology. Among those issues are whether the auction is “absolute,” “subject to seller confirmation,” or “hybrid” with a minimum bid. Will buyers be charged a “buyer’s premium?” If the auction broker compensates brokers who procure buyers, will there be any special procuring cause guidelines? This month’s article addresses the documentation needed to conduct a successful auction and identifies some of the disadvantages of auctions. There are no Colorado Real Estate Commission-approved auction forms. An attorney for either the seller or the broker must prepare the auction documents. Any broker interested in auctions should review the Real Estate Commission’s Position on Auctioning as neither part of this article repeats the information contained therein.
Listing Agreement. The listing agreement should not only specify that the broker will sell the property through an auction, but it should address the auction issues mentioned above. If the auction is hybrid, what is the minimum bid? Is there a buyer’s premium? If there is a buyer’s premium, what is the amount? Among other things, the listing agreement can also address the terms for sale (see below), any special procuring cause guidelines, pre-auction showing dates, the treatment of marketing expenses if the property doesn’t sell and the issues discussed below.
Auction Agreement. Before receiving a bid number, potential bidders should agree to the type of the auction (See part one of this article.). In addition to addressing the type of auction, it is critical for the auction agreement to address the terms of the contract between the highest bidder and the seller. Perhaps the best means to address all of the sale terms is to reference and attach a pro forma copy of the Sales Contract to the Auction Agreement. Most Auction Agreements require bidders to appear with good funds in some specified amount, where those good funds are intended to apply to the high bidder’s earnest money.
Sales Contract. The mechanics of an auction allows a seller to fill in two blanks in the sales contract: the identify of the buyer and the amount of the sales price. The seller and bidders should commit to all the other terms of the contract before the bidding begins. For example, what is the amount of the earnest money? When is closing? Is the buyer taking the property subject to the lease rights of any tenants? When is the possession date? Is there a mediation clause? Is there a broker interpleader clause? If the buyer defaults, does the seller have the remedy of specific performance, damages, both or the remedy of keeping the buyers earnest money? The list goes on. As stated above, the best way of addressing these issues is to attach a pro forma copy of the sales contract to the Auction Agreement signed by all bidders.
Perhaps the important issues are what buyer contingencies, if any, will remain. One of the ideas of auctions are that they are supposed to create finality for a seller. In part, this finality may offset the risk the seller takes that the auction process may produce a price less than the fair market value of the property. While a seller could choose otherwise, it is unusual for auction sales contracts to contain financing or appraisal contingencies.
The Colorado Real Estate Commission title contingency provides a buyer a wide-open “out” to terminate the contract based upon the buyer’s title dissatisfaction. The inter-workings of § 7 and § 8 of the Commission’s form do not fit auctions. Yet the auction seller should have some obligation to deliver good title to the highest bidder. There are a variety of ways of balancing the title considerations between a buyer and a seller.
Will the sales contract have a general due diligence contingency similar to § 10 of the Real Estate Commission’s form? While the absence of such a contingency creates more finality for a seller, it also creates extra risk for buyers. Buyers can cope with this extra risk by bidding less than they otherwise would, or by having the property inspected before the auction begins. The former solution has obvious disadvantages for the seller. The latter solution requires all of the potential buyers, rather than the one successful buyer, to thoroughly inspect the property before the bidding begins. Sometimes sellers have a reputable property inspector provide an inspection report for buyers to reply upon. This solution has disadvantages if the report turns out to be wrong.
Backup Sales Contract. Regardless of whether the sales contract has any contingencies, the highest bidder/buyer may default. Buyer contingencies enhance the likelihood that the contract will not close. The seller should consider signing the second highest bidder up to a back up contract.
Agreement with Auctioneer. While brokers are charged with overseeing the auction process, many brokers will chose to use someone else as the auctioneer or “crier” who oversees the actual auction event. The rights and obligations among the broker, seller and auctioneer should be addressed in the auction paperwork.
The competition of buyers fighting for an auction property is supposed to drive the sales price above the price fetched by more conventional marketing. To the extent an auction is an “as is/buyer beware/final” deal, it either requires buyers to accept higher risk than they would accept in a more conventional deal, or it requires buyers to do extensive due diligence before the buyer knows the buyer has a contract to purchase the property. Either way, the auction process will tend to discourage certain types of buyers. Those buyers who remain will expect an offset for their higher risk. For the time being, auctions may work best with well known, high end, high profile properties, or properties where the condition of the improvements on the property is less important (such as “handyman specials,” scrapers and vacant land transactions.) Like with any new area, Brokers should proceed with caution until they gain experience with auctions.
A version of this article appeared in the Colorado REALTOR® News, the monthly publication of the Colorado Association of REALTORS®.