How Does a Real Estate Auction Work?
Properties that are under market value most often have a distressed seller. This can mean they are about to be foreclosed on, or are behind on taxes, or are owned by someone who has recently lost their job or has become ill and wants to downsize their expenses, or an heir to a property who wants to unload it quickly. Often these homes are sold at auctions.
How do properties end up at auctions?
Although the majority of the properties sold at auctions are foreclosures owned by banks or have unpaid property tax, some can also end up in auctions for other reasons. Another reason might be the liquidation of a jointly held mortgaged property when one of the co-owners wants to force a sale of a property so that they can obtain their share of the value. This is called a “Partition Action.”
For example, if two children inherit a property and no other way of partitioning the property was agreed upon or found, such as one child buys out the other’s share of the property, then the property could be forced into a sale even if not all owners want to sell it. Also short sales, commercial properties, and non-distressed homes may be available at some auctions.
Tax Lien Sales and Tax Deed Sales
When you purchase a tax lien, you are just buying the lien and not the property. Tax liens come with fixed interest rates that are fairly high.
If a property tax lien is being auctioned for back taxes, it’s sold at a tax lien sale to the bidder who offers the lowest bid (for the interest rate) above the price requirement. In other words, the auction works in a reverse style with bidders bidding downward from a set starting rate. These bidders are competing for a tax lien certificate, at a price the covers the tax debt plus interest owed to the government, not the price for the property.
So the winning bidder will be the one who has offered the highest interest rate. These sales can offer new investors an opportunity to get started with little capital. In fact, some tax lien certificates can be purchased for just a few hundred dollars.
The money from the winning bid goes to the tax collector to pay off the unpaid taxes, and the lien transfers to the property investor who placed the winning bid. At this point, the investor owns the liens and has the legal right to collect the amount of the liens from the homeowner, plus a fixed interest rate set during the auction process. The buyer expects to make money from the interest and any penalties owed.
If the homeowner pays off these liens in the allotted time, then the homeowner keeps the property. If the homeowner pays back the debt plus interest, this amount will be paid to the investor in one lump sum. The investor does not receive individual payments made by the homeowner, and it can take years to receive this payment. There is a secondary market for these liens, but there’s no guarantee an investor could unload them if they needed to recoup their money before the loan is paid off.
Additionally, tax lien sales are not without risk. Not only could a lien buyer lose their investment, but they could end up with a property they don’t want if it goes to a tax deed sale and no one else bids on it. This might sound good, but it could also mean extra expenses such as upkeep and property taxes, or even ending up with a huge liability if the property has environmental issues that require hazardous material abatement.
It’s also important to note that a tax lien purchase is not a passive investment. There are specific requirements and a timeline for the buyer to follow, including sending all required notifications to the property owner after receiving a tax lien certificate.
If the property owner defaults on the lien debt, the lien holder has a right to foreclose on the property after the redemption periods have expired. There is a specific process that MUST be followed!
If the lien holder becomes the owner of the property after a default on the lien and the foreclosure process, there may be many hidden extra costs, such as other liens, that they will need to pay in addition to maintenance and repairs. They may even have to pay an attorney to evict the occupants.
In contrast, at a tax deed sale, the government has already become the property owner and is auctioning the property itself to the highest bidder. Typically properties sold at tax deed sales sell at prices significantly below their property value because the minimum bid is only set at the outstanding tax debt plus interest and fees, including fees related to selling the property. This makes properties at tax deed sales an attractive option for flippers as long as there isn’t so much completion that the price becomes too high during the bidding process.
However, tax deed sales also are not without risk to bidders. Typically no properties can be inspected or toured before the sale, and there may be many liens on the properties that create large and unexpected expenses, as well as preventing a resale without paying them off. There may also be a lengthy redemption period allowed in some states for the homeowner after the sale. During this time, the homeowner would need to pay the winning bidder their bid amount plus interest to redeem ownership of their property.
Although these auctions come with risk, they can provide an investor with either; 1) interest payments if the homeowner pays off the lien, or 2) a discounted property.
State customs for tax sales differ, for example Connecticut has tax deed sales instead of tax lien certificate sales. No advice, legal or otherwise, will be given by the auction company or government entity holding the auction, therefore it’s necessary for first time bidders to be prepared and understand all the details of the process and ramifications of their potential purchase.
It’s generally advised, at least for new investors, to avoid purchasing tax liens for properties with major environmental issues that require specific abatement practices, such as buried gas tanks, significant amounts of asbestos, or other toxic waste.
What types of properties are sold at auctions?
Single family homes, multi-family homes, apartment complexes, mixed-use buildings, and commercial properties may be sold at auctions.
What types of property auction formats are there?
Absolute Auction
No matter what the price, the property is sold to the highest bidder.
Reserve Auction
The seller receives the highest bidder as an offer and can accept or reject it.
Minimum Bid Auction
The seller only accepts a bid that is higher than a set minimum price.
Lender Confirmation Auction
A sale to the highest bidder on a foreclosed property is completed only after the lender has accepted the offer. In this type of auction the lender sets a minimum bid. The homeowner does not play a role in approving this amount because the foreclosure process has already started and the property is usually already vacant.
Check out some other important auction related terms to be familiar with in this article:
Where can I find property auctions listed?
Online Search
Many auctions are now conducted online, but be sure to do your research to make sure it’s a reputable auction.
County Courthouse
A list of upcoming local real estate auctions can be found at county courthouses.
Newspaper Listings
Many foreclosures are still listed by auction companies in the classified section of newspapers.
Networking with People in the Industry
Real estate brokers, investors, real estate attorneys, home appraisers, property managers, or other people working in the industry may hear of properties that will be auctioned.
Are in-person or online auctions better?
Online auctions have become more popular of late, but live auctions are still available, often at county courthouses They can also take place either at the property or at another venue determined by the auction company conducting the sales, such as a hotel ballroom. At larger in-person auctions, hundreds of properties may be auctioned in a single day. Not everyone is comfortable with making such large online purchases, and in-person auctions conducted by known, local entities, such as a county sheriff or local bank, eliminate any worry about scams that you may have with online auctions.
Online auctions, however, have some convenient advantages. Some will give you thirty days to close, and you can purchase properties anywhere in the country just by sitting in front of your computer. Many offer more types of properties in their listings than you might find going to a single in-person auction. Also, they may have lower fees. Often online auctions also have step-by-step instructions for first-time buyers that in-person auctions do not offer.
Remember to do a thorough check of the auction before you participate or give anyone your money or personal information! Don’t let scammers take your money!
When doing your research to find a good auction, choose a highly reputable company, and be sure you understand what type of auction you are going to be attending so you know if you are purchasing a tax lien or a foreclosure.
How do you prepare before attending an auction?
Before attending any auction you will likely need to register and secure your financing. You may need to provide a credit card or a deposit. Bring a government ID to the auction, such as a driver’s license or passport.
If you win a bid but do not close the deal, you will be charged a fee, so ask how much this fee will be before you bid. Most auctions require cash transactions, (or cashier’s check), which means you must pay the balance immediately or within a very short time frame after the auction and will not be able to obtain a mortgage on the property. However, if you secure a loan before purchasing the property and have access to cash from that loan, that is another option.
You will also want to check out any properties you want to bid on since you won’t get another chance to do so before you bid at the auction. Often you will not be able to tour the property, but in some cases there are open houses or virtual tours available before the auction. Some properties are posted well in advance, whereas others may only be posted hours before they are auctioned.
A good way to learn about auctions is to register and attend local auctions in person, where you can observe experienced investors and the way everything works. Some auctions have minimum bid increments, for example, so you would not be able to just bid one cent more than the last bid, for example. Also, if you win a bid, you do not typically obtain the title to the property right away. The lender (or other seller) must first approve your bid then arrange a closing, and this process can take several weeks.
Online auctions are another good way to learn by practicing with pretend bids and estimating repairs and other expenses on particular properties listed for sale.
You can also seek out attorneys, real estate brokers, appraisers, or investors familiar with auctions to ask for advice before you decide to purchase a property at an auction so you understand all of the legal issues and your rights and financial obligations. It’s important to understand the specific type of auction process in detail before you make a bid.
Since laws vary by state, some states may allow buyers to purchase title insurance, and some have redemption periods for the homeowner who is being foreclosed on that can stretch as long as six months.
If you plan to bid on properties under a company name or entity such as a trust or LLC, then you will need to have this documentation ready to provide to the auction. If you don’t provide the proper documentation, then you would need to purchase the property as an individual then move it to the entity you wish to hold it under. This may be a problem legally or for your personal and business taxes, so consult an attorney before you make a decision about how to purchase the property, and if your proof of funds are in the entity’s name instead of your personal name, the auction may not allow you to bid on it.
When attending an auction in person, you will want to confirm the auction time and location before you go because they are often postponed or canceled. They may even be canceled the day of the auction. This can happen for many reasons. The property owner might have managed to bring their payments up to date with the lender or obtained a loan modification, there may have been a short sale, or the bank may not have gathered the necessary paperwork in time.
Continue reading about how to do your due diligence before making a purchase at an auction in Part 2:
How Does a Real Estate Auction Work Part 2
How Does a Real Estate Auction Work Part 2:Opportunities for Investors