REQUIRED READING: Many servicers are gearing up for the inevitable second wave of foreclosures by hiring additional staff and implementing new systems and real estate owned (REO) processes. With the anticipated high volumes of properties clogging REO departments and retail real estate channels, both large and small servicing shops are incorporating auctions into their disposition strategies.
This article aims to explain the pre-auction process, alerting REO managers to the pitfalls that might slow down an otherwise fast-track exit.
Most auctions begin with a tape, which is essentially a spreadsheet of the properties being committed to an upcoming auction event with a variety of fields describing everything from property address to bed/bath count to delinquent property taxes. The auction company relies on the completeness and accuracy of this tape, so it is essential that it is reviewed by the servicing company's staff prior to submission.
If a tape shows the property as 123 W. Main St. when it is actually 123 E. Main St., it is far better to catch the error right away as opposed to on auction day. There are many instances where a simple error that is not corrected prior to the inception of the marketing campaign will ultimately result in the property's being pulled from the auction altogether, because it will not receive the proper exposure, or to avoid any claims of misrepresentation. The real cost is up to four weeks of downtime for a property the servicer was anxious to move.
Because auctions have the ability to deal with volumes in the tens, hundreds or even thousands of properties, transmitting property information in electronic format is the key to reducing the chance for errors. Most auction companies will provide a list of minimum fields that they require to enter your properties into their system.
While the auction company is utilizing a servicer's tape to upload properties to its Web site and prepare the auction-day catalog, the servicer should be initiating a handoff from its existing listing broker, who will be a critical component in the auction process. Many servicers' policies dictate that a property receive 90 days of retail marketing prior to going to auction. On the 91st day, the broker should know why the servicer is calling. Surprised brokers can become uncooperative brokers, which, in the fast-paced world of an auction, can really slow down the process with unreturned phone calls, unanswered questions or incomplete reports.
Listing agents are typically retained through the pre-auction phase to update Multiple Listing Service listings, complete an agent's visual inspection, provide digital photographs, help coordinate and staff open houses, and place auction-day signage, as well as for property-preservation tasks. Servicers must ensure their brokers all understand where auctions fit into the servicing company's disposition strategy so that they know exactly what to expect and what will be expected from them.
These days, many of the horror stories in the REO world come from the title reports. From assignments that go nowhere to mechanics liens, there are many factors that can put the brakes on a quick close. Due to the fast pace of marketing and closing, it is not a good idea to find out about a $3,000 municipal lien for sewer charges while the property is in escrow.
Many title-related issues can take time to resolve, and depending on what the issue is, the property may need to be pulled from an upcoming event, considering that most properties are warranted to be transferred free and clear. It is a great idea to run a preliminary title search on each property that is committed to an upcoming auction. This is another example of fully preparing your property to avoid surprises.
The most common issues that arise are late-recording county or municipal liens. As cities' and counties' budgets are getting strapped, there are a wide variety of penalties or fees that may get assessed and recorded against the property if left unpaid. The size of these liens can be significant enough to potentially alter the economics of an auction sale for the servicer and change the decision of whether or not to auction the property.
Coming to terms with reserves
Another dose of reality is in assessing current valuations: setting reserves and your own expectations. The properties that are going to auction were likely previously in the retail channel and failed to sell at or near the asking price, so servicers are advised to start there when assessing value.
If the auction company obtains independent broker price opinions, servicers would be wise to review those as well. Servicers should take into account the open-house traffic numbers, as well as Web site hits, if available from the auction house, because these represent real-time interest levels that are directly related to the bidding activity that the servicer will see on auction day. Obviously, if the numbers are low, it makes sense to revisit the reserve level.
Remember that a servicer's goal in taking properties to auction is to dispose of them quickly and efficiently while maximizing the recovery on the assets. If the auction company does its job in terms of generating interest through a concentrated marketing campaign, the servicer should feel comfortable setting its reserves at a level where the assets are priced to sell and not priced to keep. A high rate of sales "subject to confirmation" does not excite the audience the way hearing "Sold!" does when the gavel falls, and having this momentum helps greatly on auction day.
A rule of thumb would be to set reserves as late as possible in the pre-auction phase at approximately 80% to 85% of current market value, with adjustments based on open-house traffic and Web site hits.
While there could be a bidding war among investor buyers on a rough-looking property, it generally will not last too long, as investors typically have a price target that they will not exceed and rarely get emotionally wrapped up in the auction process. Property condition can be the key to obtaining the best executions, particularly on homes that have end-user or first-time home-buyer appeal.
Where feasible, consider repairs or renovations on homes that are currently not eligible for financing, in order to attract the widest population of potential bidders. Verify that the utilities are on, trash is picked up and the asset is in marketable condition before the open-house schedule commences. And finally, try to make sure that any curb appeal that may exist is reflected in the photos used in the auction catalog and on-screen – auction day is not the time to showcase the work of local graffiti artists.
We all know that the legal department can represent a big bottleneck, so make sure that you have contracts reviewed early. If a servicer already has a set of purchase contracts for each state that has been blessed by legal, the servicer is in great shape; however, the auction company's legal department also may want to review it.
When using an auction company's standard purchase contracts, servicers should have the contracts reviewed by their legal departments, paying particular attention to the specific state laws that pertain to each property. These documents should be readily available, so servicers should get these going sooner rather than later in the process.
Anyone who has seen an auction knows that they can be very fast-paced events. Speed is one of the main reasons servicers turn to auctions as a part of their disposition strategy, and throughout the pre-auction process, a good auction company will devote a significant amount of resources toward marketing an REO. However, poor preparation and communication can lead to delays that can negatively affect the exposure and interest levels shown on your property.
For example, an incomplete field on a data tape submitted to an auction company can lead to that property's not coming up in a potential bidder's search on the auction Web site. Or, an uncooperative broker might skip one of three scheduled open houses, which would represent a 33% reduction in in-person exposure. Surprise liens, bad contracts, black mold – all of these issues will conspire to dilute the marketing effort being made on the servicer's behalf.
Michael Kim is chief operating officer for Great American Real Estate Services, which offers auction disposition services for residential and commercial properties and notes. He can be reached at mkim@greatamerican.com or (310) 600-0682.
