The worst thing that can go wrong if you bid at auction without planning to
Sometimes investors find a property up for auction and can't help but have a crack - even if it's not part of their investment plan. So what's the worst case scenario if you start bidding before doing your homework?
Blogger: Cate Bakos, director, Cate Bakos Property
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It's an interesting thought. You might be walking the dog and you see the 'auction today' flag and hear the auctioneer's booming call.... you stop by and you decide "do you know what? This seems good value. I might give it a crack." Or you are out in the market to glean a bit of local property sales knowledge and while at auction you find yourself swept up in the emotion.... enough to put up your hand. Sometimes I come across a buyer who has procrastinated and whiled away the four and a half weeks' of sales campaign, only to decide at twenty minutes to auction time that they'll wander down to the property to 'see how it goes'. Either way, and in any of the above situations, every buyer who takes this approach is taking a massive risk.
I have seen plenty of people who have successfully pulled off such a tactic. But for all of the happy stories, there are some unhappy ones too. I've detailed some of the possible disasters and upsets that buyers who adopt this approach can face.
Firstly, without understanding the recent comparable sales in the area, the buyer can't be sure that they have paid at or below fair market value. I remember one buyer who bullishly felt that he could place the property on the market with one swift, bold bid. He shouted out "Nine hundred thousand dollars..." and the auctioneer asked him to confirm his bid. He nodded assertively and the crowd gasped. Not only had he placed the property on the market, but he'd bought it. It was beyond any other bids and he hadn't tested other buyers' preparedness to purchase the property at all. One could argue that he was brilliant, but I'd argue that he was paying above market value and perhaps a better degree of planning could have saved him thousands. Just because a property is sold at auction doesn't mean the bank will necessarily accept the purchase price as the final bank valuation.
Secondly, without a legal representative's review of a contract or the particulars of the contract, a buyer can't be certain that they are buying what they THINK they are buying. Only yesterday I received a text message from my very own adorable cousin. Her text read "Cat, any tips for me bidding at auction? It's at 3". My response was "Yes. You need me". She was on her way to the property and I had 14 minutes to look over the contract, look up her property listing and be ready for her call at 3pm. I'm not a qualified legal practitioner and I was quick to point that out to her. She'd missed the opportunity to have a professional go over the property searches, the title, the potentially nasty clauses in the contract, any overlays adversely affecting the value of (or opportunity to improve) the property, and the covenants or caveats which may have been present. All I could scan for were the items which flagged obvious and immediate concern. I flicked through the pages on my smart phone, cursing her all the way for giving me fourteen minutes to help her. I quickly determined that the property was not zoned the popular and accepted Residential 1; it was a Green Wedge Zone. In addition, it was a 7.5 acre property and it featured a Bushfire Risk. This property might have been special but I was under no illusions that a Mortgage Insurer could potentially reject it. That meant that if my cousin required an 80% loan or more, she may have faced rejection from the lender; or high scrutiny at the very least. This was not an auction to be nonchalant about.
Thirdly, a buyer might have chosen not to have a building/pest inspection or town planning assessment carried out. If they are assuming that the property is in good condition, or planning on conducting a subdivision or development - and choose to ignore either professional inputs - they carry a significant risk. I've seen plenty of buyers who have bought, felt the heartbreak of realisation that they were ill-prepared, and then have made the tough decision to sell based on holding a property which doesn't actually meet their plans or needs. What these buyers discover is that stamp duty, agent's fees, marketing fees and solicitor fees are ugly when the transaction is a fast-turnover one. But this cost is nothing when compared to the next point.
Finally, many a buyer I know have entered into a purchase contract without a 'Subject to Finance' clause under the misguided belief that they are right to purchase because they are already pre approved. Bank pre approval is generally always "subject to lender approval of the security property and bank valuation", which really means that:
a) the lender needs to 'like' the property. If it's not the correct zoning, the correct size (no smaller than 45sqm in most cases), the correct postcode and the correct condition (yes, that's right... the lenders don't like all renovator's dreams), then they MAY reject it.
b) the price tag needs to match that of the bank valuer's valuation (so the buyer can't get emotional or generous, nor can they buy off-the-plan and pay a premium for all the fancy lease-back deals on offer).
c) the lender can't be too exposed to a higher percentage of units in the block (if applicable). ie. if the buyer purchases a high rise apartment and the lender has determined that they do not wish to be exposed to more than (say) 30% of properties in the block, the buyer may find themselves with a declined application and reason unbeknown to them.
d) if the buyer's circumstances have changed in any way; or if they have obtained pre approval in principle but there are details they've missed, they may also face a declined loan application.
Assuming that one has pre approval to buy ANY property is naive. A buyer needs to understand which types of properties the banks might not like.
If the bank doesn't like a particular property, it means that the purchaser may not be able to finance it. In most cases, the typical auction-property deposit is 10%; either on the day or within a business day after. By the time the lender has rejected the loan application (and presumably subsequent lenders have also rejected the loan application), the buyer's 10% deposit is at-risk. If they are served a recision notice (and typically they are once they have missed the settlement date), they will lose their 10% deposit. If the vendor cannot re-sell the property at the same price, the purchaser may find themselves in a position where they are not only sued for damages and costs, but also sued for the differential. This can be a disaster.
So while this sounds quite melodramatic, I can confidently say I've seen it all. And it's never pretty.
It pays to be organised when considering bidding at auction.
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