This article appeared in the June issue of National Real Estate Investor.  It explains some of the reasons auctions are becomming a more popular form of real estate marketing, a development we have been observing in recent years and one that some of you may have noticed as well. 

Going Once, Going Twice

By Parke M. Chapman

Jun 1, 2007 12:00 PM

When Pritzker Realty Group decided to sell a Kansas City office building last summer, the private investment firm didn’t hand the listing to a local broker. Like an increasing number of sellers, the Chicago-based firm marketed the 260,000 sq. ft. building through a public commercial real estate auction.  The format has generated growing interest among commercial real estate investors in recent years. Gross sales revenue of commercial properties sold at auction jumped by roughly 27.4% annually over a three-year period beginning in 2004, according to the Kansas-based National Auctioneers Association.

Auctions appear to work best for properties that ultimately fetch $20 million or less, a conclusion based on sales achieved in the past 12 months. Auctions can be helpful in situations where the seller is unsure what a property is worth. The approach appeals to sellers because auctions at times draw many potential buyers and can fetch high prices. Also, buyers take on more of the transaction costs.  Unlike the traditional approach whereby a broker is hired to market a building, commercial real estate auctions force potential buyers to act within a compressed time frame — typically six to eight weeks — or forfeit the deal. That is why many in the business refer to auctions as “accelerated marketing� plans.

Sold! For $18 million

In the Pritzker disposition, the sale was not only accelerated, it was successful beyond expectation. Anchor tenant Farmland Industries declared bankruptcy in 2002. Farmland’s six-story building near Kansas City International airport was 85% vacant, and leasing prospects were dim. Given the challenge, Pritzker hired real estate auction firm Sheldon Good & Co. LLC to market the Class-A property in late August.  Pritzker aimed to fetch $13 million from the Farmland building. All of the sealed bids were received by the end of August last year and enclosed with a required $300,000 cashier’s check. The final price achieved at the November auction was $18 million, or roughly 40% above the minimum price set by Pritzker, according to Steven Good, chairman and CEO of Sheldon Good & Co.

The Kansas City Aviation Department (KCAD) was the winning bidder. What’s more, Good says parties on both sides of the deal were satisfied with the auction’s outcome.  “The seller did better than it would have with a conventional marketing plan, and the buyer believes that it can extract value by marketing the building differently than the previous owner,â€? he says. KCAD is subdividing the building to lease to smaller tenants.  Proponents say commercial real estate auctions offer sellers a highly transparent process, since buyers and sellers know exactly where they stand as successive bids are shouted out. “We use transparency as a way to drive excitement since we can line up all of the potential buyers at the same time,â€? says Good.

Why auctions work

Sheldon Good & Co. was founded in 1965 by Steven Good’s father. Since then, the Chicago-based company has sold more than $4 billion of real estate, making it the largest U.S. real estate auction firm by total revenues. The company conducted about $100 million in commercial real estate auctions each month last year. In the previous year, monthly volume averaged just $75 million.  What’s driving the growth of commercial real estate auctions? Good says that sellers want to ensure that the greatest number of potential buyers consider their offering. By exposing the property to the widest range of investors, Good believes that auctions allow sellers to achieve the highest price.

Commercial real estate owner and developer Roger Kellogg agrees. The Jacksonville-based office investor has repeatedly bought and sold property through Sheldon Good auctions since 2001. He’s also seen bidders face off over one of his properties, driving the sale price up dramatically at auction. In 2003, for example, Kellogg sold a suburban office property located in Florida through a public auction.  “We had 60 people bidding on that Orlando property. I was actually afraid that the pricing was getting too high for the winning bidder,â€? says Kellogg, president of Kellogg Development. That’s a problem most sellers would love to have.  Needless to say, Kellogg was pleased when the 30,000 sq. ft. suburban office building fetched $3.15 million. He says that commercial real estate auctions are an efficient way to drive interest in a property and guarantee that the buyer is willing to close on the deal.

Caveat emptor

Indeed, the auction experience differs from the traditional method. For one thing, auctions make concrete demands on interested buyers. Bidders must conduct their due diligence before a set date — typically when the first set of bids are received.  In contrast, conventional buyers often demand a certain amount of time after the sale to examine the property more closely. If entitlements or zoning issues crop up, the deal can be compromised.

For the auction buyer, however, the term caveat emptor (or buyer beware) carries great weight. Not only are most buyers required to pony up as much as 10% of their bid in advance, that money is used to fund the sale if they prevail in the auction. Kellogg believes that few people will walk away from a 10% deposit on a multi-million dollar property.  Auction sellers also fork over less money for broker commissions. Here’s how it works: In an auction, the buyer — rather than the seller — typically absorbs the commission fee. While a broker can earn as much as a 10% commission on the gross sale price of a deal, owners who sell at auction have less exposure to fees.
Sheldon Good, for example, typically extracts 3% to 10% of a so-called “buyer’s premiumâ€? from the winning bidder. But sellers are still on the hook for some of the costs. Most auctioneers ask sellers to pay for print advertising in advance of the auction, plus other marketing incidentals.  Even so, Good says seller fees incurred at auction are offset by the sale price, which tends to be higher than with traditional broker-assisted transactions, so sellers often pocket greater sums from the auction. This is especially true of auctions that end with bidding wars, which can lead many buyers to pay more than they expected at the start of the auction.

In fact, the most common method used in commercial real estate is called the “open outcryâ€? auction, which assembles qualified bidders at or near the property on a specific date.  For instance, Tulsa-based Williams & Williams conducts all of its auctions through open outcry format. In fact, the firm sells everything from golf courses and industrial properties to cold storage facilities and apartment buildings in the open outcry format.  Dean Williams, president and CEO of the family-run firm, says the average sale price achieved at a Williams & Williams commercial real estate auction is $1.5 million. “This is a great way to remove the middleman and truly find out what your asset is worth,â€? says Williams, who has seen bidding wars ratchet up the final price of an asset at auction.  The sealed-bid and open outcry auctions aren’t mutually exclusive, however. The Farmland building sale began with sealed bids, but a welter of matching bids spurred an open outcry auction.  With the sealed-bid auction, each party submits a confidential offer to the seller. If two or more of the highest bids match, the seller asks each party to raise their respective bid.

Accelerating the process

“The accelerated marketing process puts the burden on the buyer,â€? says Jerry Anderson, president and chief operating officer at Irvine, Calif.-based investment sales brokerage Sperry Van Ness. The company sold roughly $400 million of commercial property at auction in 2006, up from $300 million in 2005.  The company places up to a dozen classified auction ads in the Wall Street Journal every week. With the Journal’s global circulation of nearly 2 million readers, Sperry Van Ness ensures that the greatest number of investors is alerted to the deal.  In January, the firm’s accelerated marketing division auctioned off an entire city block in downtown Oklahoma City. The Bricktown Square property fetched $10.9 million at a public auction late last year. Bidding for the seven-building, 189,423 sq. ft. parcel started at $8 million.

The sealed bids arrived several weeks before the planned auction, at which point Sperry Van Ness contacted the highest bidders. During the public auction, which drew four willing buyers to the ballroom of an Oklahoma City hotel in November, bidding quickly shot up by nearly $3 million to almost $11 million.  The winning bidder was local property developer Jeff Moore, who officially closed on the property in a matter of weeks. Four of the Bricktown Square buildings are leased on a long-term basis by restaurants, and the property is listed on the National Register of Historic Places.

Not just for sleepers

During the early 1990s, the Resolution Trust Corp. famously auctioned off a wave of distressed commercial properties. More than $1 billion in assets were liquidated via public auctions in the early 1990s, and that activity may have typecast auctions as a last-ditch strategy.  Now, even plum lots on the waterfront are being sold at auction. In late June, for example, 12.2 beach front acres in Hampton, Va. will be auctioned off. Sperry Van Ness auctioneer John Johnson had already received more than a dozen inquiries about the property as of early May, most from developers interested in building luxury condos and townhouses on the site.

The City of Hampton recently amended the site’s zoning to allow for residential development. Five separate investors own the parcel, and existing structures include a motel and an apartment building. Johnson says that the new owner will demolish all of the existing structures.
The sellers have provided Johnson with a number — also known in auction circles as a “floorâ€? — below which they will not sell the property. When a seller doesn’t have a floor, the auction is referred to as an “absolute auction.â€?  “We expect to have about five bidders at the open outcry auction on June 21, and they will be the top bidders,â€? he says.  Johnson expects to conduct more commercial real estate auctions over the next few months, especially if a downturn motivates sellers to liquidate their assets.  But the recent flurry of commercial real estate auctions challenges that view. “The market has been very strong for a long time,â€? says Johnson. “And we expect the auction business to remain strong.

Kellogg sees the modern stock market as a shining endorsement of the auction model. Buying and selling stocks 30 years ago, he notes, wasn’t efficient or cheap.  “Fast forward to the computer age and you can buy or sell stocks in a transaction that costs pennies per share and takes place in a span of less than two minutes from placing the order,â€? Kellogg says. “That is simply an auction format, and the result is greater efficiency and transparency that ultimately leads to higher price/earnings ratios and pricing.â€?

Parke Chapman is senior associate editor at National Real Estate Investor 

PRE-CONSTRUCTION INVESTMENTS

For most of my Real Estate coaching career I have been a septic of Pre-Construction investments. Due to the many people who have been burned by these deals that never worked out for them. I personally have never purchased an investment that falls into this category of real estate investing. I have however listened to and have come to understand the problems that have occurred with many deals that went, or already were, bad. In the past months (10 to 12) I have heard of some successful deals and started to wonder why some were good and some were not. I have now completed enough research that I feel comfortable and even excited to give my blessing to pre-construction investments that have been diligently researched. In fact, I now believe that this type of investment lends itself to some investors desires and goals so well these types of investors can enjoy great success at adding cash flow, equity and or lump sums that tend to excite many.

In your reading of that first paragraph, you might have picked up on what I believe is the key to success as a pre-construction investments. Two words are and forever must be used for investors entering into investment that are relying on values of an improved property in some future time. The very title given to these investments indicates there is a timing issue. Although I believe that the success of any real estate investment has a great deal to do with timing, these types of investments are, due to their nature, almost completely reliant on future market appreciation. Therefore, market research and a confident understanding of the market will greatly increase the ability to make the proper decisions as to purchase price and terms of the investment being offered or considered.

Properly researching and understanding the market which a particular investment is being considered is wise with any type of real estate investment. Pre-Construction investments are no different. Learning how to properly research a market and understand it is an absolute must for a investor. However, far too many do not understand this research and don’t take the time to learn how to properly complete this research. I highly suggest that one of the most important tools a real estate investor can have is a strong grasp on market research and understanding. If you don’t have this find out how it is done properly and learn how to do it properly. Then make decisions based upon the information and conclusions made from this research.

Pre-Construction investments can be most easily completed and successful if you will understand the market they are located in and make decisions based upon the data and conclusions you have received and made.

Green buildings are becoming an important issue in commercial real estate.  More and more companies and developers are trying to get certification under the LEED standards for new buildings they are building and many observers expect the movement to continue growing.

The following article appeared recently in About Real Estate, a Free TWR Weekly Publication by Torto Wheaton Research, a subsidiary of CBRE

DO GREEN, MAKE GREEN          by Harvey M. Bernstein       April 20, 2007

In the highly competitive market of commercial real estate investment and development, think Green! Green… Green is for money and Green is for sustainability. Owners and builders are realizing that Green building is an important market differentiator.

Sustainability policies and Green construction practices are no longer a fad. They are having a significant impact on the real estate industry–both commercial and residential–on a daily basis. You cannot pick up a magazine or newspaper today without finding an article on Green building.

According to recent research we have completed at McGraw-Hill Construction, 63% of Corporate America (firms $250 million or greater) see sustainability, Green building and other Green efforts as providing a competitive advantage through market differentiation.
 
In 2005, Green building comprised approximately 2% of the U.S. construction market for commercial and residential construction, which was about $10.2 billion. With growth projected to increase to 5-10% of U.S. construction, the Green market by 2010 will be between 29 and 59 billion dollars, not counting residential remodeling.

Spurred into action by rising energy costs and widespread concerns about climate change, our research shows that federal, state, and local governments have become key players in the Green movement by passing legislation and establishing incentives to encourage sustainable practices in the private sector. Diverse actions–ranging from executive orders to community commitments–have expanded Green building, energy-efficiency and social responsibility dialogue to include corporate America.

Some states have recently stepped up their commitment to a Greener private sector by tackling issues beyond Green building regulations, such as encouraging alternative energy sources and reducing Greenhouse-gas emissions. Local governments, which have millions of square feet of building space under their direct control, have taken a unique leadership role in the Green building arena. Many local governments have striven to be an example to the private sector by ensuring that their public sector buildings are built according to the LEED (Leadership in Energy & Environmental Design) rating system developed by the U.S. Green Building Council (USGBC). In fact, USGBC is currently developing a full set of environmental performance indicators so that companies can better track the aggregated environmental impact of their real estate portfolios.
 
Commercial real estate is seeing paybacks that owners say justify Green building. Most notably, owners indicate that Green building is leading to the following advantages:
 
  8-9% decrease of operating costs across the industry
  Increase of building values around 7.5%
  Expected ROI improvements of 6.6%
  Expected occupancy ratio increase of 3.5%
  Expected rise in rent rate by 3%
 
We are seeing that builders are increasing their involvement in Green building at higher rates on the single-family residential side than on the commercial side. In fact, McGraw-Hill Construction research shows that in 2007 the residential construction industry will have reached its “tipping point,” with more than 50% of homebuilders building at least 15% of their homes as Green homes. With this rapid change in the homebuilding marketplace, the rest of the home builders will have to enter the Green marketplace to remain competitive.

This shift in market demand toward Green is driving more change in the real estate community and corporate America. Pension funds, corporate boards, CEO’s and CFO’s are now focusing their attention on adopting business strategies and activities that are consistent with the careful design and environmentally and energy-efficient construction, operation and reuse/removal of the built environment. When you consider that buildings account for 40% of all energy consumed in the United States as well as 71% of electricity and over 38% of carbon dioxide emissions, it is easy to see why. The less energy buildings consume the lower operational costs. Improvements in indoor air quality and the amount of daylighting are contributing to better employee performance which is also reflected at the bottom line.

Why Green? The most important factors architects, engineers, contractors, owners (A/E/C/O) and homebuilders alike identify for pursuing Green building are “lowering energy/life cycle costs” and “doing the right thing.” Approximately 86% of the A/E/C/O community and approximately 97% of homebuilders report participating in some sort of Green-building activity. Almost 70% of these leaders in today’s architecture, engineer, contractor (A/E/C) and owner communities report they believe project sales associated with commercial Green building is increasing.

To further emphasize this point, research results from McGraw-Hill Construction’s “Greening of Corporate America SmartMarket Reportâ€?, based on research conducted for Siemens Building Technologies, Inc., shows real estate portfolios of corporate America to be increasing in the percentage of Green buildings. Based on projections, Green building will reach a tipping point in 2009, with 82% of companies greater than $250 million Greening at least 16% of their portfolios.

With energy costs comprising the single largest controllable operating expense for office buildings, lowering energy costs poses a tangible payback for corporate leaders to embrace. Much of corporate America perceives Green activities and Green building as being part of their growth strategies. This is a strong enough reason for the real estate community to take more notice and to begin to incorporate the increased value associated with Green buildings in its business strategies.

Harvey M. Bernstein, F.ASCE, is a leader in the engineering and construction industry for over 30 years. He has served as a member of former Secretary of State Colin Powell’s Advisory Committee on Leadership and Management and is a member of the Princeton University Civil and Environmental Engineering Advisory Council and the Harvard Joint Center on Housing Policy Advisory Board. He also is a visiting Professor with the University of Reading’s School of Construction Management and Engineering in London, England where he serves on their Innovative Construction Research Center Advisory Board. Bernstein is a frequent speaker at Green conferences, including USGBC and NAHB, and has written numerous papers and reports covering innovation, energy conservation and sustainability in the built environment. He co-authored the book Solving the Innovation Puzzle: Challenges Facing the Design and Construction Industry (ASCE Press, 1996).

Welcome to the Global Capital Markets  By Jamie Woodwell    May 1, 2007 12:00 PM

Commercial/multifamily delinquency rates did not jump on Tuesday, Feb. 27. There were no reports of falling rents or increasing vacancy rates. No new signs of over-construction or increased balloon risk. A world away, rumors of a capital gains tax on Chinese investments set about a string of events that in a matter of hours led to slightly higher borrowing costs for U.S. commercial real estate borrowers.

‘Flight to quality’ comes quickly

For years, U.S. real estate markets have been the beneficiary of an abundance of capital. The result continues to be low borrowing costs at competitive terms, high property valuations, strong commercial/multifamily mortgage origination volumes and record levels of mortgage debt outstanding. On occasions such as the crisis of Long-Term Capital Management in 1998 and the events of September 11, 2001, flows reversed. Feb. 27 marked another, albeit much slighter, such reversal.
While commercial real estate fundamentals did not change, the broad appetite for risks among fixed-income investors did. As the Chinese stock market jitters affected the carry trade and prices in other markets, some investors looked for security in Treasuries and other risk-free instruments. A similar “flight to quality� occurred three weeks later when the Mortgage Bankers Association (MBA) reported a jump in delinquency rates on non-prime, single-family mortgages.
The resulting flight to quality, and drop in demand for other fixed-income securities such as commercial mortgage-backed securities (CMBS) and other securitized instruments, meant a drop in prices. And since a drop in a bond price means a rise in its yield, borrowing costs for commercial/multifamily real estate rose slightly.
When Long-Term Capital Management failed in 1998, the spread between AAA CMBS and swaps widened 84 basis points, from 27 basis points to 111 basis points, in just six weeks. In the six weeks following the Sept. 11, 2001 attacks, spreads widened 17 basis points, from 45 basis points to 62 basis points. In the four weeks after the Chinese stock market dip, spreads widened 6 basis points from 23 basis points to 29 basis points.

Mounting pressures heighten risks

While the timing and cause of this jump in rates may not have been foreseen, the coming of such a jump has been. In its August 2006 report, titled “Outlook for the Real Estate Finance Industry,� the Council to Shape Change, an independent group of 19 real estate finance industry leaders created by the MBA, noted: “Due to the ever tighter linkages within the capital markets, the real estate finance system could be more susceptible to shocks to the financial system.� The council concluded that the industry could be hit by a sizable financial market shock over the next several years.
In a January article in Mortgage Banking, I noted, “Participants throughout the industry are [rightly] scanning the horizon for signs of inclement weather that may be heading our way. And while no thunderheads are imminent, it’s worth raising a couple of the likely suspects that could start moving in.â€? The likely suspects included new construction, balloon risk and financial market shocks. Even with careful risk management, there’s little the industry can do to prevent such events.
Historically, the location of a property has been very important. To a large extent, the performance of a property — and the loans that back it — depends on local market conditions. Increasingly, global capital flows make the difference between a marginal uptick or downtick in values. The added capital, liquidity and transparency that stem from these global markets will continue to benefit the commercial/multifamily real estate market as a whole.
These same forces mean that real estate investors need to be just as aware of the effect of shocks to the global financial market as they are of risks linked to increased local development activity or a loan maturity date. Welcome to the global capital markets.

Jamie Woodwell serves as the senior director of commercial/multifamily research at the Mortgage Bankers Association.