Risky Business: Real Estate Auctions

risky business - blog

Have you seen the show Flip or Flop on HGTV? A husband and wife real estate team in California purchases homes at auctions with cash in order to renovate and resell them. We recently had a client who was interested in how real estate auctions work, and if they were a smart investment for her.

Home auctions and renovations produce high drama – they make for a good TV show, but are certainly a risky investment. Here are four risks you take when purchasing a home at auction:

Risk #1 – 10% Earnest Money

If you buy real estate at auction, you have to put 10% down and that is absolutely nonrefundable for any reason. You are committed from contract.

Risk #2 – No Inspections

All your inspections must be completed prior to bidding. You can’t really inspect the property before contract because usually the utilities are not on, and you are not guaranteed to win the bid. If you are buying with a loan, it is worse: no appraisal or loan contingency (and, you have to use the auction house’s lender).

Risk #3 – 5% Auction Fee

On top of your purchase price, they add a 5% auction fee. The auction house charges 5% premium and often an additional “technology fee” ($300 to $1000) for holding the auction to the buyer (in addition to whatever they charge the seller).

Risk #4 – Advantage to the Seller

The owner of the property is not required to ever sell the property to any bidder because of the central rule of real estate law: there is no such thing as an unwritten contract. So, bidders “win” the property but the seller only has to approve the sale if they want to. They are only obligated once they sign a contract, no matter what their agent says via auction. In the end, the auction is not set up to get a buyer a good deal (though that is the implicit hook that draws people in), but is completely to the advantage of the seller (and maybe more to the advantage of the auction house).

Our goal as real estate agents is to get our buyers and investors the best deal possible. We are conservative and realistic with our advice. If you’re interested in investing in real estate there are options out there with high return on investment, lower risk, and little drama. Our favorite real estate investor Warren Buffet has said, “our favorite holding period is forever.” This is our approach to real estate investment, and we believe it is the best way to establish wealth over a lifetime.