Is an Auction a Good Place to Buy an Investment Property?

09 Jul Is an Auction a Good Place to Buy an Investment Property?

It’s possible to find a real estate deal at an auction. It’s also possible to buy a bad deal.

I bought my first investment property – a 5-unit apartment building in inner-city Philadelphia – sight unseen at an auction. The next day I bought a single-unit commercial building 135 miles away at an auction. I bought my third property – a duplex – five weeks later at an auction. All three turned out to be major learning experiences.

I mistakenly believed that if I bought a property – any property – at an auction, then I was sure to get a good deal. With money burning a hole in my pocket, I asked the auctioneer which property was the best one on the entire auction block. I was told about this 5-unit apartment building. The 5-unit was fully occupied but as I found out after buying it, only one tenant was paying rent. The building had an ancient oil heating system that failed, leaving the building cold. A gas line to the water heater leaked and was shut off by the utility company, leaving the tenants without hot water for days. The windows were broken and painted shut. The roof leaked into one of the units. The 1940s electrical system used fuses and only had 15 amps going to each apartment. One of the tenants killed another one of the tenants a few weeks after I bought the building. I fixed the building up, refinanced it, and three years later allowed a buyer to assume the loan.

The single-unit commercial building only had one dedicated parking space. The roof leaked. The business that operated there had failed, which should have been a clue that the location was not ideal. The makeshift freight elevator was not up to code and broke right before I purchased the building. The code enforcement officer told me that I couldn’t use the upstairs ballroom for anything other than storage since there wasn’t a way for handicapped people to go there. The air conditioning units had all failed, leaving the place incredibly hot. What should have been my biggest clue was that I was the only one who showed up for the auction! That was a clear indicator of the lack of market interest. After buying it and trying to rent or sell it by myself, I hired a real estate broker to sell it. Months went by without an offer. I did do a lease purchase contract with a business, yet they stopped operating after struggling for several years. Eventually I sold the building for $46,000 less than my purchase price.

The duplex I bought required far more renovations than I anticipated. My first inkling occurred when the appraiser for my mortgage loan pulled me aside and told me that I was paying too much for the duplex. I thought I might spend around $5,000 for paint and minor work, but I ended up spending $105,000 on renovations. I over-improved the duplex by about $65,000 because I was going to live in it and since I was a novice. Thankfully, I did collect rent over 17 years. I sold the property via a 1031 tax-deferred exchange. I learned valuable lessons about working with contractors, dealing with tenants, and property maintenance. Over time, I got back my entire investment.

Here are some challenges you can face when going for an auction property:

• Auctions happen fast. It’s easy to get carried away and bid too high because you’re trying to win.
• No inspections. You don’t have an inspection contingency. It’s an As-Is purchase. You can’t back out of a transaction and be entitled to the return of your deposit money if you discover problems with the property. I once bought a house at a Sheriff’s Sale and budgeted $40,000 for the renovation. I was going to fix and flip it. When the contractors opened up the walls, they discovered wood rot behind them. The renovation ended up costing $64,000. I sold the house for a slight loss after having it sit on the market for months.
• Occupants may be your responsible to remove. Some lenders will allow a pre-foreclosure auction. That means the occupants are possibly still residing on the premises. You don’t even have a chance to see the interior. Not only are you bidding blind, you have to take legal action after buying the property to evict the occupants.
• Financing challenges. Auctions typically require a hefty, non-refundable deposit and a quick closing date. If you’re obtaining a mortgage loan, you may be under a tight deadline. You might not be able to extend the contract in case your lender can’t close by the deadline. The auction contract (especially if the occupant is still in the property) may not allow your bank’s appraiser to gain access to the premises. It’s hard to appraise a property when you’re not allowed on it.
• Unfamiliar title company. Some online auctions make it difficult for you to use your own title company. You might be told to use a virtual title company that has lower customer service standards.
• No concessions. If the property is not broom-clean and free of debris at your pre-settlement walkthrough inspection, you may have no recourse to negotiate a concession for debris removal or cleaning.
• Other liens. In foreclosure auctions and tax sales, depending on the state or municipality, certain liens may not be wiped clean. There are numerous novice investors who think they’re buying a property for a steal, only to discover that the mortgage loan or second mortgage are still due and payable! While the investor isn’t personally liable for the money, the lender could foreclose and seize the property if the investor doesn’t pay off the loan in full.
• No title insurance. In some states, title companies won’t insure title for 1 to 20 years after a foreclosure auction or tax sale. Think about that! If you’re a flipper or even a landlord who wants to sell after a while, you might not be able to sell to a buyer who needs clear title. Most buyers obtain a mortgage loan, and even most cash buyers expect a clean title. If a title company won’t insure title, the pool of potential buyers becomes incredibly small. That devalues your property.

I’ve bought properties via auction, and I’ve sold some flips via auction. I’ve lost money, and I’ve made money. I’m not against auctions. I just know enough to be careful.

Tai DeSa is a graduate of The Wharton School of the University of Pennsylvania.  He became a full-time real estate investor in 2004 after serving in the U.S. Navy.  Tai made colossal mistakes in investing (and learned some things along the way).  Tai has coached hundreds of entrepreneurs, real estate investors, and real estate agents on how to increase their income and net worth. He has helped hundreds of homeowners avoid foreclosure through successful short sales. Check out Tai’s books on Amazon.com. Tai may be available for coaching and speaking engagements on a variety of real estate topics.  Send an email to tai@investandtransform.com.