A Model Of Real Estate Auctions Versus Negotiated Sales

We offer a theoretical and empirical comparison of auctions and negotiated sales. We first build a simple model to show that auctions generate a higher relative price than negotiated sales when demand for the asset is strong, when the asset is more homogeneous, and when the asset attracts buyers with higher valuations. Using data from property sales in Singapore, we find support for our theoretical predictions. In addition, we find that auctions do not necessarily generate a higher price premium for foreclosed properties than for non-foreclosed properties.

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This text bridges the gulf between theoretical economic principles of negotiation and auction theory and their multifaceted applications in actual practice. It is intended to be a supplement to the already existing literature, as a comprehensive collection of reports detailing experiences and results of very different negotiations and auctions.

We propose a model of mechanism choice in the disposition of real estate assets where we consider two alternatives: a search market and an auction. Within the search framework, we derive an equilibrium whereby buyers incur search costs and sellers incur holding costs for the period during which the property is not sold. In the auction alternative, the seller joins an existing pool of sellers in undertaking a multiple-object auction and pays a commission upon sale. Buyers and sellers freely choose their mechanisms, which in equilibrium are optimal given each group's conjectures about the mechanism choice of their counterpart. In equilibrium, agent cannot benefit from deviating from his choice and each agent's beliefs are consistent with the equilibrium outcome. It is shown that (i) buyers with high search costs will choose auctions because the auction payoff imposes an upper bound on buyers' gains from search and (ii) prices at auctions will be higher. Using vacant lot sales data and a method-of-moment estimator which accounts for the presence of an endogenous discrete mechanism choice variable, we estimated a hedonic regression to detect the price effect. It was determined that, on average, lots sold for $1.44 per square foot more in auctions than in the search market, as predicted by our model.

Little is known of the effects of the auction mechanism in relation to post-auction market sales. This empirical study of unsuccessful auctions shows that approximately half of these properties were eventually sold via private negotiations, at higher prices relative to last bids. The probability of a subsequent postauction transaction is significantly higher for apartments and terrace houses and when auction turnout is high; and lower in the absence of any bid and in some years. In addition, downward evisions to the opening bid improve the probability of subsequent sale. Prices of subsequent re-auctioned and privately negotiated sales decline with time to sale, consistent with the search process explanation.

Little is known of the effects of the auction mechanism in relation to post-auction market sale. This empirical study of 966 unsuccessful auction observations over a period of almost five years is an initial attempt to provide insights on post auction effects. Approximately half of these properties were eventually sold via private negotiations. The post-auction privately negotiated sale prices are on average higher than the opening and last bids when at least one bid is received at the auction. However, properties that received no bids at the auction were transacted on average, at a discount to the opening bids. The probability of a subsequent post-auction transaction is significantly higher for apartments and terrace houses and when auction turnout is high; and lower in the absence of any bid and in some years. The price to opening bid differential increases with the number of increments at the auction, but is lower for more atypical properties and decreases with time-to-subsequent sale. The results lend support to the hypothesis that the auction mechanism provides a positive price discovery effect, ostensibly from publicity and exposure at the auctions. Interestingly, the probability of subsequent sale is also decreasing (albeit insignificantly) in the capital loss experienced by owners, lending some support to the loss aversion theory. However, the attenuation in opening bids is observed for all properties, regardless of whether they are put up for sale by owners or by financial institutions.