The Strength of Auctions in the Rising Market

Photo: Hunter Nield via Flickr

What’s Happening in the Property Market?

After last week’s clearance rate dropped from 82 per cent to 79 per cent once all results had been collected, this week’s 75 per cent rate was back in line with the year-to-date trend, which currently sits at 71 per cent. 

Initial data shows year-to-date total transactions are tracking higher than they were in 2011/2012 – currently 49,074 compared to 43,837 and 44,762 respectfully. However, we are still behind the 2010 figure, when prices peaked in October before starting a slow rewind as we entered a different phase of the oft-quoted property cycle.

In contrast to any assumed effect federal elections typically have on investor confidence, low interest rates and a weaker economic environment balanced against rising yields, limited established stock, various policies such as negative gearing, and the trend to borrow and invest in property as part of a self-managed super fund continues to buoy the investment sector.

The investor rate of growth for the purchase of second-hand dwellings outpaces that of the owner occupied sector. 

RP Data’s Home Price Index

RP data have released their August home price index, the results of which should be couched against information I’ve revealed previously, as it is not seasonally adjusted and subsequent revisions are required after any media release to allow time for the official settled sales data to filter in from the various state governments (which is typically some three months plus later).

This needs to occur before we can achieve a reliable result – hence why it’s important not to read too much into the commentary.

According to the figures, Melbourne dwelling values have increased by a more modest 0.2 per cent over August – 4.8 per cent for the quarter. The data covers the entire metropolitan area, therefore it’s important to draw a distinction across the fragmented localities which divide the inner and middle ring auction terrains from the broader outer suburban regions where ‘for sale by private treaty’ is the preferred method.

Auctions as a Method of Sale

There’s no denying that Melbourne is the auction capital of Australia – year-to-date there have been over 19,000 auction sales, which according to REIV figures, is an increase of at least 13 per cent on this time last year.

As a proportion, auctions only account for around 20 per cent of total sales. The vast majority of transactions take place behind closed doors via private treaty negotiation. 

However, whilst auction transactions only capture a relatively small sample of sales, they can indicate how consumers feel about the purchase of residential real estate (particularly in the investment sector).

In a country that has effectively hamstrung development outwards with inelastic supply side levers, ensuring we’re all squashed in a doughnut-like shape around the affluent capital city established localities, the concentration given over to the clearance rate each weekend is somewhat understandable – even if it does irk the larger proportion of agencies that work in outer suburban areas.

For an inexperienced buyer in a hot speculative-fuelled market, auctions can present a number of dangers.  The typical four week campaign – three weekends of opens before the auction takes place on the fourth – is designed to act as a stimulant, effectively putting an ‘end by’ date on the period of time they have to conduct any needed due diligence.

And as clearance rates rise (the curve of which prices typically follow) the chance of a listing attracting enough attention to sell prior also increases – shortening the marketing period further still.

The Confusion Involved with Auction Price Quotes

Added to this is the general confusion over auction price quotes. It seems silly to point out the obvious, but no buyer likes to play guessing games when it comes to putting a price on an advertised listing. 

Everyone understands real estate is a negotiated asset; however, the verbal game-playing that now surrounds a proportion of the sales industry is laughable. 

Responses to a ‘price enquiry’ range from a paraphrase of “we won’t know until buyers have ‘told’ us” to a general comment such as “properties in the area are selling in the $400,000s and $500,000s” – effectively giving any said purchaser $200K bracket in which to work it out.

It’s part of the market insanity that surrounds our residential real estate sector. If we were operating in an ideal world, buyers would ignore price quotes altogether and do their own research to establish market value prior to spending hundreds on a pest and building inspections or solicitor fees chasing an unobtainable dream.

However, closely comparable sales data is not always readily available – computer-generated estimates, are, more often than not, hopelessly inaccurate. Suburb reports are equally unhelpful, and while median data will give an indication of the dollars the majority market is spending, it’s no help when evaluating individual property prices.

In Victoria, published auction sales often result in undisclosed blank figures and private sales are just that – private. The street name will be listed, but the other relevant and essential data is missing.

It’s one reason I advocate a requirement for vendors to take responsibility for their own (typically) ‘vendor paid’ advertising campaigns, and ensure reserves – or ranges in which they’re prepared to negotiate – are published at the outset.

Whilst you can argue one way or another at the lunacy that often surrounds Australia’s addiction to all things real estate, we’re not talking about an item on e-bay – we’re talking about the biggest financial transaction most make in a lifetime. 

Hence why we need transparency in the real estate sector – information should be openly available to enable buyers to make informed decisions without the need to play guessing games and risk poor financial decisions that can have a broader impact on the economic landscape. 

Where is the Market Going?

According to RP Data, Australia’s property market is worth an estimated $4.86 trillion, which is three and a half times the value of Australia’s stock market and combined superannuation funds.

Assessment by Moody’s shows Australian banks are “way ahead” of global counterparts in their exposure to property – with two-thirds of their lending tied to the residential sector.

And as we start to tick into what most assess to be a relative boom of activity in various states – with auction rates in certain states once again approaching record highs, and analysts carefully assessing sharp price rises in the established sector – we remain in a precarious position.

As I said last week, whilst the current rally seems set to last into 2014, the prospect of higher rates coupled with higher unemployment will, in my opinion, pull up any lengthy capital city market boom. However, in the meantime, we’re in overdrive, and the sales industry is predictably doing everything in its nature to add fuel to the fire – in some cases, deriving campaigns within a shortened 2 or 3 week period.

And whilst in a downward market, I would fully agree with advocates such as Neil Jenman who campaign against auctions as a method of sale, claiming “better results” can be achieved via private negotiation, the opposite is the case when the market turns and we start to see mini rallies within certain pockets of the city.

When buyers see properties openly selling above their pre-conceived perception of market value (something that generally doesn’t happen when the sale is conducted via negotiation) it provides very visible reality that the market is moving and the effects on the mindset act like a kind of contagion.

There’s no doubt a winning bidder will only ever be one step above the under bidder – and in that sense, it could be argued the highest price is never achieved. However, having spent years working with buyers, I can confirm, without shadow of a doubt, that during a rapid moving auction, buyers spend far less time thinking about exceeding budget constraints than they in a rational, pre-auction moment, when they take time to discuss – usually with their partner – where to draw a sensible limit for the property in question.

And it’s rare to find an agent with the sharp negotiation skills to achieve similar results in private sale scenario.

Auctions vs. Private Sales

There have been plenty of academic papers outlining why auctions can achieve significantly higher prices in competitive markets compared to other methods of sale. The effects broadly fall under the title of a ‘pseudo-endowment effect.’

Without going into too much detail, as buyers bid for a property, there is a feeling of partial possession in those who take part.

If the bidding starts low – as it tends to at most auctions – the multiple bids and length of time needed to get the price to its reserve creates momentum and in addition, fuels the emotional attachment and sense of ownership the participants gain towards the property.

The results of the many scientific experiments conducted on auction sales show a strong propensity for buyers to re-assess their pre-estimate of value upwards, which stimulates a win or lose mind set, in which the main focus is to beat the competition, above and beyond simply purchasing a home.

To put it another way – when buyers bid at auction, they bid to win and in the process, lose connection to the initial goal of achieving a purchase within a predetermined budgetary limit.

With a talented auctioneer doing all in his power to convince bidders to ‘buy their weekends back’ with ‘just one more shot’ – it doesn’t take much for an inexperienced buyer to stretch past his comfort level and lose it.

Smaller increments and repeated bidding can magnify these results.  Hence why you’ll often see buyer advocates attempt to nip the momentum in the bud, with an initial high bid or by using what’s known as a snip technique – coming in right at the end an giving the impression to already stretched buyers, that there’s plenty more in the tank.

And whilst it can be very successful in gaining the vendor an outstanding result – it has little advantage for a buyer, who can end up with a healthy dose of remorse once the initial fervour has worn off.

There are numerous tips I can offer any would be buyer to heighten their chances at winning an auction battle; however, no tip is more essential than to evaluate a pre-conceived budget prior to the auction, and stick rigidly to it regardless of the atmosphere.