Auctions – In the current atmosphere, what effect are they having on buyer psychology?

There’s no denying that Melbourne is the ‘auction capital’ of Australia – at time of writing - year to date there have been over 18,291 auction sales, which according to REIV figures, is an increase of 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, for the bulk of buyers focused on sourcing properties in the middle, and particularity inner ring localities of Melbourne (followed by Sydney) – a large proportion of which are investors - ‘for sale by auction’ tends to be the preferred method of marketing, therefore, at some point, attendance on a Saturday for a game of ‘deepest pockets wins’ is all but inevitable.

As mentioned above, whilst auction transactions only capture a relatively small sample of sales, they can be a good indicator to the current ‘heat’ of consumer sentiment toward the purchase of residential real estate (particularly in the investment sector.) And in a country which 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 ‘non’ auction locations.

For an inexperienced buyer in a ‘hot’ speculative fuelled market, auctions can present a pit fall of dangers.  The typical four week campaign – three weekends of ‘opens’ with the auction taking place on the fourth – is designed to act as a stimulant, effectively putting a ‘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.

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.

According to RPData, 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 once again approaching record highs, and analysts carefully assessing sharp price rises in the established sector - yet sitting a long way from a point at which the RBA can pull the traditional ‘rate rising’ lever to offset a dangerously overheated market – we remain in a precarious position.

To argue that this is in anyway ‘good news’ or to suggest as RBA board member John Edwards did last week in A WSJ interview that “we’re a long way from it being a problem,” – in an environment as Michael Matusik pointed out in his blog, is set against a construction sector currently on its knees - with first home buyers reducing significantly in key markets such as NSW in which they are down from 14.2 per cent in 2011, to a current 7.3 per cent, the ‘lowest’ share on record – (illustrating aptly the failure of initiatives such as the first home buyers grant) – would be a sharp disconnect from a country that also champions the motto of a ‘fair go’ for all.

No matter where you sit in the world’s ‘rat race’ we all have a core requirement for secure accommodation – a place of residence which is safe, clean, and warm enough to rest at night – it’s the compass that navigates the our wellbeing and performance both in and out of work, therefore, it’s no surprise that the health of our property market dominates conversations across all demographics and remains at the top of concern for voters.

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.

Agents are deriving auction campaigns that last as little as two or three weeks with comments from Sydney agents highlighting;

"There are so many buyers ...we don't need to wait four weeks to identify the likely buyers, two to three weeks would be plenty..”

Reports show homes selling 15-20 per cent above their reserve which is typically derived from a mix of recent comparable sales combined with current interest - and even allowing for emotion, gives way to ‘jaw dropping’ results as ‘war stories’ filter in from varying pockets within our capital city markets.

In this atmosphere, auction sales ignite the problem further.  Allowing for the odd exception, I’ve yet to meet a buyer who ‘likes’ bidding at auction – and for that matter, I’ve yet to meet a vendor who doesn’t dread their ‘day in the sun’ as it’s so often termed by sales agents, which in most instances for a purchaser, will result in a battle of sorts, with a group of people guaranteed to lose all sense of rationality if heated bidding happens to occur – which in the current atmosphere holds high probability.

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’s ‘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 an rapid moving auction, buyers spend far less time thinking about exceeding budget constraints than they do when, in a rational, ‘pre auction’ moment, 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.

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 intricate 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.

I attend at least four to six auctions on any said weekend and have witnessed the effect this method of sale has in both downward and upward ‘cycles.’ In Melbourne, it plays an active part in driving our boom and bust mentality.  And whilst you can argue on the advantages and disadvantages in comparison to other sales techniques, in the current environment, the bidding wars erupting in both Sydney and Melbourne, are doing a good job at pushing prices into unsustainable territory.

If you’re a buyer – be warned.

Catherine Cashmore