When a property goes to auction as a result of bankruptcy or foreclosure, lien holders, particularly secondary lien holders, and the property owner frequently bid poorly and leave money on the table.
At Auctus Development we can help bidders bid optimally and maximize their returns.
As a typical situation…
The property owner currently owns the property that is up for auction. This could be a warehouse, barge, land, machinery, or any other asset that was used to secure the loan.
The first lien holder loaned money to the property owner that was secured by the asset. For example, if $5 million was loaned and there is an unpaid balance of $3 million. Then if the auction closes above $3 million, the first lien holder will receive the first $3 million of the auction proceeds with the balance going to secondary lien holders or the owner. Or if the auction closes at $3 million or below, the first lien holder gets it all.
The second lien holder also loaned money to the property owner. That money, however, was secured by a second lien on the property. Let’s suppose that the balance owed to the second lien holder is $1 million. If the auction closes at or below $3 million, he gets nothing. If it closes above $4 million, he gets his $1 million with the balance going to lower lien holders or the owner. If the auction closes between $3 million and $4 million, he gets the excess over $3 million.
Other interested parties are those that are interested in buying the asset provided they can get it at the “right” price. Sometimes these other parties can be independent third parties. Other times they can be affiliates of the various lien holders that are opportunistic bidders/buyers.
The matrix of possible players and their valuations is quite large, but we will describe one scenario here.
Two participants, the property owner and the first lien holder; no other lien holders or interested parties.
The auction format is an open “court house steps” style, English auction. (Strategies for other types of auctions, especially sealed bid, are different.)
The property owner should bid in the auction, but most do not. He should not bid more than $3 million since he could just pay off the loan for $3 million. He should not bid more than the property’s current value. This value could either be the business/personal value to him or it could be what he could sell it for to a third party
If it’s worth $2 million to him now (either for his own use or for resale), then that is the most he should bid. And finally, he should not bid more than he can pay.
If the owner follows these guidelines then the auction is a “no-lose” deal for him. In some situations there are strategies for the owner that involve an element of risk but can yield substantial gains. But for most owners the no-risk strategy is best.
The lien holder should bid in the auction. There are two situations to cover: the value of the property to the lien holder (for himself or for resale) is less than $3 million or the value is over $3 million.
If the value is less than $3 million the lien holder should certainly bid up to his value. With the property owner being the only other bidder there is no point in bidding above the value to the lien holder. This could be different if there are other bidders or if the other bidder is not the property owner.
Experience indicates that most financial institutions automatically bid up to $3 million, even when they should not. (Sometimes this is due to internal methods for allocating costs and profits between departments at the institution.)
If the value is greater than $3 million, the lien holder should always bid up to his value. Experience indicates that most lien holders seldom bid more than the $3 million even when it would be in their interest to do so.
Even in this simple transaction with only two players there are possibilities for improving returns. With more players the opportunity for improving returns increases dramatically.
Foreclosures and bankruptcy auctions can seem daunting at first, but once the underlying drivers are understood, sound financial strategies can be developed that minimize risk, and optimize returns.
For expert auction and reverse auction consulting to help you win more auctions with better margins, please contact: