How to Buy Houses at Auction and Not Get Burned

by Jason van Steenwyk on Real Estate Investing

Gavel and a Small House

Many investors achieve a certain level of success buying properties on the open market – but are intimidated by the auction process. For whatever reason, they shy away from anything smacking of the courtroom, or they are intimidated by the open competitive bidding process.

If this describes you, you might be selling yourself short – no pun intended. The reason: The public auction represents a significant portion of the total real estate market. If you know what you’re doing – and if you have some cash available on short notice – you can compete in these deals on an a level playing field with the big boys.

How to Find Properties

In the past, you had to show up at the courthouse to get the list of properties to be auctioned that week or month. Now they almost all post them online on the county website. From there, a number of aggregation sites scrape them from the county websites and present them for their data subscribers nationwide – though for the most part you’ll be bidding against investors from your own county and the immediately surrounding ones.

If you are simply looking for one or two houses to flip and have time to navigate your own county’s site, or you don’t mind going to the trustee’s office to pick up the schedule and list of properties to be auctioned, you can probably get away with just following your own county trustee’s site. It’s not very efficient, but if you have more time than money, it can be done.

The Auction Process

Auctions occur when a government entity or a lender finds itself in possession of a property it doesn’t want. They don’t want to be landlords. They want cash. But seizures happen, and foreclosures happen, and they are saddled with the challenge of converting a property they can’t use back into cash that they can use – in a reasonably efficient way.

The specific procedures are governed by state and local laws, so they vary from place to place. But in general, here’s what needs to happen:

  • The lender provides notice to the borrower that it intends to foreclose on the property.
  • The borrower has a chance to respond with legal challenges of his or her own.
  • The lender secures a court order transferring control of the property back to them, and gains the right to evict the owner or tenants.
  • The lender announces its intent to sell the property at auction. Normally, the investment community only gets a few days – so you have to do due diligence on a pretty tight timeline. Auctions are “as-is.” You buy it, you own it, whatever’s right and wrong. You cannot rescind an auction purchase.
  • When the trustee makes the announcement, he or she will specify the address and the minimum opening bid. This is the lowest amount the current owner will accept.
  • This amount is key, because this is the amount of guaranteed funds you need to show up with. That means you need to have a counter check from a bank in hand. Indeed, some areas require you to show up with $1 more than that amount.

Of course, this means that to play in this market, you either need the cash already in your account, or you need a good relationship with a lender. A good trustee will often go around the room when the auction starts and verify that all participants have the funds in hand. Don’t even bother to show up to the table if you can’t do that. You’re wasting everyone’s time.

Learn more about foreclosure auctions here.

The trustee will also issue the administrative directions and bidding rules. For instance, the trustee will go over these key issues:

  • The minimum opening bid and ante requirements.
  • The address of the property.
  • The minimum and maximum bid increments. (If everyone bids $1 over the last bidder, you’ll be there all day. The trustee may set a $1,000 minimum bid increment to keep things moving – and also set a maximum increment, too. For example, you may be prohibited from bidding more than $2,500 more than the last bid.)
  • What time the winning bidder has to return with the rest of the money to secure the property. (The trustee will usually give you a couple of hours to go to the bank and get a certified check for the balance of the transaction.)
  • What happens if the winning bidder doesn’t show up. Frequently, the trustee will call or email the second-place bidder, or the second- and third-place bidders, and tell them the property is theirs if they show up with guaranteed funds in hand by the end of the day.

Note that some areas have enabled online bidding. Bidders don’t even need to be present. In my view, these auctions are likely to be more efficient – in the market theory sense – than those in counties that don’t allow online bidding. This means that it will be harder to find significantly underpriced properties in these auctions.

Here’s an example of bidding rules and procedures from the office of the public trustee for Douglas County, Colorado. You’ll need to contact your county officials for rules specific to your market.

What can go Wrong?

The vast majority of auction sales go through without major hitches. But there are a few risks pertaining to auction properties that you should keep in mind before you bid.

1.)   You can’t inspect the property before the auction. Therefore, you need to account for the cost of fixing up a damaged property. Foreclosed owners frequently vandalize their homes before vacating or getting evicted. They’ll sometimes strip everything of value. Expect to replace appliances and carpeting, as a minimum, and plan on doing a good interior paint job. Adjust your bids accordingly.

2.)   The place may be contaminated. Meth labs are all too common these days. Also, the house may have been used for criminal activity in the past, which could hurt your property values going forward. To hedge your bets a little, check police blotters for incidents that have occurred at that address in recent months.

3.)   Does it have a basement? Is radon contamination common in the area? If so, discount from your bid to account for the possible cost of radon mitigation.

4.)   Foreclosed homes often have title problems. It could be difficult to get title insurance.

5.)   Research existing liens on the property. If you win the bid, you will have to come up with the old owners’ back taxes and perhaps fines and zoning penalties. If you can identify these liens in advance, you can subtract these amounts from your value estimation of the property. If someone outbids you substantially, he’s welcome to it.

That brings us to an important point: There’s nothing wrong with showing up to an auction and not winning. Yes, you have spent some time doing due diligence on the property. But it’s better by far to walk away than to bid too much. Always be willing to walk away.

 This guest post was written by Jason van Steenwyk, a staff writer for the blog. He has been writing professionally about personal finance and investments since 1999.