Auction Due Diligence


Caveat Emptor

Real estate transactions are governed by local, state, and federal laws. One of the phrases that dates back to old English law is the Latin phrase, caveat emptor, which means, “let the buyer beware.” The phrase is related to the verb “cavēre”, meaning “to be on guard.” Absent any contract language or terms that contradict this idea, the phrase implies that the buyer should proceed with caution; they are purchasing the property in its current condition, with any flaws that may exist and without any warranties. Buyer due diligence is imperative in any real estate transaction, but it is critical in an auction sale.

Disclosure Requirements

Caveat emptor implies that the seller is not responsible for any additional discourse of adverse conditions that may exist. Due to local legislative action, sellers in your jurisdiction may be responsible for disclosing certain material defects. Depending on the laws that exist in your area, it may be the responsibly of the buyer to provide disclose issues, particularly items in a that may risk an occupant’s health and safety in residential real estate transaction. In some states, sellers cannot waive disclosure with a disclaimer statement. In those instances, a seller’s failure to disclose information may be grounds for fraud. Even though misrepresentation by non-disclosure is a serious offense, like any illegal act, the law only provides recourse for a victim. As a buyer, you will want to best-protect your interest. For that reason, it is recommended that buyers perform their exercise due diligence as much as possible, as nobody will care work to protect your interests more than yourself.

As-Is, Where-Is

As-Is is a term used in warranty law to disclaim the seller’s liability. Essentially, the use of this phrase implies that the buyer is accepting the property in its current state, whether faults to the property are present and apparent or not. This language clarifies that there are no explicit or implied warranties to the properties condition, and it is used to help protect the seller.

The inclusion of an “as-is” clause in a does not necessarily insulate the seller from their common law duty to disclose defects or the required information, as required by local, state, or federal law. Furthermore, “as-is” language does not protect the seller from failure to disclosure, misrepresentation or fraud. Failure to disclose, whether intentional or negligent, is the result of not revealing known concealed defects that are not apparent from a visual inspection of the property.

As previously mentioned, many states have started to require that sellers disclose certain material defects or items related to the condition of a property, even if the property is being sold in as-is condition. In Maryland, for example, a seller cannot shelter behind caveat emptor. In the sale of a residential property in Maryland, sellers need to either complete a multi-page document disclosing the condition of various items, or sign a disclaimer statement. That disclosure statement, although stating that the property is being sold in as-is condition, requires sellers to acknowledge if they are aware of any latent defects – a defect that may be hazardous to someone’s health or safety.

Even if you are buying a property in as-is condition, you should consider hiring a professional to conduct an inspection of the property prior to purchase. There are often many situations where a defect may be visible from a home inspection; whereas, the seller may not have any personal knowledge of the defect.

Take Action – Perform Due Diligence

Performing due diligence means to investigate the facts about the property. Buyers look at performing due diligence as, “doing their homework,” before making an offer or submitting a bid, and then continuing with that same due diligence prior to settlement. The performance of due diligence can seem like an exhaustive, and with experience, the task may only become longer. Although the process may feel daunting, it is an essential step that buyers must take to protect their investment and reduce liability.

Understanding Auctions

What Is An Auction?

An auction is a sales event where prospective buyers place competitive bidders for property. Auction formats can widely vary, but for the purpose of this post, we will focus on the types of auctions and auction formats that are most common in real estate transactions.

When the word auction is mentioned, people usually think of the time they watched an episode of a storage container being auctioned, or maybe they remembered that time they heard an auctioneer quickly reciting numbers as they watched the sale of a historic Aston Martin. Auction chants are often what the general public envisions when they think of an auction, but it is important for buyers and sellers to understand the mechanics of how auctions operate, instead of simply being aware of what auctions appear to be. In short, buyers and sellers must understand why auctions are effective rather than just what an auction is.

Why Auctions?

As mentioned previously, auctions are sales events. They are nothing more than a marketing strategy that buyers use to achieve the best and highest price. With that said, auctions can be attractive options for both buyers and sellers. Now, you may be scratching your head right now asking, “How can an auction be an attractive option for buyers and sellers both?” Right now, you might be thinking that they can’t. However, the honest, more complicated answer is that they can.

You simply need to understand the mechanics behind the auction. Behind all of the theatrics and hyped-up energy that an auction brings, there are motivated sellers and ready, willing, and able buyers. An analysis of those two parties, and their intentions, will help you better understand how auctions can be fruitful for both buyers and sellers, given the right circumstances. Let’s dive into the why – understanding why auctions are effective at bringing buyers and sellers together. Before placing your first bid though, you will need to understand the mechanics of an auction.

Types of Auctions

In the world of auctions, there are a wide variety of auction types – increasing bid auctions, decreasing bid auctions, sealed bid auctions, and more. Each of these auction types are associated with a variety of strategies that can be advantageous to buyers and sellers for numerous reasons. Before you can plan your strategy, however, you need to understand the fundamentals of each auction type.

English Auction

English Auctions, also known as an ascending price auction, is an open bid auction where the price will increase as bids are placed.

Dutch Auction

Dutch Auctions, also known as a descending price auction, is an open bid auction where the price will decrease as bids are placed.

Sealed Bid Auction

A sealed-bid auction is a type of auction where bidders discretely submit their bids to the auctioneer. The bids are submitted in a manner where the bids of others are not disclosed to other auction participants. At the conclusion of the auction, the seller usually accepts the highest bid.

Due to the nature of these auctions, they are not usually used in typical real estate transactions. Instead, they are often used in bidding for situations where the bid or offer for contract involves more than just price. For example, a REO (real estate owned) sale may commonly ask that offers be tendered via a sealed bid auction. Although the offer price plays a large role in the decision-making process, the seller may also consider other terms – settlement timeframe, method of financing, etc. Another example of a sealed-bid auction would a bid for a government contract. This may entail an offer involving cost for services, but the offers being submitted may vary in other terms as well.

Common Real Estate Auction Types

English Auctions are the most common type of auction used for the sale of real estate. Most bidders will encounter two main sub-types of increasing bid auctions – absolute auctions and reserve auctions. Let’s look at how Absolute Auctions and Reserve Auctions work.

Absolute Auctions

An absolute auction is the most classic type of auction. In an absolute auction, the property, whether real estate or otherwise, is sold to the highest bidder regardless of price.

Example of an Absolute Auction

Jamie used to own a restaurant. After experiencing a series of hardships, she was forced to close her business and sell all of the kitchen equipment. She needs to immediately liquidate all of the assets and does not have a minimum price that she is trying to get for the items, as she cannot afford the cost of placing the items in storage. Jamie decided to hire a local auctioneer to sell the items at a live, on-site auction. The auctioneer will start the bidding off at $0. Although the auctioneer may suggest bidding increments to help control the flow of the auction, each item will sell for whatever high bid is achieved. Since Jamie is not reserving the right to withdraw the items from sale if a certain minimum bid is not met, this is an absolute auction.

Absolute Auctions & Real Estate

Due to the nature of what absolute auctions are, many sellers do not elect to sell real estate at an absolute auction. Instead, they tend to sell their property in a reserve auction. It is common for many auctioneers across the United States to advertise some auctions as “Absolute over $x,xxx” (e.g. Absolute over $100,000). These auctions, however, are not true absolute auctions. They are actually reserve auctions with the minimum bid being disclosed and advertised as the starting bid.

Reserve Auctions

Reserve auctions are commonly used in the sale of real estate. In a reserve auction, the seller, trustee, or their agent reserves the right to accept or decline any and all bids. At the conclusion of the auction, the high bid will be placed into the reserve, subject to the seller’s confirmation.

Prior to the start of the auction, the seller usually informs the auctioneer of their reserve price. The auctioneer will not usually disclose the reserve price to bidders prior to the auction. As bidding winds down, the auctioneer usually informs the public whether the high bid will be accepted or if it will placed into reserve for the seller’s confirmation.

In many live auctions, the seller is usually on-site and able to confirm whether the high bid will be accepted. At the conclusion of the reserve auction, the seller has three options if the reserve is not met. The seller can…

• accept the high bid, even though it is below their initial reserve price

• counter the high bidder, disclosing what they will sell the property for

• reject the high bid, and withdraw the property from sale

Example of a Reserve Auction

Mark used to own hundreds of rental properties. He is nearing retirement and is beginning to liquidate some of his assets. He knows the value of the properties, but since the properties are currently rented, he is electing to sell them at public auction. He prefers to provide all prospective buyers the day of the auction, instead of trying to coordinate multiple showings the with tenants.

Comparable properties in Mark’s neighborhood are selling for $120,000, but Mark knows that his properties need some work due to the wear-and-tear from the long-term tenants. Since the properties are rented, Mark doesn’t want to pay for any repairs. For that reason, he is stilling the property in as-is condition with a reserve price of $95,000.

Example A: Reserve Not Met

The day of the auction, the auctioneer opened up bidding at $50,000. The property quickly increased in price from $50,000 to $92,000. As the auction closed out, the auctioneer announced that the reserve was not met and the high bid would be placed into reserve, pending the seller’s confirmation. Mark considered the results of the auction, and had three options:

• accept the high bid of $92,000

• reject the high bid with a counteroffer between $92,000 and $95,000

• reject the high bid, withdraw the property from sale, and consider re-listing the property for another auction

After careful consideration, Mark decided to accept the high bid of $92,000. He knew that the carrying cost and additional risk of letting the property linger on the market. To him, it was not worth the chance of potentially only $3,000 more. He also knew that auctions don’t have guaranteed results. In reality, the next auction could end with a high bid less than $92,000.

Example B: Reserve Met

If Mark’s reserve was met, once a bid of $95,000 is met or exceeded, the auction would convert from a reserve auction to an absolute auction, where Mark would be expected to accept the high bid, regardless of the price.

Reserve Auctions & Real Estate

As highlighted in Mark’s scenario, auctions do not have guaranteed results. Although a reserve auction can help protect a seller from being required to sell the property for less than what they are willing to accept, it doesn’t mean the seller will always achieve exactly what they are expecting. Reserve auctions are often scrutinized because bidders may win an auction and still lose. Some critics of reserve auctions argue that auctions are simply a marketing gimmick to achieve a price at or above their asking price. The reality, however, is that auctions can favor buyers as much as they favor sellers. Buyers and sellers simply need to have a clear strategy in mind before participating in an auction sale.