Distressed Assets Fuel Auction Renaissance

Anyone who's been watching the FDIC trade billions of dollars worth of commercial real estate loans and properties knows how important auctions have become, especially in the sale of distressed assets. A staple of the RTC, auctions have again become commonplace, thanks to firms such as DebtX and LFC.com. "There's a resurgence of auctions because of the overabundance of assets," says Kelly Lovegrove, director of operations for LFC.com. "And auctions are the quickest ways to clear assets."

And with the likes of eBay and Amazon.com so ingrained in our culture, e-commerce seems a logical solution for the commercial real estate industry. "Buyers are accustomed to going online," says Guy Ponticiello, managing director at Jones Lang LaSalle Corporate Capital Markets in Chicago.

JLL recently formed a partnership with auction firm Real Estate Disposition LLC to auction off assets. "It's a fabulous way to sell-distressed or non-distressed-commercial notes and properties in an effective manner," Ponticiello says. REDC has disposed of roughly $5 billion of residential assets via auction over the past two years. The venture just went to market last month with its first offering: a non-distressed office property in Dayton, OH for Procter & Gamble.

The current use of technology is perhaps the biggest difference from when the RTC turned to auctions in the early '90s to sell off large portfolios of distressed assets. And because of technological advances, offerings at online auctions can be scaled to suit much smaller transactions, says Kingsley Greenland, president and CEO of Boston-based DebtX.

"In the RTC days, it was very costly to put a sale together because of the paper, etc.," Greenland points out. "You had to have larger pools available, and that excluded a lot of people. Now there's a much larger participatory base." For the FDIC, DebtX has priced 61,401 commercial loans with an aggregate principal balance of $714.1 billion as of Aug. 31. Some 627 US CMBS trusts collateralize the paper, a mix of performing and non-performing loans. And last month, DebtX auctioned $788 million in loan participations from the failed Silverton Bank of Georgia, among other deals, for the FDIC.

The auction platform has kicked trades into gear, and those transactions are setting pricing for the industry, Greenland says. That's been a real challenge throughout the industry-not enough deals have been done to establish pricing. Also, with commercial loans, compared to residential, the values differ wildly and can be 500 basis points apart, Greenland adds, making price discovery all the more important.

"Every seller will be successful with the right minimum bid," says Lovegrove." It's a better opportunity to get buyers off the sidelines."

Still, there's a gulf between what sellers are willing to trade at and what buyers are hoping to pay. "The bid-ask gap brings it all to a halt, a gridlock," says Joe Tang, founder and CEO of Auction Point, a company that launched in Marina del Rey, CA in August. "What auctioning does is get rid of the gridlock. It's competitive, fair bidding and you wind up with market value." Auction Point's process factors in an additional five minutes of bidding each time a new bid comes in after the deadline. That helps to keep the process fair and stop the dark horses who wait till the last second to place a bid and wipe everybody out. In some cases, the company's trades have run an additional two hours to accommodate everyone. Tang likens it to the traditional going once-going twice approach to sales and says it creates "true market value."

Auction Point adds its own twist on the online auction process by working with local brokers who market the properties using the tools it provides. Tang and partner Keith Yang, co founder and president of Auction Point, were developers in Orange County, CA, before the markets crashed in 2007. That left them holding a lot of commercial real estate they wanted to move. The brokers they hired to market the properties weren't getting anywhere and so the partners decided to create a platform that married traditional brokerage with online auction technology.

"Auction houses wanted to replace our local broker," Tang says, noting that the auctioneers planned to market and sell the properties for him. "That's not our approach. We believe that local brokers best understand the buyer pool so they drive all the buyers to the site."

One advantage of auctions is that in this process, the sellers are committed to a sale. And as long as there are bidders, a deal will get done. The bidding process seems to level the playing field, because bidders know they are competing fairly and on the same terms as other buyers, Ponticiello explains.

Auctions can also connect to a much broader audience. "You get more reach and higher proceeds," observes Greenland. In fact, because of the extensive reach of the Internet, he adds that prices should be higher now than they were on a relative basis during the RTC. "The more illiquid the asset, the greater need to distribute information, the more efficient the online marketplace," he says. And with the nation bracing for the possibility of up to a thousand or so small banks collapsing over the next few years, placing failed assets in the hands of the FDIC, a fast method of sale will be critical. There's talk that banks have thus far kept most distressed assets on their books. Back in April, Chris Marinac, an analyst at FIG Partners in Atlanta, told the New York Times that the transaction volume of distressed loans over the next three to four years will possibly dwarf-some 20 times over-what the industry witnessed during the past two years. In that same article, Greenland pointed out that auctions may ultimately play a role in the economic turnaround. "Whoever's saying that bad assets can't be moved off of banks' balance sheets they can," he said. "It's a pricing issue. It's not that there's not liquidity out there."

For auctions to be successful, sellers have to provide in-depth information to potential bidders, so they must be organized. "They're asking the buyer to make a decision in an accelerated time frame, so they need to provide all of the information to receive a good offer," Ponticiello says. And while in traditional trades due diligence is done before an offer is submitted or during inspection, with auctions, it is done upfront. Like other areas of the industry, auctions have become more transparent too, he adds.

Bidders provide refundable deposits, which can run the gamut in size, prior to the auction. For example, Auction Point charges a flat $2,000 deposit to each bidder for every auction, while some FDIC auctions require a $50,000 refundable deposit. And in many cases, bidders must meet other financial criteria, like a certain threshold of net worth. It's all just another way to vet potential bidders and guarantee the sale.

With several options now available, there are many factors that asset owners look for in their auction partners. Competence is important, as is size and scale to be able to process the business, argues Greenland. "Size does mean something. It has an impact," he says. Another key factor is comfort, he adds. Going forward, there could well be a firm place for online auctions within investment sales. As Tang says, online auctions bring lasting efficiencies to the industry. And with major organizations such as the FDIC divesting assets via auction, it certainly brings a lot of credibility to the auction process. Tang likens the commercial real estate auctions to what has been happening on Wall Street with stock trades for years. "Technology has been brought to Wall Street, but technology has not been brought to commercial real estate," he says. "The transparent online auctioning platform makes a lot of sense in the distressed world. This is game-changing technology."

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