When Pritzker Realty Group decided to sell a Kansas City office building last summer, the private investment firm didn't hand the listing to a local broker. Like an increasing number of sellers, the Chicago-based firm marketed the 260,000 sq. ft. building through a public commercial real estate auction.

The format has generated growing interest among commercial real estate investors in recent years. Gross sales revenue of commercial properties sold at auction jumped by roughly 27.4% annually over a three-year period beginning in 2004, according to the Kansas-based National Auctioneers Association.

Auctions appear to work best for properties that ultimately fetch $20 million or less, a conclusion based on sales achieved in the past 12 months. Auctions can be helpful in situations where the seller is unsure what a property is worth. The approach appeals to sellers because auctions at times draw many potential buyers and can fetch high prices. Also, buyers take on more of the transaction costs.

Unlike the traditional approach whereby a broker is hired to market a building, commercial real estate auctions force potential buyers to act within a compressed time frame — typically six to eight weeks — or forfeit the deal. That is why many in the business refer to auctions as “accelerated marketing” plans.

Sold! For $18 million

In the Pritzker disposition, the sale was not only accelerated, it was successful beyond expectation. Anchor tenant Farmland Industries declared bankruptcy in 2002. Farmland's six-story building near Kansas City International airport was 85% vacant, and leasing prospects were dim. Given the challenge, Pritzker hired real estate auction firm Sheldon Good & Co. LLC to market the Class-A property in late August.

Pritzker aimed to fetch $13 million from the Farmland building. All of the sealed bids were received by the end of August last year and enclosed with a required $300,000 cashier's check. The final price achieved at the November auction was $18 million, or roughly 40% above the minimum price set by Pritzker, according to Steven Good, chairman and CEO of Sheldon Good & Co.

The Kansas City Aviation Department (KCAD) was the winning bidder. What's more, Good says parties on both sides of the deal were satisfied with the auction's outcome.

“The seller did better than it would have with a conventional marketing plan, and the buyer believes that it can extract value by marketing the building differently than the previous owner,” he says. KCAD is subdividing the building to lease to smaller tenants.

Proponents say commercial real estate auctions offer sellers a highly transparent process, since buyers and sellers know exactly where they stand as successive bids are shouted out. “We use transparency as a way to drive excitement since we can line up all of the potential buyers at the same time,” says Good.

Why auctions work

Sheldon Good & Co. was founded in 1965 by Steven Good's father. Since then, the Chicago-based company has sold more than $4 billion of real estate, making it the largest U.S. real estate auction firm by total revenues. The company conducted about $100 million in commercial real estate auctions each month last year. In the previous year, monthly volume averaged just $75 million.

What's driving the growth of commercial real estate auctions? Good says that sellers want to ensure that the greatest number of potential buyers consider their offering. By exposing the property to the widest range of investors, Good believes that auctions allow sellers to achieve the highest price.

Commercial real estate owner and developer Roger Kellogg agrees. The Jacksonville-based office investor has repeatedly bought and sold property through Sheldon Good auctions since 2001. He's also seen bidders face off over one of his properties, driving the sale price up dramatically at auction. In 2003, for example, Kellogg sold a suburban office property located in Florida through a public auction.

“We had 60 people bidding on that Orlando property. I was actually afraid that the pricing was getting too high for the winning bidder,” says Kellogg, president of Kellogg Development. That's a problem most sellers would love to have.

Needless to say, Kellogg was pleased when the 30,000 sq. ft. suburban office building fetched $3.15 million. He says that commercial real estate auctions are an efficient way to drive interest in a property and guarantee that the buyer is willing to close on the deal.

Caveat emptor

Indeed, the auction experience differs from the traditional method. For one thing, auctions make concrete demands on interested buyers. Bidders must conduct their due diligence before a set date — typically when the first set of bids are received.

In contrast, conventional buyers often demand a certain amount of time after the sale to examine the property more closely. If entitlements or zoning issues crop up, the deal can be compromised.

For the auction buyer, however, the term caveat emptor (or buyer beware) carries great weight. Not only are most buyers required to pony up as much as 10% of their bid in advance, that money is used to fund the sale if they prevail in the auction. Kellogg believes that few people will walk away from a 10% deposit on a multi-million dollar property.

Auction sellers also fork over less money for broker commissions. Here's how it works: In an auction, the buyer — rather than the seller — typically absorbs the commission fee. While a broker can earn as much as a 10% commission on the gross sale price of a deal, owners who sell at auction have less exposure to fees.

Sheldon Good, for example, typically extracts 3% to 10% of a so-called “buyer's premium” from the winning bidder. But sellers are still on the hook for some of the costs. Most auctioneers ask sellers to pay for print advertising in advance of the auction, plus other marketing incidentals.

Even so, Good says seller fees incurred at auction are offset by the sale price, which tends to be higher than with traditional broker-assisted transactions, so sellers often pocket greater sums from the auction. This is especially true of auctions that end with bidding wars, which can lead many buyers to pay more than they expected at the start of the auction.

In fact, the most common method used in commercial real estate is called the “open outcry” auction, which assembles qualified bidders at or near the property on a specific date.

For instance, Tulsa-based Williams & Williams conducts all of its auctions through open outcry format. In fact, the firm sells everything from golf courses and industrial properties to cold storage facilities and apartment buildings in the open outcry format.

Dean Williams, president and CEO of the family-run firm, says the average sale price achieved at a Williams & Williams commercial real estate auction is $1.5 million. “This is a great way to remove the middleman and truly find out what your asset is worth,” says Williams, who has seen bidding wars ratchet up the final price of an asset at auction.

The sealed-bid and open outcry auctions aren't mutually exclusive, however. The Farmland building sale began with sealed bids, but a welter of matching bids spurred an open outcry auction.

With the sealed-bid auction, each party submits a confidential offer to the seller. If two or more of the highest bids match, the seller asks each party to raise their respective bid.

Accelerating the process

“The accelerated marketing process puts the burden on the buyer,” says Jerry Anderson, president and chief operating officer at Irvine, Calif.-based investment sales brokerage Sperry Van Ness. The company sold roughly $400 million of commercial property at auction in 2006, up from $300 million in 2005.

The company places up to a dozen classified auction ads in the Wall Street Journal every week. With the Journal's global circulation of nearly 2 million readers, Sperry Van Ness ensures that the greatest number of investors is alerted to the deal.

In January, the firm's accelerated marketing division auctioned off an entire city block in downtown Oklahoma City. The Bricktown Square property fetched $10.9 million at a public auction late last year. Bidding for the seven-building, 189,423 sq. ft. parcel started at $8 million.

The sealed bids arrived several weeks before the planned auction, at which point Sperry Van Ness contacted the highest bidders. During the public auction, which drew four willing buyers to the ballroom of an Oklahoma City hotel in November, bidding quickly shot up by nearly $3 million to almost $11 million.

The winning bidder was local property developer Jeff Moore, who officially closed on the property in a matter of weeks. Four of the Bricktown Square buildings are leased on a long-term basis by restaurants, and the property is listed on the National Register of Historic Places.

Not just for sleepers

During the early 1990s, the Resolution Trust Corp. famously auctioned off a wave of distressed commercial properties. More than $1 billion in assets were liquidated via public auctions in the early 1990s, and that activity may have typecast auctions as a last-ditch strategy.

Now, even plum lots on the waterfront are being sold at auction. In late June, for example, 12.2 beach front acres in Hampton, Va. will be auctioned off. Sperry Van Ness auctioneer John Johnson had already received more than a dozen inquiries about the property as of early May, most from developers interested in building luxury condos and townhouses on the site.

The City of Hampton recently amended the site's zoning to allow for residential development. Five separate investors own the parcel, and existing structures include a motel and an apartment building. Johnson says that the new owner will demolish all of the existing structures.

The sellers have provided Johnson with a number — also known in auction circles as a “floor” — below which they will not sell the property. When a seller doesn't have a floor, the auction is referred to as an “absolute auction.”

“We expect to have about five bidders at the open outcry auction on June 21, and they will be the top bidders,” he says.

Johnson expects to conduct more commercial real estate auctions over the next few months, especially if a downturn motivates sellers to liquidate their assets.

But the recent flurry of commercial real estate auctions challenges that view. “The market has been very strong for a long time,” says Johnson. “And we expect the auction business to remain strong,.

Kellogg sees the modern stock market as a shining endorsement of the auction model. Buying and selling stocks 30 years ago, he notes, wasn't efficient or cheap.

“Fast forward to the computer age and you can buy or sell stocks in a transaction that costs pennies per share and takes place in a span of less than two minutes from placing the order,” Kellogg says. “That is simply an auction format, and the result is greater efficiency and transparency that ultimately leads to higher price/earnings ratios and pricing.”

Parke Chapman is senior associate editor.