The distressed residential real estate market early this year generated plenty of headlines about sprawling Long Island mansions, surplus Miami condos and raw land around Las Vegas all going up for auction after owners fell on hard times.

Now it's the commercial property sector's turn. Auction houses that have been preoccupied with foreclosed subdivisions now report a looming cascade of auctions featuring troubled warehouses, office buildings and hotels ready to come to market in the second half of 2008.

“We've had the calm before the storm in the commercial marketplace. All the attention has been focused on residential housing until recently,” says Rick Levin, owner of auction house Rick Levin & Associates in Chicago. “Now we're starting to promote commercial properties. Commercial owners desperate to dispose of their assets are looking for new marketing avenues.”

In Rainbow City, Ala., Michael Fisher, president and CEO of the Redfield Group, says that he's looking at twice as many commercial properties to be put up for auction compared with a year ago. “June and July this year are shaping up to be big months for us,” says Fisher.

Storm preparations

One auctioneer after another is predicting a boom in commercial sales this summer and fall, continuing a growth trend that goes back at least five years. In 2003, U.S. commercial auction transactions were valued at $11.8 billion, according to the National Auctioneers Association in Overland Park, Kan. By 2006, that total had jumped to $15 billion. In 2007, it rose another 5% to $15.7 billion. Residential auction sales also have made great strides. Last year, residential sales rose 6% to $16.9 billion, up from $16 billion recorded in 2006.

The sheer dollar volume tells only part of the story. Steven L. Good, chairman and CEO of the country's biggest auction house, Sheldon Good & Co. in Chicago, notes that pricing has plummeted — down by 10% to 30% — on many commercial properties in the past 12 months. So despite the higher transaction volume these days, sale prices are less per property than in the past.

Still, Good is bullish on the state of the market. “We're processing $150 million a month right now in our auction pipeline. That's increased by a third from a year ago,” he says, adding that not all of those leads result in sales.

Sheldon Good lately has turned down 40% of the prospective deals it's seen. “That's because the capital structures of some commercial property assets are upside down owing to drastic drops in valuations,” Good says.

Still, he expects to see a rush to auctions, particularly in the months leading up to the November elections, on the theory that a Democrat in the White House in 2009 could lead to higher capital gains tax rates. Presidential candidate Barack Obama supports an increase.

“I think we're going to see a lot of folks trying to liquefy their assets now to take advantage of the current low capital gains rates,” he says. “Volumes by the end of this year could be up by a big margin over 2007 for us and all auction firms.”

What kinds of properties is Good working on? The auction house scheduled a late May auction for a 228-room Holiday Inn hotel in Collinsville, Ill. The hotel was erected in 1982 with the help of a $13 million state development loan that was supposed to be repaid out of profits. But the hotel never turned a profit, and by last year when the state foreclosed, the loan with interest had ballooned to $32 million.

State officials suspect the previous owners of financial impropriety. “We can't rely on the old expense numbers at the hotel,” says Good. “The state decided on the auction because they wanted to be sure that somebody who was politically connected could not come in the back door and steal this hotel away at a very low price. An auction makes the process absolutely transparent, giving everybody an opportunity to bid.”

Expediting the process

More and more, auction houses are forming brokerage divisions to be able to provide a wider range of services to clients. Sheldon Good started up a new brokerage division in 2002 and brokerage now accounts for 10% of all revenues. Rival Inland Real Estate Auctions in Oak Brook, Ill., came from the other direction. The company was formed seven years ago as an adjunct to the older development and brokerage businesses already assembled under Inland Real Estate Group.

Frank Diliberto, president and CEO of Inland Auctions and a former Sheldon Good executive, reports that his firm's auction volumes have doubled over the past year. His recently promoted sales include a 50-acre golf course in Bensenville, Ill., a 108-acre golf course in Green Lake, Wis., and a 396-unit apartment building in Grayslake, Ill.

Why auction these assets? The golf course in Green Lake is owned by an investor ready to retire who doesn't want a long, drawn-out brokering process. The Bensenville golf course is being sold by its owner, the municipality, with the provision that its zoning will be changed, perhaps to offices, retail or residential.

“The village wants to use the auction to determine what the golf course property is best suited for in the future,” Diliberto says.

As for the apartment building, it would likely be sold to a local investor under ordinary circumstances. But in this case the partnership owning the complex wanted to reach out to a national audience in order to fetch a higher selling price. Hence, the sellers are financing a $1.2 million advertising campaign spread over eight weeks to promote the property in national publications.

“A broker who would take the apartment listing could never afford the kind of advertising investment we've made here,” Diliberto says. “He would probably have the listing for a year or more and do bits and pieces of ads. We've consolidated the marketing into a tight time frame. We front-end the advertising investment to launch the property onto the market in a big way.”

Beating the brokers

In suburban Atlanta, the Redfield Group earlier this year sold three dozen commercial parcels north of the city in Jasper Highlands. The seller was a local partnership that had listed the lots with local brokers some two years ago, but sales stalled when the market soured. The average auction price for each one-acre lot was $350,000, more than most observers had expected. “We got a higher price by focusing national bidders on the property,” says Fisher of Redfield.

Earlier, Redfield sold a hotel in Big Bear, Calif., in federal receivership. Three different brokerage firms had tried to sell the hotel, garnering a high bid of $8 million. With just 21 days to market the property before auction, Redfield ran an ad blitz and attracted a half-dozen new, interested bidders who had never seen the property before. A group of investors from Southern California ended up paying $10.3 million for the property.

Contrary to the image of auctions, only a small share of sales involve commercial properties in foreclosure. Fisher estimates that just 5% of his auctions represent foreclosed assets. “Most of my clients have already tried to sell their properties through other means,” he explains. “They hire me finally to accelerate the sales process.”

He isn't always successful, of course. “We sell about 80% to 85% of the properties we handle for auction,” he reveals. The rest, he admits, don't meet reserve prices, or the minimum amount at which a property may be sold at auction.

A decade ago almost all of the 100 or more auction firms in the U.S. were little boutique operations, often manned by a single auctioneer. But that's changed the past couple of years as a handful of businesses led by Sheldon Good bulk up with more staff and multi-state licensing.

Williams & Williams Marketing Services in Tulsa, Okla., for instance, handled mostly high-end homes until five years ago. “We made a strategic commitment to broaden our services and scale and compete with traditional brokerages across the country,” says CEO Dean Williams. The company still has a single office in Tulsa, but auctions properties in 50 states and has 200 employees. “We've doubled our sales every year in the past five years,” says Williams.

A layer of transparency

Other auction houses, alas, are moving toward sealed bids. Newcastle Ltd. in Chicago negotiated the sealed-bid sales of big parcels such as the 14-acre South Water Market produce terminal on Chicago's South Side, which went for $35 million back in 2003 to condo developers. Newcastle received $24 million in the sale of a 70-acre parcel belonging to Baxter International in suburban Deerfield a short time later to Takeda Pharmaceutical Co., which built a new headquarters on the land.

Newcastle sold two one-acre parcels via sealed bid on Chicago's North Side a year ago for Loyola University, but otherwise such transactions have been harder to execute lately. And Michael Haney, president and CEO, thinks he knows why.

“We used to auction a lot of vacant land with development potential,” Haney recalls. “But there isn't much new commercial development occurring today. So that limits your pool of bidders, whether you're in a brokerage or an auction situation.”

Haney still thinks that sealed bids remain underappreciated and underutilized. True auctions, he notes, typically carry no buyer contingencies and no questions asked — purely a financial transaction. But many of Newcastle's clients over the years have been nonprofits seeking more than just the highest price.

“We represented Loyola University in the sale of vacant land in Chicago that was going to be rezoned for a high-rise,” Haney says. “But Loyola wanted to negotiate with the winning bidder a lease for university facilities to be put on the first couple of floors of the new building. Loyola could have offered the deal through a broker, but universities like the transparency of an auction.”

Brokers won't yield easily

There are still plenty of naysayers in the conventional brokerage community who doubt that commercial real estate auctions will ever gain wide acceptance. One obstacle is the high prices charged by auctioneers, who charge premiums up to 10% of the sale price.

“The auction houses claim that they can bring an asset to a wider audience,” says Daniel Herrold, a director at Stan Johnson Co. in Tulsa, Okla., a commercial brokerage and advisory firm. “But we have 25 brokers and a deep database of clients, and when a listing comes up we're calling probably 90% to 95% of the players that we know will be interested in that product. Maybe we might miss a foreign player or a new investment group. But a good broker doesn't miss much.”

Even some of the leading auctioneers are tempering the bullish outlook with some caution. In Chicago, Levin of Rick Levin and Associates estimates that the pricing gap between buyers and sellers is as much as 20%. “Sellers think it's 2004 and buyers think it's 1930,” Levin says. “The gap between seller and buyer expectations is usually just 5% to 10%. With current conditions we may be setting ourselves up for a high percentage of auctions ending up with no sale later this year.”

Levin rejects more than half the auction prospects he sees, usually because the seller is asking too high a price. But other executives in the industry aren't so concerned. Auctions will always fill a critical need, they argue. Attorney Irwin Gzesh in Chicago had a client who had inherited a chain of grocery stores around the Midwest with estate taxes due within four months and no cash to pay the taxes. A Sheldon Good auction of the grocery sites raised the capital he needed in short order.

And finally there is the matter of valuation. “If you list your property with a broker and ask $10 million, that sets an artificial ceiling on what you will get,” Gzesh says. “Nobody is going to offer you $11 million. They'll assume you'll settle for $8.5 to $9 million. But an auction just might get you that $11 million. The auction is always the best way to determine the market value of a piece of property.”

Lee Murphy is based in Chicago.

Web auctions: The wave of the future?

The latest wrinkle in commercial auctions is the Internet. The LFC Group of Cos. in Newport Beach, Calif., has been staging auctions online since 2003, but has worked for clients willing to put larger and larger assets up in cyberspace recently. Late last year, the firm sold the former headquarters of bankrupt Adelphia Communications Corp. in remote Coudersport, Pa.

The palatial building carried a replacement value of $30 million, but its quirky location made it impossible to sell through conventional means. After some false starts — the first two winning bidders online could not close — Adelphia ended up selling to Klek Development Co. of Chicago for $3.6 million.

Currently LFC is in the process of selling 3,000 acres in Florida owned by St. Joe Co., a timber and paper conglomerate based in Jacksonville. Kelly Lovegrove, LFC's director of operations, predicts that assets as varied as the Adelphia headquarters and the St. Joe land will increasingly be peddled online in the future.

“The problem with the traditional open-outcry auction is that you're forcing buyers to be at a certain place at a certain time,” Lovegrove says. “And buyers in an auction feel pressure, and often don't perform at their best. We've had the sense that people walking out of a live auction would have bid a little more if they had more time to think about what they were doing.”

LFC's sales feature bid extensions in 24-hour increments. If a bid is made within 24 hours of a deadline, then bidding is automatically extended an extra 24 hours to give other potential buyers time to regroup. One sale was extended an extra 30 days as bids kept going higher.

Louis B. Fisher III, the national auctioneer for Sperry Van Ness in Irvine, Calif., is betting that the Internet and open outcries will be married in the future as buyers watching video streams of ballroom auctions many miles away have the option of bidding for properties on their computers. He has established a new company, AmeriBid in Las Vegas, to create such events.

AmeriBid together with Sperry Van Ness has a contract to sell via auction in July a group of 80 commercial assets owned by a Florida bank. “We'll do it in real time in a hotel ballroom with simultaneous bidding over the Internet,” Fisher says. “It's a pilot program for us. If it's successful, we may eventually do such sales Internet only.”
— H. Lee Murphy