Competition at distressed property auctions is starting to slip after hitting record highs in the first quarter of 2022. This trend foreshadows a continued slowdown in the larger retail market while also signaling emerging opportunities for real estate investors willing to swim against the current.
Proprietary buyer bidding data from Auction.com shows competition at distressed property auctions has started to ease after hitting all-time highs earlier in this year. The data also shows the average discount below estimated as-is market value rising in the second quarter of 2022, after dropping to a nearly nine-year low earlier in the pandemic. These two trends point to distressed property buyers who are starting to hedge against a price slowdown, or even correction, by shrinking their buy box and bidding more conservatively.
Easing Competition
Competition at both foreclosure auctions and bank-owned (REO) auctions hit an all-time high in first-quarter 2022 as measured by bids per property for REO auctions and online saves per property for foreclosure auctions, according to the Auction.com data. In both cases, competition pulled back from that all-time high in the second quarter.
Competition was still well above pre-pandemic levels in the second quarter, partially a function of the low supply of foreclosure and REO auctions. Properties brought to foreclosure auction during the quarter attracted an average of 24 online saves—four times the average saves per property in the first quarter of 2019. Properties brought to REO auction received an average of 11 bids, up from an average of nine bids per property in the second quarter of 2019.
The quarterly decrease in competition at foreclosure auction could in part be due to a gradually increasing supply of properties available at foreclosure auction. That number increased to a new pandemic high in the second quarter, although it was still 52% below the pre-pandemic level in second quarter 2019. But rising supply doesn’t explain the pullback in competition for REO auctions. The REO supply number decreased 12% between the first and second quarters of 2022.
Shrinking Buy Box
More likely the decrease in competition is the result of real estate investors shrinking their buy box to properties that represent a safer investment, based on factors such as location, price point, and surrounding market conditions.
“We’re transitioning from a super red-hot market and it’s cooling off a bit, mostly interest-rate driven,” said Paul Lizell, a real estate investor and coach who’s been investing since 2001. “We’re telling (our real estate investing students) to back off of some of the higher end properties and stay under $350,000. That’s a safer range.”
The foreclosure auction data broken down by value range indicates that other investors are also shrinking their buy box in terms of price range. Based on their “after-repair” market value, properties valued above $300,000 saw the biggest drop in competition from the peak in February to June, the latest month with data available. That above-$300,000 value range saw a 31% decrease in competition over the four-month period, while properties priced in the $100,000 to $300,000 range saw a 21% decrease drop in competition and properties in the under $100,000 price range saw a 12% decrease in competition.
Broken down by region of the country, the foreclosure auction competition decreased the most between February and June in the West (down 39%) and the Southeast (down 36%). Competition was down 22% in the Northeast and 16% in the Midwest. The bigger drops in the West and Southeast align with what Lizell is recommending to his students: a retreat from the heightened risk of “cyclical” markets more prone to bigger price swings and toward the relative safety of “linear” markets that tend to experience slower but steadier price growth over time.
“Some of your more cyclical markets may take a 20% hit (in prices),” said Lizell, noting that the retreat from cyclical markets like California has been in place for some time now as those markets became too pricy for many investors even before the pandemic. “A lot of our students are California people. It’s hard for them to find deals, so we teach them how to find deals in these other states: Indiana, Ohio, Kansas, Texas.”
More Conservative Bidding
Even within a smaller and safer buy box, investors are bidding more conservatively at distressed property auctions. That’s evident in the recent uptick in average purchase discount at auction relative to the estimated as-is value of the property. That as-is value is typically based on an exterior appraisal or broker price opinion, given the interiors of the homes are often not accessible. This discount represents the percentage below (or in rare cases above, in which case the discount would be expressed as a negative percentage) the estimated as-is value buyers are paying, on average.
The average purchase discount rose to 14.7% in the second quarter for foreclosure auctions, up from 11% in the first quarter and up from a nearly nine-year low of 8.9% in the first quarter of 2021. Similarly, the average purchase discount for REO auctions increased to 15.3% in the second quarter, up from a nearly nine-year low of 13.6% in the first quarter.
Lizell said he’s built in an extra 5% to 10% cushion when calculating his maximum allowable offer for distressed properties purchased at auction. Instead of starting his calculation at 75% of a property’s estimated after-repair value (ARV), he will start at 70% of ARV. Or he’ll start with 75% ARV, where the ARV is based on a 10% haircut off comparable sales.
“Just be a little more conservative,” he said of his bidding strategy. “Got to be nimble in this market. Super important. Otherwise, we’ll be out of business.”
Purchase Discounts Rising
Depending on the level and type of competition from other investors and credit strategy employed by foreclosing lenders, a more conservative bidding strategy by enough bidders could eventually raise the average purchase discounts at auction for a given market. That shift toward bigger purchase discounts is taking place in just over half (54%) of the 123 metropolitan statistical areas analyzed in the Auction.com data.
Markets with the biggest increase in average purchase discounts between 2021 and year-to-date 2022 were Buffalo, New York; Knoxville, Tennessee; Kingsport-Bristol, Tennessee; Honolulu, Hawaii; and Lansing, Michigan. Average purchase discounts increased in five of the 10 markets with the most properties brought to foreclosure auction in the first half of 2022: New York-Northern New Jersey, Atlanta, Detroit, Chicago, and St. Louis.
Among the top 10 markets, average purchase discounts decreased in the first half of 2022 in Cleveland, Ohio; Houston, Texas; Miami, Florida; Washington, D.C,; and Philadelphia, Pennsylvania. Among the larger set of 123 markets, those with the biggest decreases in average purchase discounts were Fayetteville, Arkansas; Macon, Georgia; Scranton, Pennsylvania; Greenville, South Carolina; and Hartford, Connecticut.
Deeper discounts at distressed property auctions could come if demand continues to deteriorate in the retail market, putting downward pressure on prices. Although he’s not expecting that scenario to play out in most markets, Lizell is putting aside some dry powder to ramp up acquisitions if it does.
“It’s more shifting to get cash quicker … so if it does shift, we are more in the position to take advantage of falling prices,” he said, recalling how quickly the market shifted in 2008. “We make more money in a down market than we do in a market like this.”
Richmond, Virginia-area investor Rick Starnes is already in “aggressive acquisition mode” and said he would become even more aggressive if prices fall in his market.
“If that happens again, I’ve got some money set aside. I’ll go out and buy four or five of them,” said Starnes, who has been purchasing properties at foreclosure and REO auction since 2018, while continuing to hold down a fulltime job. “If you’re holding the asset as a cash investor, the market is going to turn around. It might take years to turn around, but in the meantime, you can rent it out.
“The best thing I can see to hedge against inflation is to buy real estate,” he added.
Daren Blomquist is vice president of market economics at Auction.com. In this role, Blomquist analyzes and forecasts complex macro and microeconomic data trends within the marketplace and industry to provide value to both buyers and sellers using the Auction.com platform.
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