Recently I bought a new house at auction and now I am in the process of selling the old house, which will also be by auction. As a result, I have spent a lot of time of late pondering the best way to approach an auction, both as a buyer and a seller.
There are a lot of different types of auction. In a Dutch auction, popular at wholesale fish markets and also known more prosaically as a descending price auction, the auctioneer starts with a high price, which is then reduced in increments until a buyer is prepared to pay that price for the fish (or whatever is being sold). Bond market tenders are closely related to Dutch auctions.
Another type of auction is a sealed bid auction, where buyers submit a single secret bid to the seller and the highest bid wins. I seem to recall that property sales in Scotland are something like a sealed bid auction (Scottish readers, please correct me if I have that wrong). Sealed bid auctions are also used in the bond market when investors are trying to sell illiquid bonds. In this context, the process is known as a “bid wanted in competition” (or BWIC) and banks will provide the investor with a single bid invisible to the other banks.
One problem with sealed bid auction is that bidders may be concerned about over-bidding, since they do not know what anyone else will bid, and may therefore place lower bids. The economist William Vickrey came up with a variant of the sealed bid auction designed to address this problem. His solution, known as the second-price sealed bid auction or Vickrey auction, still awards the auction to the highest bidder, but the bidder only pays the price submitted by the second highest bidder. The aim is to encourage buyers to bid the maximum price they are prepared to pay, with less fear of over-paying. Although popular with academics, Vickrey auctions are rare in practice. Still, given how bad liquidty is in bond markets today and how cautious banks are when providing BWIC prices, perhaps Vickrey auctions would be a good idea.
The most common type of auction is the English auction, also known as an ascending price auction. Bids at an English auction are made publically, increasing progressively until no further bids are offered and the highest bidder wins the auction. Typically English auctions are subject to a reserve price below which the vendor is not prepared to sell. If bidding does not exceed the reserve price, there is no sale. Australian property auctions use the English auction system and also adopt the practice that if the reserve price is not met, that the highest bidder has the first right of negotiation with the vendor to attempt to agree a sale price.
Before my recent house purchase, I spent a lot of time thinking about the best bidding technique and now that I am about to sell, I am thinking about how best to set a reserve price. When it comes to bidding techniques, I suspect that most of the time technique is irrelevant. Most people approach an auction with an upper limit in mind and either your limit is higher than everyone else’s limit or it is not. However, people are emotional and not everyone will stick to their limit. In the heat of the moment, with the property of their dreams apparently in reach, a bidder may stretch past that supposed upper limit. The primary aim of any auction bidding technique is to stop this happening. A popular approach is to wait until close to the end of the auction, when the bidding has all but run its course, and then jump in with a firm bid. The idea is that the other bidders, who though that the property was almost sold, will be dispirited by the appearance of the new bidder and will be discouraged from further bidding. Advocates of this approach often go further and recommend waiting until the auctioneer announces that property is “on the market” (i.e. the reserve price has been reached).
The problem with the bid last approach is that everyone seems to want to use this technique. As a result, at a number of auctions I have attended recently, no one wants to start the bidding and so the auction takes a painfully long time to get started as the auctioneer desperately tries to drag a bid out from the potential buyers. So, I decided to adopt a different approach. My aim was to appear to be an extremely confident bidder who was not prepared to be outbid. To achieve this I wanted to have the opportunity to make as many bids as possible, so I decided to start the bidding straight away at an almost ridiculously low price. The auctioneer appeared shocked first by how quickly bidding started, but then by the very low start. He attempted to brush off the bid as too low, so I simply shrugged and stepped back. Obviously keen to get the process moving, the auctioneer decided to accept the bid after all. The low price quickly attracted other bidders and after every other bid I immediately followed with a counter bid. In making these bids, I stepped up in smaller increments than the auctioneer was looking for but again, while trying to talk me into higher increments (“you won’t impress anyone with a bid that small”), he would never reject a higher bid. The aim of this exercise was simply to be very visible with my bidding. As the bids rose, the other bidders started to get nervous and partners had intense whispered conversations to determine their next bid. But again, when they did come up with a bid, I simply bid again without hesitation. Of course I had my own limit, but the plan was to bid as though I would never stop right up until I hit the limit and then simply stop. Whether it was the success of the technique or not, I ended up winning the auction, although the reserve was not met and so there followed an hour and a half of negotation with the vendor (via the intermediary of the agent) before we finally bought the new house.
Compared to selling, that process now seems quick and easy. Selling is far more stressful. Our auction is next week and we are yet to decide on a reserve price. While we have a good idea of the minimum amount we would accept, and we certainly would not set the reserve any lower, the question is whether it would be sensible to set the reserve higher. One line of reasoning is to set the reserve low to ensure that the property gets onto the market during the auction and then let the heat and enthusiasm of an auction where the property will definitely sell do the work to push to the highest price. On the other hand, it may make more sense to set a higher reserve in an attempt to take advantage of anchoring bias. The idea here is that if the property passes in (i.e. the reserve is not met) and we proceed to negotiate with the highest bidder, that bidder is then informed of the reserve price. While they will not want to pay that price, it may anchor their expectations of a fair price. Regardless of how realistic the reserve price, a bidder negotiating a price below the reserve will tend to think that they got a good price. So a higher reserve could tempt someone to pay a higher price than they would otherwise have reached if the auction completed with a lower reserve.
I have yet to decide which of these two theories I favour and, since I have brought up the subject of cognitive bias in decision making, I would have to concede that it feels even harder to make a rational decision about selling your house than about buying one. If anyone has any suggestions, I would welcome them!