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Auctions: How to get over the risks of being under the hammer
- Nov 28, 2023
- Latest Journal
by Maia Smith, Trainee Solicitor, Wedlake Bell
The rising popularity of auctions
Amidst a turbulent property market and unfavourable mortgage rates, transacting with speed and certainty is ever more attractive to commercial sellers – a package offered more readily by the auction process. With contracts exchanged on the fall of the hammer and a typical completion timeline of 28 days (in accordance with the Royal Institution of Chartered Surveyors Common Auction Conditions (“CAC“)), auctions are on the rise. A growing commercial property auction market also increases the likelihood of securing a true market price, paired with confidence the deal will go through. So what is the catch?
Caution before auction
As both the buyer and the seller are bound by the terms of the contract at the point the hammer falls on the highest successful bid, the buyer’s due diligence on the property must be conducted before the auction. However, buyers are often reticent about spending money on legal work which might turn out to be pointless if they are outbid. The fact remains, a blind purchase may later reveal severe defects in the property or its title (particularly if the property being auctioned was tricky to sell on the open market), and there is limited time to perfect them before completion and perhaps no obligation on the seller to assist to resolve any such defect. Any defect, if known, may have lowered the price the buyer was willing to pay or even precluded a bid altogether. The buyer may not be able to claim any of the unexpected cost of dealing with the newfound issue(s) from the seller.
A non-cash purchase will require meticulous financial planning prior to auction, and certainly an agreement in principle with the lender. The ultimate sale price can also differ considerably from the ‘guide price’ – leading to unanticipated expense.
The CAC (19.1) states that the buyer must pay the deposit before leaving the auction venue. If the buyer is unable or unwilling to pay the balance, the seller may, at any time after completion date, serve the buyer with a ‘notice to complete.’ This allows 10 days from service of the notice for completion. Thereafter, the seller is entitled to:
• retain the deposit;
• sue for the remainder of the purchase price;
• claim damages for breach of contract; and
• relist the property and sell elsewhere.
For the seller, marketing property with an auction house incurs higher fees. Sellers need to pay a non-refundable auction fee which can vary from a few hundred to a few thousand pounds (tending to be more than an estate agency – and the property may not even sell on the auction day.) Each unsuccessful auction is a fee lost. The marketing of the property may not rival the estate agent offering, generating less interest. The risk of letting the property go for too little is largely counteracted by setting a ‘reserve’ price. However, the reserve price must not exceed 10% above the guide price (CAC 10.2). So, if a guide price is set on the low side to drum up excitement about the lot, sellers could be in for disappointment.
Going once, going twice, but dodgy due diligence won’t suffice
So how are these risks mitigated? Unsurprisingly, the answer is due diligence. The auction pack could well contain information which prospective buyers deem comprehensive, but closer scrutiny by an expert (be that surveyor, commercial property solicitor or planning consultant) could reveal:
• a restrictive covenant which could hamstring development;
• a lack of planning permission and potential inability to secure it from the local planning authority;
• arrears on the subsisting tenancies for which the buyer must account to the seller;
• an Energy Performance Certificate rating not up to scratch for the buyer’s purposes;
• the property’s use class is incompatible with the buyer’s intended use;
• insufficient easements or lack of formal access rights where needed; or
• structural issues such as subsidence.
This list is not exhaustive. A legal expert could also pinpoint information which is missing from the auction pack, such as missing searches or incomplete title documentation.
In order to identify any issues which may not be revealed by the title documents, buyers are strongly advised to commission a survey of the property. At the very least, buyers should physically visit the property during the marketing period prior to auction. This could reveal, for example, rights of way burdening the property for the benefit of neighbouring land or the need of extensive renovations. Buyers looking to move straight into an office or shop should be doubly advised to check the property is in good repair, whilst others may welcome remedial work.
Budgeting for auction
Buyers will understand the benefit of comparing the guide price of the property to others in the area. The CAC clarify that the guide price is a price at which the seller might be prepared to sell at the time it is given. What is more, with prospective buyers competing in real-time with ever increasing bids, it is conceivable the eventual buyer will pay a premium. Therefore, it is advisable to plan for an unexpected deviation from the guide price on auction day. Both seller and buyer should factor in auction fees, with the latter most likely needing to account for stamp duty land tax also.
If handled with care, the uptick of auction sales could be an exciting development in an otherwise uncertain market.
Maia is a Trainee Solicitor currently taking her third seat in the Private Client Team.
Maia joined Wedlake Bell in September 2021, she has previously taken seats in the Commercial Team and Pensions and Employee Benefits Team.