Why Investors Lose Money on 27 Percent of all Auction Deals


Nearly one out of every four properties purchased by investors at auction over the past four years has cost them money, not because they didn’t know what they were doing but because lenders overvalued them when setting minimum bid and reserve amounts, especially in markets with weaker demand and an older housing stock. As a result, investors in one market alone, Cleveland, have lost over $56 million since 2006.

A new study by two economists at the Federal Reserve Bank of Cleveland, Thomas J. Fitzpatrick IV and Stephan Whitaker, found the systematic overestimation of property values in weak housing markets by appraisers, investors, and lenders is causing lenders to foreclosure rather than modify loans, increasing already swelling foreclosure inventories, and creating huge losses for themselves as well as investors and federal agencies who end up with overpriced properties in declining markets.

How Lenders Overvalue

Rather than basing their valuation on what properties are actually worth at the time they are sold at auction, lenders are using a uniform process that works well in higher value areas but not so well marginal markets full of aging housing where prices are declining quickly—which also happens to be the scenarios many investors consider to be happy hunting grounds. A drive-by appraisal of new housing stock is more likely to produce an accurate market price in stable, suburban neighborhoods than it would for older, distressed housing stock. With few exceptions, newer homes will be in good condition inside and out. However, the age distribution of REO homes in weak markets is much older. Over the decades, some older homes were well maintained and others were neglected, leading to a very wide range of conditions and values.

In weak markets, lenders also are failing to account for the relatively poor condition of repossessed properties.  While the lenders own them, which has been years in some state, the homes may be rapidly deteriorating. The lower-value homes in distressed neighborhoods are often vandalized and stripped of metals. Despite winterization, homes may suffer weather-related damage without an attentive occupant to immediately address problems when they arise.

Another potentially contributing factor is any downward trend in home prices that occurs while homes sit in REO—like the triple dip in prices that began last fall and is still underway in dozens of markets.

The inaccuracies may also be due to appraisers or brokers not having enough comparable arms-length property sales (regular market-based sales) in extremely distressed markets, where most sales in the last five years have involved recent foreclosures. Looking to older arms-length sales at stale prices for a drive-by appraisal or broker price opinion may also overestimate the sale price in these markets.

Finally, lenders’ overvaluations may not be accidental at all.  They first is that they may not actually be overvaluing property at all, but know the property is not worth the minimum bid they are asking.  However, they believe they will get a better price with a higher minimum.  If that’s the strategy, it’s backfiring.  Or, there may be incentives that encourage lenders to overvalue foreclosed properties. Doing so would allow them to shift accounting losses from their loan portfolio to their REO portfolio. Solvency tests and supervisors of financial institutions place less emphasis on REO portfolios than on loan portfolios. This is a function of banks having relatively small REO portfolios in normal times, but always having an active loan portfolio that can be analyzed.

Lenders are the Biggest Losers

Overestimating the value of a foreclosed home leads lenders to set too high a minimum bid at the sheriff’s sale in judicial states, which lowers the chance that someone will buy the home at the auction and take it off the lender’s hands.  More often, lenders end up taking back the property and turning it into an REO where it remains their problem.

The authors studied the Cuyahoga County market, analyzing property transaction data from the county auditor from January 2006 to June 2011, comparing the auction price paid by the lender and the subsequent sale price of the home. If the sale price is less than the minimum that was set, we say the lender took a “loss.”

In Ohio, a judicial state, the minimum bid (or auction reserve) at the first auction is set at two-thirds of the appraised price. If there are no bids at the first auction, the lender can set the minimum bid for subsequent auctions, which are held weekly, at any amount up to the amount of the unpaid loan. For example, if a borrower had $100,000 of loan principal outstanding at the time of foreclosure, the lender could set the minimum bid at $100,000 plus foreclosure costs.

The table below summarizes the losses in the Cleveland market over four and a half years of the housing depression.   Major participants are either lenders who hold the mortgages and take ownership of property that is not purchased at auction, investors who purchase property at auction or federal agencies such as Fannie Mae, Freddie Mac, and the Federal Housing Administration.

Summary of Losses by Type of Auction Winner

Auction winner


Median loss (dollars)

Median loss percentage

Mean loss percentage

Total loss (millions of   dollars)













Federal agencies







Implications:  Huge Losses, Blighted Neighborhoods, Unnecessary Foreclosures, Lowered Values

The Cleveland findings, if true in other cities in judicial states with large tracts of aging housing stock and soft prices, suggests lenders and investors are losing billions because no one is asking the firth questions.  It’s an issue that is terribly relevant, as prices are down and foreclosure saturation is high in Cleveland as well as other Northern cities in judicial states such as Detroit, Chicago, Milwaukee, Boston and Cincinnati.  Multiply the losses incurred in the 24,000 properties in this study by the 4 million foreclosures to date and the sum is truly staggering.  Finally, consider the fact that the study did not encompass the period of the robo-signing scandal, when foreclosure timelines broke records and banks’ carrying costs and repair costs skyrocketed.

Consider the homeowners who lost their homes but who would have gladly modified their mortgages if their lenders had valued them in light of what they would actually be worth as REOs.  Had lenders realized that they would have been better off with a lowered principal than with what they would eventually receive at an auction sale or an REO, hundreds,  perhaps thousands of Cleveland foreclosures could have been avoided.  These unnecessary foreclosures only added to the already bloated distress sale housing stock, lowering prices even more when they hit the market.  Unnecessary REOs ended up vacant and abandoned, adding to urban blight and costing the taxpayers.  Last but not least are the investors who thought they were getting a good deal by buying at auction properties that they could have bought for less if they had waited patiently until lenders fixed them up a little and tried to sell them as REOs.

Hindsight is fifty-fifty.  Perhaps it’s not fair to expect better marketplace smarts from the lenders involved in this study during a period that we all know now was unprecedented in the history of America’s real estate economy.  But part of the message is that they are not the only ones who suffered.  Bureaucratic and inept foreclosure valuations hurt everyone:  homeowners, taxpayers, investors, local communities and most of all, the lenders themselves.



About Author

Steve Cook is the editor of Real Estate Economy Watch and writes for a several leading outlets in addition to BiggerPockets, including Equifax and Total Mortgage. He also provides communications consulting services to leading real estate companies. Previously he was vice president of public affairs for the National Association of Realtors.


  1. Hi Steve, that’s exactly the reason I don’t go to auctions. Way too many good deals when they show up as REOs. I can never figure out why home owners and “wanna bees” don’t rent them out instead of walking away. Many yeras ago Lenders used to call me up stating they have a home owner who cain’t make the mortgage payment, would I be interested in taking over the property? Every body wins, they don’t do that anymore! If Lenders would do modiification loans or hand them over to investors for a small fee, there would be a lot less money losses and foreclosures.

  2. Fascinating points to consider, thank you. I’ve always been averse to auctions myself, as they draw on emotion rather than plain financial judgement, to elude higher than deserved buy prices and really, are all about boosting the agent’s reputation and publicity at the expense of the buyers (and sometimes even the sellers, who get drawn into an auction that’s doomed to fail before it starts, as the agent staged it for their own interests rather than in consideration with market condition, who may not fit an auction at that time).
    Fortunately, auctions are virtually non-existent in our Asian niche. :)))

  3. It’s for these reasons that appraisals are SO much tighter now than a couple years ago. This absurd amount of inflation has gotten out of hand. Luckily I’m in Texas, where we’ve kept it in check to some effect. I see markets in California and New York City am just baffled at home prices and how little you get for your money. We’re in a bubble here though. A pleasant, protective bubble.

  4. Steve Toohey on

    Thanks Steve – Auctions have become very frustrating lately. Some auction services will not set a minimum bid, but the final winning bid must go to the bank for approval. On more than one occasion, I have won the auction, but lost the house. The bank usually will not accept the winning bid if they think it is low and they will counter… unfortunately, their counter is generally at full market value and won’t allow an investor to make any money, or even account for unexpected expenses like well and septic issues on rural properties, which the investor may be taking a big risk on without an inspection. The lender is usually simply applying a % loss equation without knowing the market conditions. Thus, the property goes back on the market after a failed auction and the lender generally ends up holding it much longer, and is exposed to additional failed contracts for all the expected reasons.

  5. I have my own take on the problem at hand.

    Everyone is calling the Bank that handles the property the “Lender”. This is not necessarily true. Most banks never loaned money, they underwrote the loan and collected the monthly payment as the “Servicer”. They received 1% to 10% of the loan amount for underwriting the loan(called a Service Release Premium, not disclosed to borrower) and 1% of the monthly payment for collecting that payment.

    If you are late on that payment they get 100% of the late fee. If you default on that loan they charge fees for checking on the property and anything else done to secure the property. The only way for them to get paid for these charges, is when the property is sold at auction or REO. The longer they hold the property the more charges incurred. They have authorization to foreclose and get a judgement. At auction they try to get full judgment, which includes loan amount and any allowed charges.

    Now for the real kicker!!! The actual “Lenders” insured the loan as allowed by the Federal Reserve for 10 times the amount of the loan. After the 91st day of default they were paid by the insurance company. Not only did they insure against this loan but so did the trustees from the secondary markets. Google Regis Sauger and listen to what he discovered for a more in depth research.

    Also have you heard any investors in Mortgage Backed Securities market screaming that they lost money? I haven’t.

    As far as buying properties at auction yes, you better know what you are doing and then it can get dicey.

    Best to all,


  6. Great article, Steve. I also cannot figure out why these homes aren’t rented out instead of walking away. I don’t think these owners understand the potential investment power of these properties if handled correctly. I am always offering to provide counsel on these decisions to ensure there aren’t opportunities these property owners are missing that could not only save their home but provide them with the benefits of a long-term investment.

  7. Homes that have been somewhat gutted, inside doors, all part of the kitchen cabinets removed can be replaced but the lender may not even know about the pre condition.Nor will the biddder is many cases. There can be other problems with the house. Let the lender keep the house they will not spend the money to restore the house. Sooner or later the the house price will have to take into consideration the true condition. I will not waste my time playing a fixed and rigged game. If I cannot buy a fixer upper at a price which will allow me to restore the house and make a profit in time, I will not buy it. Two years ago there were many great deals out there in many states, some states today are still in a decline.

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