Why you shouldn’t buy your home at auction

For most Australians, owning property is high on life’s list of priorities, and if you’ve attended an auction, you’ll know how hearing an auctioneer’s call of “going one, going twice, sold!” feels.

With more and more Australians finding it difficult to break into home ownership amid frenetic home price speculation, many desperately turn up to snap up a bargain at an auction.

Auctions are behavioural science-backed traps not just for those who end up making a costly mistake to win it but also for those who just attend or leave empty-handed.

The worst part of winning an auction is, if it so happens you regret it, it will be a lifelong one given the amount of money you spend, especially if you are going to be an owner-occupier. 

Auction: why and how 

The conventional belief is that by providing buyers with more favorable information (such as a lower starting price), an agent can attract more buyers to bid, which in turn should lead to higher closing prices. 

Auctions have been around for at least 2500 years and the open ascending price auction, a.k.a English auction is arguably the most common form of auction – participants bid openly against one another, with each subsequent bid required to be higher than the previous bid. The auction ends when no participant is willing to bid further, at which point the highest bidder pays their bid.

In Australia, auctions were traditionally used as an alternative to the private sale method to sell property that, due to its unique characteristics, was difficult to determine a price for. During the 1990s and 2000s, auction became the primary method for the sale of real estate in the two largest cities, Melbourne and Sydney. 

The logic was to prevent potential buyers from low-balling the price disclosed by a vendor but this method has in the past decade lost its true purpose amid the rapidly rising housing market as it became common for a property to sell for significantly more than what it is worth – exceeding the market price, vendors’ reserve price and advertised price range. 

Quote it Low, Watch it Go. Quote it High Watch it Die.

Over the recent years, auctions’ lack of transparency about the value of the property was brought into question, with estate agents and their vendor clients being accused of “underquoting” –  a (mal)practice when a property is advertised at a lower price than what the vendor is willing to accept.

It’s a tactic employed by doggy real estate agents to lure buyers who waste time and money on building and pest reports and solicitors’ fees investigating a property – buyers preparing to buy a property they cannot. Yes it is illegal on paper, but notoriously difficult, if not impossible, to prove as most agents have got the hang of it. Underquoting is reportedly very common at a whopping 50% rate in Australia. 

Talk to any buyer you can find in an auction area and they will be able to regale you with many stories where the underquoted dream property ended up selling for more than they could afford.

The winner is a loser 

An auction is designed to extract the maximum possible price for a property by bringing together emotional buyers who would otherwise pay the lowest possible price under normal circumstances. You let them fight, get ahead of themselves and fall over. The loser takes the property. 

Let’s explain this. 

We all get nervous and make mistakes under pressure. The agent has all sorts of sneaky tricks to build up this pressure and speak to your subconscious mind directly.

  • Why do you attend an auction? 
    To buy your dream home at the lowest possible price. 
  • What do you do at auction? 
    You keep increasing the price for the property you wanted to buy at the lowest price. 
  • Where do you end up?
    You pay the highest possible price. 

This phenomenon is known as the winner’s curse in behaviour science:  A bidder who doesn’t adjust for the winner’s curse ends up losing because they win the bidding only when they’ve bid too high.  The person who bids the most and wins the auction may ultimately regret the bid since it often exceeds the intrinsic value of the property. 

An here is the science behind it. 

Let’s assume we have ten bidders and one property to sell.

The property is worth N, so it is actually worth the same amount to all bidders no matter what they think, but bidders don’t know the value of the property  and must independently estimate it.

Obviously, if all bidders could objectively value the property equally, the auction would fail. So, the only possible scenario for an auction to actually work is if at least one of our bidders values the property higher than others. Now one we have the highest bidder.

If we assume that bidders in general estimate the value accurately, then the highest bidder has overestimated the property’s value (So, if the N hidden from the bidders was $10, and nine out of our ten bidders got it right not to bid above $10, the only conclusion possible is the winner’s guess was wrong).

In other words, winning the auction carries bad news about the highest bidder’s value estimate:
the winner is “cursed” in one of two ways: either the winning bid exceeds the value of the auctioned property making the winner worse off in absolute terms, or the value of the property is less than the bidder anticipated, so the bidder may garner a net gain but is worse off than anticipated.

In scientific experiments, it has been shown that repeated experience as a bidder leads to little learning and repeated winner’s curses. 

So, don’t think the articles you have recently read about what to do at auction, how to win at auction on real estate websites are useless and won’t help you much.

Buyer’s Remorse

There is a concept of buyer’s remorse – the sense of regret after having made a purchase of an expensive item such as real estate. Regret is the emotion of wishing one had made a different decision in the past, because the consequences of the decision were unfavorable.

In science, decisional regret is a consequence of decision-making under pressure, and happens when the buyer appears to have made the wrong decision even if the decision appeared to be the right one at the time it was made. 

In the stage before purchasing, a prospective buyer often feels positive emotions associated with a purchase (an anticipation of the enjoyment that will accompany living in the picture perfect house), and afterwards, having made the purchase, they are more fully able to experience the negative aspects: all the opportunity costs of the purchase.

Opportunity cost is the loss of the benefit that could have been enjoyed if the best alternative choice was chosen instead.

Opportunity Cost = FO (returns on best foregone option) – CO (returns on chosen option)

So, buyer’s remorse is an example of post-decision dissonance, where a person is stressed by a made decision and seeks to decrease their discomfort.

The more resources such as money, time, and cognitive resources that are invested into making a purchase, the more likely the buyer will experience buyer’s remorse or psychological discomfort.

Solution to buyer’s remorse?

Well, yes and no. Legislation exists in all Australian states enforcing the right to a cooling-off period applicable when buying a home or an investment property, during which either seller or buyer can back out of the contract.

Unfortunately, you waived this right when you turned up at auction: there is no cooling off period if you buy your home at an auction. 

Savvy choice, happy choice:  Pause, then think

Much has been said on the subject of decision making – how to make the best, effective, decisions by gathering and analysing information, evaluating options, and selecting the best course for success.

Humans aren’t great at making smart decisions under pressure, whether we’re trying to put out a fire at work or deciding to buy a home where we will live for 50 years.

When cornered, our heart amps up, blood pressure flies high, adrenaline makes us a lion, we lose our common sense: have to fight and win at any cost, and suffer later.

When you are involved in negotiating for a property you’ve fallen in love with, emotions can (over)rule logic.

You’re making the biggest purchase you’ll probably ever make. Pause, think and make the right choice at home while sitting with your legs crossed.

Once a cold-headed decision is made, you can now call the agent and make a reasonable offer, putting the agent under pressure to make a decision, let them go through it. You can either get it or not.
If you don’t, it is not the end of the world…. What matters is you can’t lose. You can’t regret.