Buying at auction puts you in with a chance of bagging a property at a great price. But it isn't risk-free. So what are the risks of buying a property at auction?
The three main risks when buying property at auction are:
- Not having enough information about the property (whether about the structure itself or the legal aspect of it),
- Not being prepared in advance (particularly having your financing in place),
- Getting carried away during the auction itself, and overpaying for the property.
All these risk factors can be overcome though.
We're going to address the risks throughout this article, along with what you can do to tackle them and make it safe to buy at auction.
1. Risks with the property
Let's just say it up-front. Auctions attract two main types of properties:
- "Normal" properties. There's nothing "wrong" with these houses. The owner just chose to sell by auction for the convenience that the process offers. Nothing to worry about here for a buyer.
- "Problem" properties. The owner chose to sell these by auction because the house has something wrong with it, which made it difficult to sell on the open market.
The second batch of properties can be a serious problem for you (which is why we call them problem properties...)
1.1. "Problem" properties
Now, just because something's a "problem property", it doesn't mean no one should want to buy it. They can actually be fantastic opportunities.
If you can buy the property at a good price and then invest some time, effort and cash into fixing any issues, you can make real profit.
Avoiding disaster with problem properties
But being successful with problem properties relies on you doing two things:
- Buying at a suitable price, given the defects
- Having the time or cash available to fix the problems.
But if you don't even know about the issue then you certainly can't bid accordingly. And you may not have set aside the time and cash the project's going to need either.
This can be a disaster. Not only do you overpay for the house in the first place, but you'll struggle remedying the issues too. This can be a real "money pit" situation.
This is perhaps the biggest risk when buying at auction.
1.2. 11 Examples of "Problem properties" you may find at auction
Honestly, there are a huge number of things that can go wrong with a property. There are loads of obvious ones which I'll list here:
- Structural issues (for example properties with subsidence)
- Non-standard construction,
- Short leases,
- Japanese knotweed,
- Problem tenants.
- Fire damage,
- Flood damage,
- Roof problems,
- Neighbouring property issues,
- Derelict houses, or properties needing complete renovation.
- Dry rot / wood rot
This is no where near being an exhaustive list though.
Something that continually surprises me, even after more than 12 years in the property industry, is that you're constantly coming across new problems you'd never think up.
The high number of "problem properties" available at auction are one of the biggest advantages of buying at auction (because of the opportunities you'll find), and one of the biggest disadvantages (because of the risks involved). Check out more pros and cons of buying at auction here: Want To Buy At Auction? 12 Crucial Pros & Cons to Consider First.
So what does this all mean for an auction buyer?
1.3. How to mitigate property risk
There are steps you should take as a buyer to minimise these risks.
View the property
You need to view the property - preferably more than once. Andy Thompson, Head of Auctions (North West) at SDL Auctions, likens it to "watching a film for the second time. Sometimes you'll spot something you missed the first time around".
It's a great idea, and I'd certainly recommend it too.
Get a survey done
But just seeing a property yourself probably isn't enough. We'd suggest getting a surveyor to have a look too. Although it's a bit of an investment, it could save you a fortune if they pick on something you'd missed.
I've actually written an in-depth guide on this recently. Check it out at the link below:
Recommended: What to do before bidding at an auction
Check out this download as well:
2. Risks with the legals
Unfortunately, it isn't just the building itself you need to check up on.
A property could be physically perfect, but if it has overhanging legal issues then you've still got problems on your hands. Unfortunately, they're likely to be time consuming and potentially very costly for you.
2.1. Why is there more legal risk when buying at auction?
When you buy a property through an estate agent (i.e. a "normal" house sale), all the conveyancing is done after you agree the price.
This is nice for you from a "risk" point of view: If your solicitor finds anything strange, you just pull out of the sale.
There's no law that stops you doing that, and there are no costs or penalties either. So when you buy through an estate agent, you don't really run the risk of getting lumped with a scary legal complication.
Auctions work completely the other way around though.
With auctions, you do all that legal due diligence before you bid on the property. Agreeing the price is the last thing you do, and then there's no backing out afterwards.
Because you need to do all the valuation work before you bid, it's the seller's solicitor's job to provide a legal pack. This is basically all the legal information about the property, all provided for you up-front.
You should then get a solicitor to review the legal pack, and pick out any potential issues. This is how you avoid buying a property with a severe legal issue.
Obviously though, as with any legal work, you'll incur a fee for it. And if you end up deciding not to bid on the property, or if you get outbid, then it's a sunk cost you just won't see again.
This is why so many auction buyers still run the risk, and decide not to get the legal pack reviewed by a solicitor.
2.2. What are the legal risks when buying at auction?
There are so many legal complications that properties can have. Here are a few examples of potential issues, and checks solicitors carry out:
- Title checks to ensure you’ll end up with full legal ownership of the property.
- Enforcement notices which could force you to carry out certain works once you've purchased.
- Easements to check no one has any unusual rights of way over the property.
- Encroachments to make sure a neighbour's land doesn’t overlap yours.
- Positive covenants which create an obligation for you to do something (like contribute money towards maintaining a road or walls).
- Negative covenants which restrict how you can use the property.
- Local area – checking there are no plans for major roads or developments to be built near the property.
- Tenancy checks to uncover any existing tenancies and to make sure a tenant is paying rent and is dispute-free.
Some of these are highly technical, and trying to pick out the issue by reading the legal pack yourself can be difficult.
When you pay a solicitor to do a pre-auction legal report for you there are a lot of checks they’ll carry out. These protect you from a long list of problems you could end up with otherwise.
According to Aucspace, a technology company trying to simplify the auction buying process, "Only 1 out of 3 potential buyers hire a solicitor to review the legals before auction."
The rest run the serious risk of running into these issues once they've bought.
But outside of the risks associated the the property itself and the legal aspect of it, what other risks do you face when buying at auction?
3. Risks with finance
Another risk of buying property at auction relates to how you're going to finance your auction purchase.
Remember, once the hammer falls you are legally committed to buying the property. This means that if you're relying on finance and it doesn't come through, then you're in breach of contract.
You'll face losing your whole deposit, and could face further penalties too.
So any uncertainty around finance is a real risk you face when buying at auction.
3.1. Financing issues you could run into
Here are some of the risks you potentially face when buying at auction in terms of your finances:
- Is your cash available? I've seen situations where a buyer's money is in a high-interest savings account, sometimes called a "notice account". These give a higher rate of interest, but you have to give plenty of notice if you want to withdraw your funds. Some require up to 120 days notice. With auctions you'll only have 28-56 days to complete, so check the availability of your funds first.
- Will the lender come through in time? Conventional lenders aren't the fastest, and if they don't come through then you run the risk of being in breach of contract.
- What if the lender decides not to lend? A lender could refuse a loan based on your personal finances and income, on the property itself, and on the legals surrounding it. If you win the auction and the lender lets you down, you'll have a serious problem.
3.2. Mitigating finance risks: Using auction finance
One way around many of these problems is to use specialist auction finance. These are essentially the same as bridging loans.
These lenders will typically have a higher risk appetite. This means even if you're buying a house that would otherwise be unmortgageable, they're likely to still lend.
They're also used to working to much shorter deadlines, removing a lot of the risk out of financing an auction purchase.
3.3. Buying through "Modern Auction"
Another way the risk is mitigated is if you buy through modern auction. Generally speaking, modern auctions tend to allow more time to complete after the auction finishes - meaning more time for you to get financing in place.
3.4. Downsides with auction finance
Auction finance isn't without its own risks though unfortunately:
- Personal liability. Most bridging lenders will expect personal guarantees. This means that if things don't work out then you'll be personally accountable for any losses. This is even the case if you buy within a limited company.
- Expensive. Auction finance has higher interest rates, and usually higher arrangement fees and exit costs too. While normal residential mortgages often charge less than 2% interest, expect interest on auction finance to cost 9-15% per year.
- Short-term. Auction finance usually comes with a maximum term of 6-12 months, so you need a clear exit plan.
- Deadlines. You'll face steep penalties if you miss repayment or redemption deadlines (we've seen penalties as high as 5% of the total loan if you go over the maximum term).
- Dodgy industry. Bridging loans/auction finance are forms of unregulated lending. This means cut-throat practices can creep in. Have your solicitor check the loan terms closely, and make sure you have a thorough understanding of them too. Check reviews thoroughly before engaging.
4. Risks with the auction process
So, imagine you've done your due diligence by checking out the property and the legals. And imagine you've got all your financing locked in. What other risks are left? Well, unfortunately the auction process itself still present a few that you should know about.
There are three main risks you face from the auction process itself:
- Unknowns surrounding auction terms and fees.
- The risk of losing legal and survey costs.
- The risk of overpaying.
4.1. Auction Terms
When you buy or sell a house through an estate agent, everyone knows what the deal is with fees: The seller's going to pay them, and they'll be about 1-2%+vat.
It's not so straight-forward with auctions though:
- The fee will vary, depending on the auction house (3-4%+vat is not unusual)
- Who pays the fee will vary (the buyer or seller could be liable for the fees),
- There may be additional fees on top.
You need to check the auction terms closely to be clear who's paying the fees, and how much they are. It's not unheard of for buyers to win an auction, then be landed with a big unexpected bill.
(Imagine winning a £300,000 property at auction then finding out you have to pay a 4%+vat auction fee... That's £14,400 in unexpected costs!)
Check the auction terms closely.
4.2. Running up sunk costs
As we've outlined here and throughout our auction articles, it's highly recommended to do your due diligence before bidding.
However, this due diligence costs money. A survey could be £300, and a solicitor's report on the legal pack could be £500. If you spend this then show up to auction and get outbid, that's £800 in sunk costs.
Unfortunately there's not really a way around this. It's crazy to do no due diligence, but it's painful writing that amount off with every failed auction attempt. It's certainly a risk you need to factor in up-front.
4.3. Overpaying in the auction
The best way I can explain this is as follows: The auction process has been developed over literally thousands of years to get the best price possible for the seller. A key part of this is making you pay more than you actually wanted to.
So how do you combat it? You set your ceiling price.
Unfortunately though, this advice is nothing new. Just about everyone goes into auction knowing the top price they want to pay. But time and time again, people come out having overpaid.
Do not underestimate how powerful the process is! Set your limits, and be prepared to walk away.
Property auctions can be a really good way to find great deals. But not all properties that sell at auction are great deals. This is, in part, because of the risk factors that come with buying in auction.
You face risk factors from the property itself, the legals surrounding it, the finances you'll rely on, and from the auction process itself.
If it feels like daggers are coming toward you from all angles, it's because they kind of are. But as the saying goes, "if it were easy then everyone would be doing it".
Although there are numerous risk factors, there's a lot you can do to bring them under your control. And if you can navigate these auction risks successfully, there's certainly money to be made.
For more help figuring our how to mitigate auction risks, as a starting point check out our article on What to do before bidding at a property auction.
By Matthew Cooper, Co-Founder of Home Selling Expert