Is it profitable to buy real estate via auction?

In many countries, real estate or construction lots are sold via auction. Usually, the auction form that sells the real estate is a first-price seal bid auction or an English (oral) auction. 

A first-price auction is a process where participants submit sealed bids and the highest bidder wins. The winner pays the amount they bid.

An English auction is an open auction where participants can openly bid against each other, typically starting from a low initial price. Bidders call out their bids, and the auctioneer increases the price incrementally. The auction continues until no one is willing to bid higher; at this point, the highest bidder wins the item and pays their final bid amount.

Furthermore, in a real estate auction, the valuation of the sold is usually known as the common value. Namely, refers to a scenario where the item being auctioned has a value that is the same for all bidders, but that value is unknown at the bidding time. Each bidder has their own estimate of what that standard value is, and these estimates can vary based on information available to each bidder.

In our case, bidders are typically interested in a property with an estimated market value that everyone believes to be similar. Still, no one knows the exact worth until after the auction. In this scenario, paying more than the actual value of the sold real estate is dangerous. This danger has a name, and the name is Winner's Curse (to read more about winners course link)

Winner’s Curse usually occurs in auctions with many buyers. Why is that? The explanation is quite simple. If some of you have studied probability theory (which is not mandatory in this case), there is a law on large numbers. The Law of Large Numbers states that as the sample size grows, the average of the sample will get closer to the expected value. In other words, as the number of buyers in the auction increases, the average bid will get closer to the expected bid, reflecting the market value. But the winner paid the highest bid, which is higher than average. Namely, he fell into the Winner's Curse and paid more than he should have.

Then the question is, how do we know how many buyers in the auction are considered to be large? What number will indicate that we will be cursed in the current real estate auction? In general, more than 20 buyers are almost certain indicators of being cursed in the case of winning. In my opinion, if there are more than 10 buyers, you should be careful.

To conclude, if you are buying real estate via auction, please understand how many buyers are beside you in the auction, which might save you a lot of money. GOOD LUCK.

The pictures in this post were taken from Unsplash.