Do Auctions induce a Winner s Curse New Evidence

Do Auctions induce a Winner’s Curse? New Evidence from Real Estate Auctions Clare Branigan, Cal Muckley, Paul Ryan June 2012

Winner’s Curse “A mental mask that induces a majority of subjects to produce a systematic error, ” Thaler (1988) It occurs in a competitive situation when a successful buyer finds that he has paid too much for a commodity of uncertain value

Winner’s Curse In an auction setting Bazerman & Samuelson (1983) show that 2 factors affect the incidence & magnitude of the Winner’s Curse • The degree of uncertainty concerning the value of the item up for bid • The number of competing bidders

Winner’s Curse Increasing either value will increase the range of value estimates & bids; thus the winning bidder will overestimate the true value of the commodity and overpay

Common Value Auctions Common Value: To what extend can these residential property auctions be described as Common Value? Goeree & Offerman (2002, 2003) note that in practice few auctions can be neatly categorized as either private or common value. In the context of residential property, the bidder will take into account both common price information (comparable house sales) and private information (e. g. , specific styling preferences).

Property Sales Prices Ireland Under existing legislation (Data Protection Act) sales prices may not be publicly disclosed without the consent of both vendor & purchaser; the only exception being auction results. In the absence of a public register of prices, it has been almost impossible to value Irish property accurately. Price movements, for example, have been expressed by reference to asking prices which can only ever indicate sellers’ aspirations. Public auction sales however are totally transparent

Four years ago, houses on Shrewsbury Road were among the most expensive in Europe after 12 years of almost uninterrupted nationwide rises. For example, in 2005, a 4, 000 sq ft (372 sq m) house on Shrewsbury Road (Dublin 4) set an Irish record when a buyer paid more than € 55 m for a home with extensive land to the rear that remains undeveloped. Currently valued € 8 m (2012)

Irish House Price % Changes

Data Gathered Data for all available auctions in Dublin area was collected between Sept 2004 and Nov 2005.

Summary: 1565 Auctions

Methodology Observed over 200 auctions in this time period 105 were sold at auction, by an average of 40% over the guide price

Variables Guide Price Sale Price announced on the market No. of Bidders Progression of Bids Previous Advertisement and Newspaper Editorials Characteristics of House Comparable Sales Agent

Self-Similar Properties Self-Similar Properties; Used a hybrid Approach; Currently the properties are clustered by four dimensions • • Location No. of Bedrooms; Size (in sqft) Type of Property (apartment, semi-detached, Detached, Period)

Bid Progression 1 950 1100 1230 1240 2 1000 1150 1225 3 1050 1235 1245 1255 1265 1250 1260 1275 1272

We are interested in how the auction mechanism can affect the selling price. We are looking at the winning bid compared to an estimation of what the price should be.

Auction Room Sunk Costs (Legal Fees, property survey, search costs) Endowment Affect Bidders view auction as a competition; wanted to win at any cost Easy lending policy by banks

Preliminary Findings Three Bid Price Relatives 1 Natural Log of Selling price to Guide Price 2. Natural Log of Selling Price to average of self-similar properties

Result 105 Auctions #bidders Avr Bid 2 26 3 35 4 42 5 67 6 73

Samples

27 Belmont Ave, Donnybrook Apr 05 Guide 700, 000

27 Belmont Ave, Donnybrook Apr 05 Guide 700, 000 Sold 1. 36 m, 4 bidders 94% over guide price

8 Temple Cresent, Blackrock May 05 Guide 650, 000

8 Temple Cresent, Blackrock May 05 Guide 650, 000 Sold, 1. 3 m, 5 bidders 100% over guide

Samples: Priory Grove, Blackrock March 05, € 730, 000

Priory Grove, Blackrock April 06 ?

Priory Grove, Blackrock April 06 ? Initial: 730, 000 15% 109, 000 Upgrades: 90, 000 Total: 929, 000

Priory Grove, Blackrock April 06 € 1. 8 m

48 Ardagh Park Sale Agreed Sept 2011 € 349, 950 Price in 2007?

May 2005 27 Ailesbury Rd € 9 m

July 2011 35 Ailesbury Road, Dublin 4 July 2011 € 2. 325 m

Summary

Implications for Property Purchasers High Value purchase – significant prices paid Typical buyers less sophisticated than experienced investors Transaction Costs are high Involves a great deal of risk and uncertainty

Implications fot the Economy Property - Important Sector of Economy , in 2005 construction employment accounted for 12 ½ % of total employment The Auction method contributed to huge price fluctuations and unrealistic valuations • Houses in “South Dublin” had 8 -10 times increase in value compared to Dublin average of 4 times (1995 -2005) • Also influenced house valuations in rest of Dublin and nearby counties Previous studies on property auctions are limited Percentage of Auctions increased each year by 25% from 2002 • By 2006 - 1, 400 houses were auctioned, the majority of second- hand residential homes in South Dublin

Contributions to Public Policy Transparency in Sales Results Sales Prices should be made available in a Public Registry Changes to Guide Prices Changes to Auction Policy

Questions clare. branigan@ucd. ie