A Losing Bid
On today’s show we’re talking about a losing bid.
Any time you lose a bid on a property, there is a natural reaction to second guess your offer. Did we offer too little or was the winner out of their mind?
It happened to us this week. There were a total of 8 offers on this property in a good location. We calculated our offer price based on a reasonable set of zoning assumptions and a reasonable balancing of risk.
A day after losing the bid, we spoke with the winning bidder to understand why they had bid nearly $900,000 more than our offer price.
It came down to assumptions on the entitled density. If we could only get a low density approved, we would earn zero profit at the price the winner offered. But if he was right, even his offer price was still a bargain purchase price. It all comes down to what you believe the planning commission and ultimately city council will approve in that location.
After careful deliberation, and the opportunity to do due diligence, we made an even higher offer to buy the contract from the winning bidder. So not only did we offer to pay $900,000 more than our original offer, we put a premium to compensate the winning bidder for their efforts.
We may have got it wrong, or maybe we were right. But now we will have the time to perform the proper due diligence and determine the true potential for the property, and therefore its value.
So why would we offer an even higher bid on the same property after having lost the bid? As long as the project ultimately meets our financial metrics, it really doesn’t matter that we’re paying a bit more. Would I prefer to pay less? Of course.
The unfortunate thing about auction environments is that the winner almost always ends up paying more than if they were the only bidder.
The question is whether auction fever takes over and the winner ends up paying too much. We are pretty disciplined investors and make sure that we don’t take needless risks.
So now that we have the property under contract, the key is to determine the viability of the project during the due diligence period.
The fact is, we don’t know if the project is truly viable yet. We will need to take the time over the next several weeks and truly determine the envelope of this project. We will run multiple different scenarios. What happens if we get a density of 4 units per acre, or 6 units per acre or how about 12 units per acre. Each one of these scenarios is a completely different product with a different market positioning.
But now that we have it under contract, we have the control to make good decisions. Do we feel bad that we’re paying even more? Not at all. We’re constantly learning.
What makes this project safe is the notion that land in the core of the city is fully developed. The city is one of the fastest growing cities in North America. It’s certainly within the top 10 fastest growing cities. The inventory is low, and the product we’re aiming to develop will continue to be in high demand, even if market conditions soften.
Typically when there is a downturn in real estate, it affects the most expensive end of the market first. This particular property has multiple exit strategies. So we feel safe in developing a few hundred units of new residential housing. We’re still buying the land in a hot area at under $3.50 per square foot.
The process of development can a little messy and unpredictable at times. You are literally dealing with a blank canvas. It takes multiple iterations of a design concept to arrive at something that truly fits in every respect. It has to fit the area in terms of features, price point, amenities. It’s truly a creative process that is an art form.