The Winner’s Curse in the Real Estate Market
The Southern California real estate market is known for big-ticket deals such as the $100 million sale for the Playboy Mansion. On 14 Sept 2021, one the most historic homes, The Hearst Estate, was sold for a whooping $63.1 million in an ascending bid or English auction. Built in 1926, the Hearst Estate is a salmon-colored, 3.5 acre showplace that has an Old Hollywood history – having been featured in “The Godfather” and “The Bodyguard”, as well as Beyonce’s 2020 visual album “Black Is King”. The owner Leonard Ross listed the trophy home for $195 million in 2016, but could not find a buyer. After 5 years, he faced a debt of more than $50 million on the estate and finally decided to sell it for a lesser in a Chapter 7 bankruptcy sale through auction.
The bidding began at $48 million with 24 people and increased in $100,000 increments until there were only 2 left at the $52 million mark. Nicolas Berggruen, a real estate investor, ended up winning the bid at $63.1 million – the most ever paid for a home at an auction. The question is – did Berggruen maximise his value with his winning bid?
In a first price action, the nash equilibrium for bidder i with value vi is [(N – 1)/N]vi. It is wise to bid less than your actual value and at the price that the second highest bidder bids. However, the bidding began at $48 million – which was $1 million more than Berggruen’s original offer. Assuming that $47 million was the value of the property to Berggruen, he ended up paying $15 million more. Berggruen would have been better off not buying the property at $52 million since 0 payoff > negative payoff. This also demonstrates the “Winner’s Curse” that comes along with first price auctions where the winning bid exceeds the true worth of an item. In this case, this property that was initially listed for $195 million in 2016, was brought down to $89.75 million in April and finally $69.95 in June before the auction. The intrinsic value hence might very well be below the $52 million that Berggruen forked up.
Though the owner Leonard Ross might have benefitted from the Winner’s Curse, using a second price auction would have incentivised Berggruen to only bid his maximum willingness to pay (or his value). This is because the payoff to bidder i is vi – Maximum of others bids if bi > Maximum of others bids. The optimal bid would then be bi = vi.
I then wondered – what is the incentive for sellers to use second price auctions if bidders just bid their perceived value (no Winner’s Curse)? I looked into Google AdSense and it seems like enabling buyers to bid their true maximum without the worry of overpaying results in higher bids being submitted. This then benefits the publisher. However, Google announced that they would be transitioning to First Price auctions by the year end. As food for thought, I hope to dive deeper into these questions and think about if second price auctions will ever be more beneficial for the real estate market.
Source:
https://finance.yahoo.com/news/homeless-billionaire-nicolas-berggruen-wins-224839713.html
https://www.mansionglobal.com/articles/the-hearst-estate-one-of-los-angeless-most-historic-homes-sells-at-auction-for-63-1-million-228698
https://oko.uk/blog/first-price-vs-second-price-auctions