What yield would you use in a sealed bid auction ? - Posted by Abdenour Achab

Posted by Michael Morrongiello on May 18, 2008 at 14:42:39:

While you deal is not a plain vanilla Real Estate secured note deal -In your prior post You stated:

“I am surprised to learn that you accepted a sub 8% yield. I was under the impression that funding sources
demand 14% to 15% minimum yield…”

See my reponse to Don about why and when such low yields might come into play.

Best to your success;
Michael Morrongiello

What yield would you use in a sealed bid auction ? - Posted by Abdenour Achab

Posted by Abdenour Achab on May 12, 2008 at 22:54:10:


I am planning to bid on a cash flow next month. The LTV is not an issue (very well secured). The payment history is good (all payments currents, seasoned for almost 2 years). The investment amount is above what I like to invest for risk management reasons (6 figures, while my favorite investment amount is 5 figures).

The auction is a sealed bid one. What yield would you use in this day and age ?

Yield I use in a sealed bid auction - Posted by John Behle

Posted by John Behle on May 27, 2008 at 21:40:48:

I never get as technical as David’s amazing analysis, etc. I always work under an assumption of worst case scenario.

With one to one open negotiating, I’ve more often than not suffered from “buyer’s remorse”. I start too high and end too high. My approach is to look at my worst case scenario as the most I would pay. When one to one and open, I then build in a negotiation buffer so that I can negotiate to or below my worst case price (the most I would pay).

But, with a sealed bid, I have one shot. So, I look at the worst case as my highest price and what my bid must be. If you find you are paying more than other people, you adjust.

If I am going to be unhappy on losing a bid, then I just am not bidding high enough. I’m ok if someone wants to pay more than me and accept higher yields, but I don’t want to lose a deal I would have paid more for.

If I would have remorse that someone else got it, then I really wasn’t at my maximum. If I have remorse upon getting a bid, then I can look at raising my expectations.

From a mathematical point of view, take those two points. What is the highest price I would pay if I were the only bidder and I had one shot? That would be the high point. Next question is at what price would I be upset if someone overbid me? There is the low point. Choose a number between them or just take the high point.

Your cash/credit situation comes into play also. At times when cash is plentiful, sometimes you have to lower yields to get it invested. If cash/credit is not plentiful, you raise yields to get better deals.

A Knight’s Tale! - Posted by David Butler

Posted by David Butler on May 15, 2008 at 09:39:48:


The two posts you’ve made in your thread are quite interesting, and fortunately, you don’t have to do a great deal of figuring to sort out the dilemma you present here.

When I first spotted your original post, my instinctive response was the same that Mike Morrongiello actually gave, with regard to the decision making process if buying for yourself.

To add a little “spit-shine” to it… In a scholarly paper written in 1961 (when economists were only starting to get a sense of game theoryâ??s importance), Columbia University economist William Vickrey used game theory to analyze auctions - and his brilliant study of auction strategies is seen as the pioneering paper in the field of auction theory. Ultimately, he concluded that the optimal bidding strategy is also the simplest… just bid the amount at which YOU value the object. Ahead of its time, Vickery’s theory was relegated to an obscure journal and overlooked for years.

I first became interested in game theory and auction bidding as a result of my time as a private contractor field manager-appraiser for HUD’s property disposition unit in California’s Central Valley. In that role, I witnessed “auction fever” and how it worked to cause bidders to overpay for HUD repo properties, to the point they could have purchased similar properties right next store for less. As we worked through the major real estate crash in the early 1980’s, I saw the phenomenon repeated over and over again at many public bank repo auctions, similar to what is happening today, once properties become REO (interestingly enough, auction fever doesn’t seem to affect public foreclosure auctions when the property is first put up for sale BEFORE the lender gets it back!)

Over the years, I became acquainted with Frank Knight’s seminal work (Risk, Uncertainty, and Profit), which was first published in 1921. This led me to explore other writings, further leading me to become familiar with more credited writers, including reknowned Princeton economist John Nash Nobel Prize , Hungarian mathematician John von Neumann, and the University of California’s John Harsanyi (who developed a method to do Nash equilibrium analysis even when players have incomplete information about each other’s values). Nash and Harsanyi shared the Nobel Memorial Prize in Economics with another game theorist Reinhard Selten, of the University of Bonn (Germany) in 1994 “for their pioneering analysis of equilibria in the theory of non-cooperative games”.

Over time, I developed modules in various of my private note investing workshops in relation to business planning, and investing as well, only using the auction process as a way of showing examples to offer explanations on various concepts of “auction fever”, “winner’s curse”, “prisoner’s dilemma”, “disappointment aversion”, and “great expectations”.

In the end, Vickery’s optimal solution, with a dose of Knight’s two step approach to dealing with the uncertainty of working with incomplete information (1. forming your best estimate of value for a given action, and 2) formulating your best estimate of that value actually being realized if you take THAT specific course of action), is generally the best way to approach your bidding process.

We are faced with that process daily in making offers on notes and real estate. For us, our approach is to pay what we feel it is worth, regardless of what other “offers” are supposedly out there. We never sweeten a bid based on what somebody else is supposedly willing to pay.

Hope this is of some help to you, and best wishes for your success in the Bidding Wars! And…

Have Fun For A Living

David P. Butler

yield to use in a sealed bid auction - Posted by Michael Morrongiello

Posted by Michael Morrongiello on May 14, 2008 at 07:03:31:


Assume this is a REAL ESTATE secured instrument?

If you are paying your own funds to actually BUY this investment then “bid” at whatever yield you wish to earn as a rate of return.

If you are planning on trying to broker this instrument to another “paper” investor (such as Sunvest) because the size of the Note might stretch your capital then more details need to be ascertained with regard to the EXACT repayment terms of the Note, the collateral itself, and perhaps even the payor credit (if its known).

We’ve purchased residential loans with yields in the sub 8% yield range and up from there…

Best to your success;
Michael Morrongiello

Re: A Knight’s Tale! - Posted by Abdenour Achab

Posted by Abdenour Achab on May 15, 2008 at 13:42:27:

Hi David !

Wow !!! … That’s a lot of material to study. Thanks for all the references. I will lookup those authors to see how I can pick up their brains to solve my dilemma.

Before studying their theory though, my intuition tells me that, when there is only a handful of bidders, I should bid less than what I think it’s worth. Here is why:

Let’s assume an asset is worth $101 to me, and the maximum I am willing to bid is $100 (to make $1 in this case). If anybody’s sealed bid is higher than $100, it doesn’t matter whether I bid $1 or $100, I won’t get the asset anyways. So the decision of how much I should bid in the sealed bid auction should be carried with the assumption that nobody’s bid is higher $100.

If there was a billion bidders, the odds are pretty high that at least one bid will be higher than $99.99. So I should bid $100 (what’s it’s worth to me).

On the other hand, if there is only 2 bidders (myself and one opponent), and the odds that other bidder bids higher than $99 are low (remember I assume his bid is no higher than $100). Let’s call that probability p. It’s reasonable to assume that p p, $99 is definitely a better bid strategy than $100.

The reason the probability p is low (less than half) is because, for the other guy to bid between $99 and $100, both of the following have to be true:

  1. The other guy’s analysis must almost exactly match mine.
  2. He decides to bid less than $2 of what he thinks the asset is worth.

So, with 2 bidders only, $99 bid is a more rational choice than $100. How about $98 ? How about $90 ? I don’t know. More precise assumption and sophisticated study needs to be done.

The small number of bidders is what makes bidding what I think the asset is worth, minus the minimum profit I am willing to accept, not an optimal strategy.

In the case where mid bid was more than 20% higher than the second higest bid, there was only 4 of us. At the upcoming sealed bid auction, I will be able to know how many people will present sealed bid 1 or 2 days before the auction. The higher the number of bidders, the closer my bid should be to the highest I would be willing to pay in a live oral auction. The smaller the number of bidders, the more I should push my luck with a lower bid, and take the chance of walking out with no profit at all.

I will look up the writings of the authors you mentioned, hoping they figured ways to translate the above into numbers.


8% - Posted by Don

Posted by Don on May 16, 2008 at 06:39:19:


Under what criteria do you purchase SFRs for an 8% yield?

Re: yield to use in a sealed bid auction - Posted by Abdenour Achab

Posted by Abdenour Achab on May 14, 2008 at 22:03:50:

Hi Michael,

Thank you for your reply. I am planning to hold on to the investment if I get it, not broker it. Even though I would gladly sell it at 8% yield if any investor is willing to accept 8%. In fact, I would sell all the cash flows I currently own at 8% yield to any experienced investor (i.e. without the liability involved in selling to an unsophisticated person).

In terms of bidding whatever yield I “wish to earn”, well, I wish to earn 30%, but the odds are, if I bid based on a 30% yield, I won’t get it. I have kicked myself in the past in sealed bid auctions on both sides of the fence: both for not getting the cash flow even when I would have gladly paid what the highest bidder paid, and also for getting the cash flow (good) after bidding more than 20% higher than the second highest bid. Maybe I need to use some decision tree analysis to develop a formula to map the least yield I would be willing to accept in an oral auction to the yield I should use in a sealed bid auction. My intuition tells me that the 2 yields should be different.

The security is not real estate. It’s membership in an LLC that owns real estate with a multi-million dollar equity. The value of the security is way above the current balance of the note. The payor has bad credit (recent bankruptcy), but the LLC is making payments directly to the note holder on his behalf.

I am surprised to learn that you accepted a sub 8% yield. I was under the impression that funding sources demand 14% to 15% minimum yield.


Knight & Day! - Posted by David Butler

Posted by David Butler on May 15, 2008 at 15:29:15:

Hello again Abdenour,

You are welcome, and glad to see it has helped you at least in terms of perspective. But don’t make the dilemma more than what it should be. What is the item worth to you? What is not having it worth to you? Which of these two carries the most weight in your decision making process?

Actually, you should always bid less than what you think it is worth - its more a question of degree.

Game theorists long ago recognized that in a first-price auction (most commonly used English or Dutch auctions) using sealed bids, the best strategy is to bid less than your value for the item. This best strategy also varies depending on the circumstances of the auction â?? for instance, the number of bidders involved. In any auction presumably some people will overestimate the value of the item. If everyone bids what they think the item is worth, the person with the highest overestimate will win and pay too much for the item (and subsequently suffer the “winner’s curse”).

So the safe strategy for each bidder in a sealed bid auction environment is to assume he has overestimated, and consequently, lower his bid somewhat - what auction theorists call â??shadingâ?? your bid. If he really has overestimated, this strategy will bring her bid more in line with the actual value of the item. If he has not really overestimated, lowering his bid may hurt his chances of winning the auction; but itâ??s worth taking this risk to avoid the winnerâ??s curse. This reasoning applies to bidders in any situation where the item has some intrinsic value about which the bidders are uncertainâ?? what economists call â??common valueâ?? settings.

But to what degree should you lower the bid? Therein lies the rub.

Using Nash’s Equilibrium as his basis, Vickery concluded that the more bidders in the auction, the less each bidder should shade his bid, since there is less room between the highest bidderâ??s value and the second-highest bidderâ??s value. By Comparison…

In the later 1960s Stanford University economist Robert Wilson also decided that game theory was the way to understand common value auctions. He too used the Nash equilibrium to figure out just how much bidders should subtract from their value estimate to provide a good safety net against the winnerâ??s curse. As Vickery had, Wilson also concluded the optimal strategy depends partly on the number of bidders.

But Wilson concluded that in this case the more bidders in the auction, the more each bidder should lower her bid, because if there are many bidders, the distribution of their value estimates is probably very spread out, with the most optimistic bidder greatly overestimating the value of the item.

The difference is how much lower to make your bid? Back to square one. What is your walk away price?

Happy Bidding!

David P. Butler

Re: 8% yields for notes - why not - Posted by Michael Morrongiello`

Posted by Michael Morrongiello` on May 18, 2008 at 14:38:43:

We don’t typically buy at this low of a yield but on occasion where we have a VERY strong file we will get down that that type of 8% +/- yield level or close to it. This is what we would be looking for;

Residential property ONLY - owner occupied use - not an investor

The Note instrument must be Well seasoned (typically 24+ months or more)with a good track record of payments associated with it (recently bought a note with over 15+ years of payments associated with it like this)

The property must show well with pride of upkeep also in the property and overall location / area.

The Note payors must have strong credit scores - typically 700+

Note Interest “coupon” rate must be better than 5%

Note term - or time left to run on the Note may be a factor

There must be some minimum discount off the current unpaid balance (typically $3K to $5K or more)

If all or most of the above factors align - we are purchasing that sort of “paper” with VERY aggreesive yields. Is only some of the above factors exist we trade up from there. While we clearly do not see a lot of this type of high quality “paper”- you’d be surprised how some of it does in fact exist.

Best to your success;
Michael Morrongiello
Since 1983 - “Creative People with Creative Solutions”