By Dr Wong Woei Chyuan

Foreclosure sales initiated by lenders due to borrowers not able to make mortgage payments are expected to rise with the expiry of the second blanket loan moratorium on 31 December 2021.

It is likely that there will be an increase of property to be auctioned. Auction is the common disposal method used by lenders to recoup loan balance owed to them. A quick search on an online auction properties portal, https://www.auctionpro.my/ , reveals that a total of 2,651 properties were being auctioned in Malaysia as of 20 January 2022. The auction market is known to offer a bargain for investors who are willing to bear the risks and unknowns when bidding for auctioned properties.

This article focuses on one of such market imperfections, i.e., no inspection of the interior of the auctioned properties by potential bidders. Interested readers who want to know more about the imperfection of the Malaysian auction market could refer to my previous newspaper article titled “Making auction a viable option to sell foreclosed (lelong) properties during the COVID-19 Pandemic”. In Malaysia, it is a common practice where prospective buyers do not have the opportunity to inspect the interior of the auctioned properties before submitting their bids. The auctioned properties are locked if they are unoccupied. Bidders can only view the properties from the outside.

In my opinion, this limitation is a major reason why auctioned properties are selling far below their market value. The discount is to compensate winning bidders for the possibility of major repairs such as leakages, cracked walls, and/or damaged tiles that could not be verified from the auction proclamation of sales document. Practically, a rationale bidding strategy is to price the worst scenario into the submitted bid price as claimed in my research paper titled “Apartment foreclosure discount in Kuala Lumpur” published in the Pacific Rim Property Research Journal. I found foreclosed properties’ listing prices were 33.4% lower than the listing price of non-foreclosure apartments located in the same apartment building as in the foreclosed properties.

Lenders in Malaysia typically take the passive approach in disposing foreclosed properties by delegating the selling role to licensed auctioneers. This is understandable given foreclosure is the final step invoked by the lenders after exploiting all possibilities of a loan workout. It does not make financial sense for lenders to further invest more resources on these distressed properties particularly in a situation where lenders could easily recoup their loan from the auction sale, i.e., when the outstanding loan owed to them is much lower than the property value.

Inspection of foreclosed properties

However, I am of the view that to protect the interest of all stakeholders, consideration to inspect foreclosed properties prior to the auction date should be made possible. To the lenders, the default mode of delegating foreclosure sales to the auction houses warrant a relook given the current pandemic situation that could witness the auction market being loaded with many unsold auctioned properties. This may further depress the sale prices obtained by the lenders, resulting in a lengthy recovery process if the sale proceeds are not sufficient to cover the loan’s balance. Provision of viewing opportunities could be a low hanging fruit strategy that lenders should seriously consider.

To the distressed borrowers, while it may seem too cruel to have their houses open for viewing (infringe of privacy and hurting of ego), it is in their favour as the auctioned property could fetch a higher price. Any balance between the debt owed to the bank and the selling price would go directly to their pocket after deducting other liabilities due such as the utility bills and taxes. This extra cash could come in handy during the current crisis period. To the prospective buyers or investors, they are more assured of the market value of the foreclosed properties, thus protecting them from overbidding and investing in properties with huge repair costs.

The onus is on the lenders. They are fully empowered by the loan agreement to take steps to dispose distressed properties. For judicial auctions (properties with individual titles), lenders must apply from the high court or the land office for an order for sales before they can proceed with auction sales. What lenders need to do is to have a small change in the auction selling process by roping in the help of auctioneers or property agents. These intermediaries have financial incentive to ensure the auction sales succeed. For example, they could arrange a one-time viewing session or the use of virtual tours to record the interior of the property to minimise occupants’ (defaulted borrowers’) aversion to property viewing.

It is worth noting that inspection of foreclosed properties is a common practice in countries such as Singapore and the United States. In Singapore, bidders are given approximately two weeks to view and to inspect the foreclosed property before the auction date.

Interested bidders can arrange with the auction agents to view the foreclosed properties. In the United States, foreclosed properties initiated by the commercial banks and federal or government agencies can be inspected before the auction. These institutions have their respective preview and pre-sale inspection policies arranged by the real estate agents.

Interested bidders in the United States can also get help from a professional home inspector to investigate the interior condition of the foreclosed properties before making their bidding decisions.

Increase in selling price

The implementation of a viewing opportunity for foreclosed properties will hopefully increase the selling price, thus, improving the financial well-being of defaulted borrowers, many of whom belong to the B40 household. This small initiative is also in tandem with the commercial banks’ corporate social responsibility commitment towards the lowest 40% of income earners in Malaysia where financing needs and inequality are the greatest. The non-resource nature of the housing loan means that defaulted borrowers are personally liable to the outstanding debt if the auction sale proceeds are not sufficient to cover the housing loan.

This may further exacerbate income inequality issues when the defaulted poor households are trapped in this vicious circle. This small initiative is also in line with the recent positive development in the Malaysian auction market, such as the introduction of online bidding since 2018 that has significantly reduced the price distortion and has increased the transparency of the auction market.

-- BERNAMA

Dr Wong Woei Chyuan is Associate Professor at the School of Economics, Finance and Banking, Universiti Utara Malaysia.