Land Auctions with Budget Constraints

Abstract

This paper tests for the effects of financial constraints on open-bid English land auction prices and bids. It is argued that bidders’ ability to pay, taken as capital resources and/or capital budget constraints, influence bids and final auction prices. While high capital resource developers may elect to bid more than optimal to win auctions, or bidders may elect to pool resources in joint bidding, budget constraints imposed by firm-specific financial variables on the other hand are expected to restrict bids. Land auction data in Hong Kong are used to test systematically these predictions. It is found that a firm’s age, the number of winners in a joint bid, and firm status in the market are positively related to prices, all factors which may be attributed to a firm’s ability to finance the auction price. Firm size, internal funds, financing cost, debt capacity and existing capital expenditure are also shown to affect bids submitted in land auctions: firm size and internal funds are positively related to bid prices; while constrained debt capacity, financing cost and existing capital expenditure lower bids. The results are consistent with predictions that a firm’s financial constraints, and thus its effect on capital budgets, are relevant factors in predicting land auction outcomes. More generally, these findings confirm that similar financial factors that constrain corporate capital investment also influence directly acquisition of assets at auctions.

Appendices

Appendix 1

Land Auctions in Hong Kong

Hong Kong manages its land resources through a leasehold system where the state owns all land (with trivial exceptions), and alienates land through long leases. Land prices thus reflect the value of long land leases (see Yao and Pretorius 2014), with vacant or (re)developable land released to the market mostly through auction or tender (for example, following lease maturation and reentry, or occasional release of previously unalienated or newly reclaimed land). Detailed auction information is made public well before auctions (typically at least four weeks before the auction date, and two to three months for some major and complicated land sales). The Government sets a reserve price; only bids larger than the reserve price would typically be considered at auction. The auction process is transparent and the bidder that offers the highest price wins the auction (for insight into the nature and complex dynamics of land auctions in Hong Kong, see Tse et al. 2011).

Land auctions in Hong Kong provide a good experiment to test the impact of financial constraints on auction outcomes, for at least three reasons. First, the auctions are highly transparent and the data from auctions are well documented, with information on the auctioned land, participants and bidding strategies. Second, urban Hong Kong is almost exclusively high-rise and extremely densely developed, with strict constraints on release of additional developable land. Industry participation in a high-rise, high-density environment demands high capital resources for typically large-scale/value projects (typically in excess of US$1bn). This reflects very high barriers to entry and advantages to leading developers,¹² often presented as causal to the industry’s concentration. Development in Hong Kong is often considered to be oligopolistic but stable, with some 14 big developers in Hong Kong accounting for most of total activity and with genuine contestability restricted only to smaller developments. The top four developers - Sun Hung Kai Properties, Cheung Kong, Kerry Properties and Sino Land - accounted for some 70% of all new flats sold in the first half of 2012 alone (Kwok 2012). Thus the developers’ ability to pay (the capital resources advantage) may be substantially reflected in auction outcomes, but the significant size and value of sites at auction also makes joint bidding an important financial and development risk-sharing strategy. Most developers who obtain land from auctions in our sample are thus large listed companies, and thus insight into their financial constraints and financial strength, also prior to auctions, can be obtained from public sources. Third, typically the Government sets a deadline for successful purchasers to pay the balance of the auction price in one lump sum, within 28 days after auction date, and commence development shortly after winning the auction and complete the project within a set time constraint (Audit Commission 2001), a common constraint in many markets. This indicates a substantial commitment of corporate capital at the time of the auction as the cost structure of development in Hong Kong is heavily weighted towards the cost of land, sufficiently so potentially to influence bidding if there is are both bidders with binding constraints and ones that bid strategically. The Auction rules allow Government to repossess the site if a winning company bids more than its ability to pay and defaults after winning (Zheng 2001).

Appendix 2

Table 10 Variables for Land, Auctions and Companies