Escalation Clauses with Offers

We are experiencing one of the hottest real estate markets in recent times, if not ever. One very useful tool for buyers is to use an escalation clause in your offer. Escalation clauses have become very popular recently. Read on to see exactly what an escalation clause is and some of the pros and cons of using this tool and also, whether or not you should employee this in your next offer.

Escalation clauses can have several different variations but generally speaking they are meant to increase your offer in the event a seller receives one or more competing offers. The simplest version of an escalation clause would be written to increase your offer by a stepped amount to make it higher than the highest bona-fide offer that a seller has received. Normally you would include a maximum offer amount. For example, you make an offer of $250,000 with an escalation clause stating that you will beat the highest bona-fide offer by $1,000 up to a maximum of $265,000. Basically, if your offer is at $250,000 and the seller has received a competing offer of $257,000, your offer would automatically increase to $258,000. Simple, right?

Next, you have to ask what are the Pros and Cons of an escalation clause?

First the Pros:

1. An escalation clause can help your offer to stand out in a sea of multiple offers that a seller is reviewing.
2. You may be able to avoid the unknown of a highest and best offer period as your offer automatically increases a certain amount to be the highest offer.
3. It could help to ease negotiations from both buyer and seller side as you are making your highest offer, yet could save you a bit of money as you only agree to beat the next highest offer by a pre-determined amount.
4. The escalation clause could be just the right tool to help you win the bidding war and secure an executed contract on your next home.

Now, the Cons:

1. The most important con: You are disclosing the most you are willing to pay for the home in the first offer. Therefore removing any real ability to negotiate counter offers. If there aren’t multiple competing offers you have shown your proverbial cards prior to any negotiations. Once the seller sees that you are willing to pay a higher amount they could skip everything else in the escalation clause and counter at your highest offer.
2. A large number of sellers and their agents don’t understand escalation clauses. These escalations are a fairly new tool in the real estate negotiating world in our area. If they don’t truly understand the escalation they may not realize that your offer is actually better than it initially appears.
3. It is possible and probable in this market that a seller may refuse any and all escalation clauses in favor of a highest and best offer period. There is some thought that a highest and best period will generate a higher sales price or better sales terms.

Some additional escalation clause considerations whether you are the buyer or seller:

1. Seller will be obligated and expected to show the other bona-fide offers that have caused the escalation clause to be triggered. There can be private information on competing offers that should not be disclosed to other parties.
2. If the escalation clause is triggered will the financing amount change or does the buyer plan to bring the additional money as cash at closing. Appraisal values will affect the buyer’s financing. The buyer may have to bring the difference in cash if the appraisal comes in lower than sales price.
3. What happens when there is more than one buyer who is using an escalation clause? This is more a direct seller issue but which one does the seller choose? Keep in mind from a seller point of view the highest offer is not always the best offer.

From the seller’s point of view, what are you obligated to do with an escalation clause? Well, you could agree to accept the initial offer without triggering the escalation clause. You are free to decline the offer all together and go with a different offer, even if it is a lower sales price. You could call for a highest and best offer from all of the current offers you have received and set a deadline for those offers to be received.

Again to the Buyers, there are lots of tools in the tool chest to use when presenting your offer to purchase a home in a “seller’s market.” The escalation clause is one of many that we see being used regularly in recent transactions. We normally recommend using other tools first. These include making your highest and best offer first and including the most favorable sales terms to include short inspection periods, cash or strong financing terms, offering to pay some or all of the seller’s closing costs, and also being flexible with closing dates and timelines.

Hopefully this helps you decide whether including an escalation clause is the right tool for you to use. Give us a call and we will help you win in a hot market.