What buyers need to know about escalation clauses
An escalation clause can help buyers gain a crucial edge in today's seller's market, but these offer addendums need to be handled with care. What is it? An escalation clause is a real estate contract, sometimes called an escalator, that lets a home buyer say: “I will pay “x” price for this home, but if the seller receives another offer that’s higher than mine, I’m willing to increase my offer by “Z” to “Y” price. Just be sure you have the cash to back up the offer.
How does an escalation clause work? While escalation
clauses vary significantly, the general escalation addendum has a few basic
components:
• What is
the original offer of purchase price?
• How much
will that price be escalated above any other competitive bid?
• What is
the maximum amount that the purchase price can reach in case of multiple offers?
For example, buyer Brown offers $100,000 for a home or piece
of real estate. Her Realtor® adds an escalation clause that, in the case of a
higher competing offer, will increase Brown’s offer in increments of $2,000
above the competing offer.
Her escalation clause goes up to a maximum of $110,000. If
no other offers are submitted, Brown’s offer remains at $100,000.
If buyer Green offers the seller $103,000, then Brown’s
offer would automatically escalate to $2,000 above that, bringing Brown’s offer
to $105,000. If buyer Orange offers $111,000 for the home, then Brown’s maximum
of $110,000 will be exceeded, and Orange will have the top offer.
Will the seller accept an escalation clause?
Some home and real estate sellers simply state that they
will not accept an offer with an escalation clause. They would prefer that
every buyer submits exactly what they’re willing to pay for the home or real
estate.
Sellers sometimes prefer this method, because it motivates
buyers to outbid one another on the first try. It also streamlines the contract
paperwork and the decision-making process.
Will there definitely be multiple offers? Almost always
in the 2021 market so far. Some folks hate to put all their cards on the
table upfront- Yes, I get that, but in the market, it does help the seller
select the best offer.
Escalation clauses should only be used when the buyer is
fairly confident that there will be multiple offers, or when the buyer expects
to pay an increased price.
Buyers who submit an offer with an escalation clause are
laying all their cards on the table: The seller knows immediately how far the
buyer will go to secure the home. If that offer ends up being the only offer
submitted, it technically remains at its original price.
A Realtor representing the seller will know, however, to
counteroffer to the buyer at a higher, escalated price, since the buyer is
clearly willing to pay more. While there’s no guarantee that the buyers will
agree to the higher price, it is likely that they will.
A buyer gives up a lot of negotiating power and potentially
leaves money on the table when using an escalation clause that goes unmet by a
competitor. The only protection they have is the appraisal, and if they chose
to waive that, too—they are agreeing to the price no matter what… so be sure
you can come up with all the extra money before adding this clause.
Has the seller’s agent clearly stated a one-day review or
multiple rounds of offers? In hot real estate markets, a wide variety of
offer-review processes can be available. Some might specify, for example, that
the property is going on the market on Friday, and that all offers will be
reviewed the following Thursday. The sellers and their Realtor will make a
final decision that day.
This situation can be ideal for the escalation clause, when
a buyer knows it’s an all-or-nothing offer. Other sellers take a back-and-forth
approach.
They may collect offers from buyers for one week, and then
respond to a handful of the best offers by saying “Send us your highest and
best offer.”
This technique is particularly disliked by many consumers
and professionals for its lack of clarity, but it’s important to know that it
exists. Before writing an offer, a buyer’s Realtor can inquire to feel out the
details and make sure the buyer is prepared for the situation.
Writing an escalation clause on the initial offer in a
multistage situation could put the buyer in a weak position during the second
round. It’s perfectly legal for a seller’s Realtor, with the seller’s
permission, to reveal to all potential buyers what the top initial offer is and
to ask everyone to beat it.
In this case, the escalation clause would reveal that
buyer’s maximum, losing a competitive edge.
Bid with careful confidence, and know that each situation is
unique
If you’re considering an escalation clause, The Realtor’s knowledge of normal practices and
probable outcomes in your market will make your offer much more likely to succeed. They will help you see what the downfalls are and explain any advantages.
Escalation clauses can cause a lot of stress for home buyers, but when they’re boiled down to the basics, they’re fairly straightforward. Remember to be realistic, to be comfortable with how much of a competing bid you’re willing to offer, and to confidently go after a piece of real estate at that price.
Potential buyers who are only looking to get a steal often
end up not being buyers at all. With the way homes are going up in value in 2021-- 2
months of looking for a home could potentially cost you $10,000- $20,000… so
some buyers are taking that value on at the time of the offer, to hedge their bet.
But bottom line, the only protection the buyer has in this situation is the appraisal. Now, that could bite you too- as what if the appraisal come in low—will you
have the cash on top of your down payment to make up the difference? So just tread carefully and know what you are
getting into- before you jump in!!
