Escalation clauses should be avoided by both buyers and sellers. In tight real estate markets, buyers want to have their offer selected and sellers want to maximize sale price. Having the offer price automatically “escalate” seems like a winner for both parties, but there is no chicken dinner and many say only chicken...
What is an Escalation Clause?
An escalation clause is a stipulation inserted into a buyer’s offer to ensure it remains competitive. It's typically considered in highly competitive, multiple offer situations. It is not a guarantee; with or without an escalation clause, a seller is free to accept the offer they consider best. Sellers can (as many do) instruct the listing agent to notify buyers that escalation clauses will not be accepted. Remember that.
The escalation clause states that the buyer will increase their offer by $X over any offer that exceeds it. The clause states what the incremental increase will be and what the buyer’s cap is. For example, a buyer of a home listed at $400,000 can state they will increase their offer by $1,000 over any other offer received, with a max price of $415,000. If it gets over that max, the buyer is out.
Sample Escalation Clause (in GA):
In the event of multiple offers, Buyer agrees to increase the purchase price by more than $XXXX.XX over any other offer presented to the Seller with comparable terms and conditions (the “Competing Offer”), provided that:
- The Competing Offer is an arms-length transaction;
- The notice of Seller’s acceptance of Buyer’s offer is provided on or before XXXXX;
- The above referenced notice includes a copy of the Competing Offer; and
- In no event shall Buyer pay more than $XXX,XXX.XX.
Upon receipt of the above, Buyer agrees to execute an addendum to this offer reflecting the increased final purchase price. A Competing Offer’s comparable terms and conditions shall mean similar financing contingency terms, similar time frames for closing, and similar requests for seller concessions and contribution to closing.
When a seller calls for highest and best, remember that highest isn’t always best and best isn’t always highest. Task your agent to find the seller's hot buttons...push them.
Buyers Should Avoid Escalation Clauses
It is critical for buyers to remain as controlled as possible when writing offers in a highly competitive market. That’s difficult because emotion, personal situations and a myriad of other factors play into the mix; keeping it “all business” can be a challenge. In theory, the buyer’s agent should be the detached gate keeper, provide data supported guidance and keep the buyer out of trouble. That’s not always the case.
Decide and Make Your Best Offer
Instead of relying on an escalation clause, task the buyer’s agent to prepare a though appraisal level pricing analysis of the property. Price is not the only motivator, sellers often have other hot spots. Quick close? Delayed close? Extra earnest money? Short contingency periods? It’s up to the buyer’s agent to find them and play to them as well. Simply “paying more to win” and disregarding the market conditions is stupid.
Tip Your Hand
If an escalation clause is used, the seller knows what the buyer is willing to pay. In the seller’s mind, this is now what the home is worth. What if the seller just counters that buyer back at their max cap price? Does the buyer then say “well no, that was just in case we had to go that high”? That’s a dopey answer because the escalation clause already states that is the price they are willing to pay.
Is it a Real Offer?
How does the buyer with an escalation clause know that the competing offer they are shown is legitimate? The risk of fraud exists; the buyer has no idea if the presented offer is genuine. The seller may have a friend or relative submit an offer simply to activate that escalation clause. Sure you can check with the buyer’s agent, but they may be duped into the game or the fake buyer may not have an agent.
Sellers Should Avoid Escalation Clauses
Make the buyers come in with their best offer, no escalation. The buyers know to be competitive as the seller make just pick the best offer or counter one or two. Buyers will get to their top end right away; an escalation clause allows the buyer to ease up to the cap. If the seller loses the ability to vigorously counter and exploit competition, money may be left on the table.
When the Contract Blows Up
A popular but very disingenuous move is for buyers to simply do what it takes to be selected. Once selected, they chop down price by hitting the seller with every possible repair or other issue found during due diligence. Gambling on the appraisal coming in below sale price is popular; if that happens both sides have to come up with a solution or the deal falls apart. Of course buyer agents shouldn’t operate in this manner but some buyers misrepresent their intentions.
Some buyers “win” and sober up; “I’m paying what for that home?” and terminate. Buyer remorse is a legitimate issue in strong seller’s markets. Acting initially on emotion, the buyer may regret their decision and bail. Now the seller has to rekindle interest and repeat the selling process – and likely have to answer “what happened with the contract that terminated”?
Keep it Simple
Highest is not always best and best is not always highest, keep it simple. Smart buyer agents understand that it’s important to work with the listing agent; find out the most important things to the seller and cater to that. Write a strong, simple contract that recognizes the market and hits the seller’s key requirements. Perhaps waiving or significantly reducing contingencies and/or time frames is an option; maybe a rent back for the seller.
Listing agents need to be savvy to the games being played by some buyers and agents; verify everything to ensure that the seller is protected. If the offer looks to be ridiculous, call BS and challenge it. Counter with things that benefit the seller, eliminate contingencies, shorten or eliminate time lines, boost EM and make it non-fundable once binding. The listing agent’s duty is to get the best deal for the seller, not chase nonsense offers.
Escalation clauses aren’t going away, some agents regularly use them and some buyers feel they are an effective tool. That’s a minority opinion; both buyers and sellers can often do better without them.
The Hank Miller Team puts 30+ years of full time sales & appraisal experience to work for you. Act with complete confidence & make sound, decisive real estate decisions. 678-428-8276 and firstname.lastname@example.org Posted by Hank Miller on