Escalation clause: Secret Weapon or too good to be true?

I had a first time buyer that came to me last week and he thought he had just discovered the holy grail of real estate negotiation.? He was beaming with excitement. He felt he had found a silver bullet.? The secret he had discovered is called an “escalation clause”.? It's actually pretty common these days.

While an escalation clause can be a great tool in the right situation, there are cons of an “escalation clause” that buyers need to consider.?

What is an escalation clause?? In its simplest form, instead of just stating a purchase price, there is a clause that says “the buyer offers “$400k” and will pay “$1k” amount over any other buyer's offer, up to “$450k”.? Often the clause will speak to the seller providing a copy of the “competing” offer as proof of the offer that escalates yours.?

The advantage of an escalation clause:?It might save you thousands of dollars.??

Why use it?

When you know a property will sell well over the list price but you don’t want to pay many $thousands more than you might have to by guessing.?

How?

An escalation clause might keep you within $1000, $2500, or $5000 or your nearest competitor rather than you throwing a hail mary that could be tens of thousands more than the nearest competing offer.???

Sounds like a “no brainer” right?

However, with advantages come disadvantages, potentially unforeseen.? Here are some potential “cons.

1. Buyers need to understand that an offer with inferior terms can escalate their offer.? Competing offers might have “home sale contingencies” or other contingencies/terms that make the competing offer inferior and/or unacceptable to begin with, yet it escalated the price.
2. Put yourself in the seller's shoes. Some listing agents/sellers have strong and conflicting opinions about escalation clauses.? Some agents love them and welcome them, some agents are convinced they are evil.? Opinions, good and bad, simply often relate to an agent's past experience.? Some agents will state up front “no escalation clauses”.? I have seen sellers that perceive escalation clauses as “cheating” and some that perceive them as “less sincere” than another buyer, despite the price.? Everyone has an opinion, it just might not match yours.
3. The mistake of thinking it's all about price.? Smart listing agents and sellers know that the best offer doesn’t necessarily come with the highest price.? There are other terms that provide certainty and therefore value to a seller, including but not limited to: appraisal contingencies, appraisal gap coverage, inspection and remedy clauses, closing and seller possession timeframes, other concessions, etc…The highest offer often doesn’t win, it might simply get matched by another behind the scenes with better terms.?
4. It's all in how you write the clause.? Experienced listing agents smell a disaster waiting to happen when they see an unprofessionally drafted escalation clause. It should have plenty of fineprint that outlines every detail and scenario.? Experienced buyers agents utilize forms/clauses/disclosures written specifically by the CBR attorneys where there is a universal understanding of what is to transpire. Many naive buyers won't realize their offer never even had a chance due to the way the offer was unprofessionally drafted.
5. You have disclosed your max bid. Is the seller going to feel good about selling it for less than what you stated was your max.? They feel like they were taken advantage of by a technicality.? This is one reason some listing agents don’t like them.? You need to consider the message you are sending to the seller and how they can feel about it.? Just because you were the highest doesn’t mean they need to accept it.? You might even get a counter offer at your max bid regardless of other offers.
6. Understand the fine print.? If the clause states that the buyer will pay $2k over the highest “net offer, what does that mean?? If one offer is asking for $5k in buyer paid closing costs, a mortgage rate buy down, a home warranty, etc…What is the actual “net offer”?
7. There are escalation clause busters.? Ex: A competing offer might offer to pay $10k of the sellers closing costs.? Why? The buyer with the escalation clause might be “2k” higher in price but the offer paying $10k of the sellers closing costs artificially maxes out your escalation clause and nets the sellers bottomline $8k more.? Sellers/agents also welcome that the lower price brings less appraisal risk.?
8. An escalation clause can escalate an escalation clause. You are effectively auto-bidding against other offers/escalation clauses up to your max bid.

As you can see, there is more than meets the eye with an escalation clause.??

Bottom line, an experienced agent will have their finger on the pulse of the market, know when its the right strategy to deploy,? and likely have a relationship of trust already built with the opposing agent to advise how it will be received.

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