ˆWhat is an escalation clause? When you’re deciding on what price to offer as a home buyer, the situation may call for what we call a ‘single price’. Sometimes it calls for including an escalation clause.
What is an escalation clause?
An escalation clause is a real estate contract addendum that lets a home buyer be more aggressive during bidding wars. Heres how it works:
“I (John Smith) will pay x ($100,000) sales price for this home, but in the case of a higher offer to the seller, I’m willing to increase my escalation amount up to y ($200,000) price in z ($2,000) increments.”
Technically, an escalation clause is fairly simple. In practice, there are a lot of details involved in applying this clause during bidding wars.
How does an escalation clause work?
The general escalation addendum has a few basic components:
- What is the original base offer for your purchase price?
- How much will you escalate that price over a competitive bid?
- What is the maximum amount that your final home purchase price can reach during the multiple offer bidding war?
Example: Homebuyer, John, offers a $100,000 sales price for a home or other kind of real estate. His Real estate agent, the Realtor, adds the escalation clause so in the case of higher offers, will increase John’s offer in increments of $2,000 above the competing offer (Only to be done when multiple offers have been confirmed, of course!)
His escalation clause hits a maximum escalation amount of $210,000. If no other offers were submitted, John’s offer remains at $100,000.
Buyer Smith offers the seller $103,000, then John’s offer would automatically escalate to $2,000 above that, bringing John’s offer to $105,000. If buyer Tommy offers $211,000 for the home, then John’s maximum of $210,000 will be exceeded, and Tommy will have the top offer and oftentimes win.
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. In this case, including an escalation clause simply won’t work. They are allowed to reject your offer legally and ask that every buyer submit exactly what their highest and best offer is for their home or real estate.
Sellers and some listing agent 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?
Escalation clauses should only be used when the buyer determines that there will be multiple offers and not in other cases.
Why? Well, buyers who submit an offer including an escalation clause are laying all their cards on the table. That means Mr. seller knows immediately how far you, 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. Now the seller knows that they can push you up and leverage that against other interested parties to get them to shoot in offers.
The listing agent, Realtor, representing the seller will know, however, to counteroffer to you. They will push the buyer, at a higher, escalated price, since it’s clear you’re 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 without properly checking things out. It’s not your responsibility though. Have your real estate agent check things out if they didn’t already.
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 listing agent, Realtor, will make a final decision that day.
This is the type of situation that calls for including an escalation clause, when a buyer knows it’s going to be an all-or-nothing type of offer. Other sellers take a back-and-forth approach.
They may collect offers from home buyers for a week, and then choose to respond. They often answer a handful of the best offers saying “Send us your highest and best offer.”
This technique is disliked by many home buyers and real estate professionals for its lack of clarity, but it’s important to know that it exists. Before writing an offer, a buyer’s real estate agent, Realtor, can inquire to feel out the details regarding the particular property and make sure the home buyer is prepared for the situation.
Writing an escalation clause on the initial offer in a multiple offer situation could put the buyer in a weak position. That’s if a second-round happens. It’s perfectly legal for a seller’s real estate agent, 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, including an escalation clause would reveal that buyer’s maximum, losing a bit of a competitive edge. Keep in mind, you are also made aware of this, so you can react accordingly.
Bid with careful confidence, and know that each situation is unique
If you’re considering including an escalation clause, your real estate agent, Realtor, is probably busy researching. Knowing the circumstances around the seller’s process of reviewing offers is crucial to structure the best offer. When two offers are close, the best terms make a difference. The Realtor’s highly experienced knowledge of normal practices and possible outcomes in your market will position your offer for much more likely to succeed.
Escalation clauses can seem stressful for home buyers, but when they are simplified, they’re fairly straightforward. Remember to be realistic, comfortable with your bid you’re offering, and confidently go after a piece of real estate at your chosen price.
Buyers shouldn’t be pressured to escalate their purchase price above what they would be comfortable paying. At the same time, keep in mind, if inventory and interest rates are low that aggressively pursuing the right home is absolutely necessary. That’s the only way of winning in a competitive market like this full of bidding wars.
Potential buyers who are only looking to get a steal often end up not being buyers at all.
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