What’s an Escalation Clause, and should you use one in 2020?
2020 has experienced a shift in the real estate market timing. The normally busy Spring time was quieted as we stayed home in quarantine across the country. Now the normally quiet Fall season is booming.
Home inventory is low–in some areas inventory is down to a one or two month supply of housing. This makes competition fierce. Most homes are staying on the market for days only, and are going under contract after having received multiple offers.
How Can You Compete?
There’s an old, and often little known, clause that may be of help. An escalation clause is made specifically for competing in a multiple offer situation.
Here’s how it works:
The escalation clause essentially states that your offer will automatically escalate to a higher price when there’s another offer that’s higher than yours. You specify what incremental increase you agree to, and what your top price is. In this way, your offer automatically moves to the top of the list in a multiple offer situation. The advantage of it is that you try to mitigate your risk of overpaying.
Here’s an Example:
Let’s say you’re bidding on a home that is listed at $200,000.
You’ve worked with your Realtor and researched the comparable sales and you feel comfortable going up to a price of $230,000 for this amazing home. However, you don’t want to offer $230,000 off the bat, if there’s a chance you can buy the home for $210,000 for example. At the same time, you want to beat out other offers that are under $230,000.
Your Realtor prepares an Escalation Clause (also called Escalatory Clause by some). In it you specify that you’re offering full price for the property ($200,000).
However you’re also willing to pay $500 above any other offer that is received, up to a final purchase price (the cap) of $230,000.
Now, let’s say that seller receives multiple offers that look like this:
One offer at $200,000
Another offer at $210,000
A Third offer at $217,000
Offer #4 at $224,000
Your offer at $200,000 but with an escalation clause to $230,000
Clearly, the highest offer at face value is $224,000.
Your escalation clause is automatically triggered, making your offer now an offer of $500 above the highest offer. Therefore your offer is now “seen” as an offer of $224,500.
In this ‘best case scenario’ you win the property, and you pay less than what you would have been willing to pay.
Congratulations! Maybe….. Here are some other considerations….
Wait–How do I Know The Sellers are Telling the Truth About Their Highest Offer?
This is a common question. You ask the listing agent to provide a copy of the highest contract that triggered your escalation clause. It’s actually part of the clause in most of the ones that I’ve seen. Could they provide a fake contract? Well, I guess so, but this would likely go against the Code of Ethics and at some point you need to believe in the integrity of people.
What you Should do Before Using an Escalation Clause:
Before using an Escalatory Clause, be sure that your Realtor speaks with the Listing agent. It is important to know if the listing agent is familiar with this form. (Many new agents have never heard of it.)
Some listing agents prefer not to work with the Escalation Clause. It happened to me recently. I wanted to use one for a client of mine on a property that had 12 offers on the table. After speaking with the agent, she explained that this clause would make things very difficult because multiple escalatory clauses would be in place and the seller really didn’t want to deal with that type of situation.
In speaking with that listing agent, I learned that the seller was more focused on having a clear offer (not one that was trying to jump over another by a few hundred dollars) and she mentioned how much they loved this home they’d owned for years.
The way to go in this situation was to forgo the Escalation clause, make the best offer my client was willing and able to make, and include a sincere letter to the seller letting them know what the new home would mean to these buyers and how they envisioned themselves in it. So, the reason for that side-story is to highlight that every situation is different. Don’t count on this clause to be the absolute solution, communication is always key in understanding what will motivate the seller to accept your offer.
Legality of the Escalation Clause
Many feel that the Escalatory Clause creates a gray area in negotiations. There are those who feel it is unethical and an “ugly” way to negotiate. Some State and Local Boards have banned the use of Escalation Clauses, so you need to know the rules and laws in your area. Be sure that any form used in your transaction is legal and approved in your area. Any addendum that is created for use in a real estate contract should be prepared by an attorney.
**Disclaimer: Please note, I am not an attorney and am not acting as an attorney or providing this form for use in a real estate transaction in your area. This is just an example of an Escalation Clause I have seen used so that you can see an example of it.
Good luck with your transaction!
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