Tuesday, December 8, 2020 / by Vanessa Saunders
Can I win the deal with an escalation clause?
By Vanessa Saunders, MBA, MIMC , Broker Owner, Global Property Systems Real Estate.
The last six months in the Hudson Valley real estate market have admittedly been crazy. With little inventory and a high demand for any kind of Hudson Valley home, buyers have been beating down the doors of the few homes on the market, trying every tactic imaginable to present a winning offer on a house. We’ve written before on tactics for buying a house, but these days, getting an offer accepted is akin to a contact sport among buyers.
One tactic we’re seeing more often here in The Land of Competing Offers, with multiple buyers and all cash deals, is the inclusion of an Escalation Clause. An Escalation Clause in a buyer’s offer says that the potential buyer will raise his offer up to a certain amount over competing buyers. The clause is used to strengthen a buyer's offer by promising the best price.
It sounds like a win-win, no? The buyer wins the bidding war and the seller gets the highest sales price on his house. Unfortunately, I’ve seen escalation clauses screw up deals more often than facilitate them. Here’s a few things that can happen.
An escalation clause is basically the buyer giving the seller the key to his piggy bank and saying to the seller, “Help yourself!” Most buyers cap the escalation offer to keep from paying more than they are willing to offer. They will say they are willing to pay $X dollars more than the next highest offer not to exceed $Y. So what is to stop a seller from simply countering the offer at the capped price? There’s no guesswork to figure out how much the buyer is willing to pay.
Another problem for buyers is not knowing how big the competing offer is. Realtors are allowed to disclose when there are multiple offers, but not allowed to reveal the amounts to other parties without the permission of the seller. So a buyer going in with an Escalation Clause has no idea what he’s bidding against.
Along those same lines, a buyer also does not know if the competing offer is legitimate. Are they really competing against another bona fide offer or just a phony offer solicited by the seller to raise the price of their property?
On the seller side, if there are competing offers with specific dollar amounts, and another offer including an Escalation Clause, at what point does the seller have a concrete dollar amount representing the highest sales price for the property? An exact sales price has to be agreed upon at some point.
What an Escalation Clause basically amounts to is just the buyer asking for a free right-of-first-refusal. Smart home sellers won’t accept an offer with an Escalation Clause, and will recognize only an offer with an exact dollar amount and clearly stated terms.
A worst case scenario occurs when a buyer wins the bidding war but then gets “buyers remorse” before the ink is dry on the contract. If the contract has an escape clause, the buyers can back out, feeling like they were stuck paying more than they wanted to in the heat of the bidding war. In that case, it’s a lose/lose, with the buyers walking away without a house, and the sellers starting over again in hopes of finding a new buyer.
My advice for buyers and sellers alike: “Show me the money!”
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