“It’s crazy out there!” That’s how more and more top agents are describing their local markets. Buyers are desperate. Multiple offers. Backup contracts. Bidding wars. We saw it before in the boom times before 2007. Today a shortage of inventory and pent-up demand fueled by low rates are requiring buyer techniques we haven’t seen in years.
Case in point: Escalation Clauses.
In red hot markets where numerous buyers put offers on a desirable property, one solution for serious buyers is an escalation clause addendum to their purchase offer (also, “sharp bids”).
An escalation clause says the buyer will pay a fixed amount more than any competing offer the seller might receive. Amounts are pre-determined by the buyer and include a maximum price cap. That said, an escalation clause isn’t a fool-proof way to get an offer accepted, but it increases the buyer’s chances — especially against those who don’t know about this powerful strategy.
Here’s how it works: Your buyers find a home they like for $250,000. But because of its desirable condition, location or amenities there will be other offers. Your buyers would really like to offer only $240,000 for the house. Yet they’re willing to offer up to $268,000 which is the current market value for similar homes in the area. With an escalation clause the addendum can increase the offer price, say, in $1,000 increments (or bigger increments, as directed) up to a maximum $268,000.
That means, if other offers come in at $245,000, $260,000 and $261,500, your buyers’ offer can escalate to a $262,500 purchase offer. That’s still under your buyers’ cap of $268,000 which means your buyers will save $5,500 since they didn’t blindly offer their maximum price upfront.
Multi-offer example: If offers came in at $265,000, $267,000 and $269,500, your buyers would lose the house since their maximum price cap was $268,000. However, they can walk away pleased, knowing that they didn’t “win” the bidding war by overpaying…and face the deal collapsing from a below-contract-price appraisal.
Yet another scenario: Your buyers offer $240,000 and include an escalation clause with a cap of $268,000. If the seller shares that fact with another buyer, that other buyer – who planned to offer $250,000 but couldn’t go as high as $268,000 – decides not to make an offer at all. Without a competing offer, your buyers get the property for $240,000. Sometimes playing the escalation clause strategy can drive away the competition.
Caution: An escalation clause tips a buyer’s hand to the seller signaling the buyer is willing to pay a higher price. Yet, in a super-competitive situation an escalation clause can be the deciding factor (especially if other buyers also include escalation clauses). The seller also must take into account if the house will appraise for that escalated price. If the seller counters with a higher price – instead of invoking the escalation clause – your buyers have the choice to counter the counter offer or walk away because a seller’s counter offer doesn’t trigger the escalation clause (only a competing purchase offer can trigger an escalation clause).
Downside for buyers: Buyers should carefully consider if an escalation clause is wise when competing offers include a sale contingency, longer escrows, or seller financing. Plus buyers need to define a satisfactory seller response and specify how long the seller has to solicit and consider competing offers. Be aware, some lenders have specific requirements with escalation-clause purchase offers as well.
Escalation clauses are not for everybody. In some jurisdictions escalation clauses are not used, plus some sellers won’t accept offers with an escalation addendum. Top agents who use escalation clauses are careful to properly draft the addendum (or use a Board or MLS provided form) that requires evidence of a competing purchase offer to trigger an escalated price offer before the contract can be ratified.
When is an escalation clause strategy most effective?
Have you seen deals where an escalation clause carried the day for buyers? Where it backfired?
What is your experience?
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