Perhaps you’re a buyer and you’ve never heard of an escalation clause. Or maybe you’re a young Realtor and you’ve never come across one before. An escalation clause is a term in an offer where the buyer agrees to increase their offer by a set amount over and above the actual highest offer. It’s a way to help a buyer out bid the competition in a multiple offer situation. It’s pretty crafty if you’ve never seen or used one before. An escalation clause goes something like this: Here is my full price offer for $700,000 and we agree to pay $2,000 over the next highest offer. In this scenario, if a competing buyer wrote at full price, you would escalate your offer to $702,000. If a competitor wrote at $710,000, our buyer would pay $2,000 over the $710,000, thus their final offer would be $712,000. Pretty clever. If you’re a buyer, this strategy is designed to help you win the bid (View Tim’s listings here). It’s an obvious win-win right? The buyer gets to win the house and the seller gets more money. If that’s so then, why doesn’t everyone do it and why do I decline/counter, offers with escalation clauses on my listings? Before I tackle why I decline offers with escalation clauses, let me explain how multiple offers are working in this market.
With inventory at historic lows, sellers are commonly receiving multiple offers on their property. This is because there are far more qualified buyers than available properties listed for sale. As an example, I just listed a home in Ventura for $599,900. I had to use a digital scheduler to manage the showings which I set up for every 20 minutes. I had 24 showings on Saturday and another 20 on Sunday. I then put it on hold and sat back and waited for the offers to come in. At last count I have 16; I’ll be presenting them today. In this scenario the most common response from a seller in this situation is a counteroffer called “Best and Final.” This essentially turns the sale into a blind auction (Search for homes here). Buyers hate them, because any buyer would rather a seller just come back and say, “give me this price and these terms and it’s yours.” However, because we are seeing so many multiple offers, it’s become the standard to counter best and final and then a seller chooses.
You can see that in this environment having an escalation clause gives you as a buyer, an advantage because you will always have the highest price. Of course, if there’s no cap you could find yourself spending way more than you bargained for. When I’ve used this technique, I’ve often capped it by writing in an “up to” dollar amount to limit my client’s liability. For many this trick is working, so why won’t I allow an escalation clause on my listings?
An agent just asked me this yesterday on my Ventura listing. I told him I don’t allow them for 3 reasons. First, it’s not fair. If a buyer responds with their best and final, they expect that their competitors will do the same. But the guy who wrote with the escalation clause did not have to since he built in a way to jump over everyone else. Second, what if everyone writes with an escalation clause? How would I and the seller deal with that? We would have to go back and ask each one to rewrite and that’s ridiculous. Finally, an escalation clause doesn’t necessarily get the seller the highest price. Think about it. If a buyer places a $2,000 escalation clause on and the highest offer for our $700,000 asking price home is $710,000, the seller would get $712,000. But if that buyer with the escalation clause has to come up with an actual number to win, maybe they choose to “buy the home” and writes a $725,00 or higher offer. This gets the seller the possible highest price. I mean that’s sort of the whole point to a blind auction (Contact Tim here). It’s also why buyers hate “best and final” because they very well may end up bidding against themselves and have no way to know it. As you can see that while an escalation clause can be a good ploy for a buyer when they’re the only one doing it, it isn’t fair, doesn’t always fly and almost always works to the disadvantage of the seller.