Should You Use an Escalation Clause?
These sharp bids on purchase offers can backfire
An escalation clause is language inserted into a purchase offer for a home that's intended to make sure a buyer is the highest bidder. It's typically used when a buyer and their real estate agent strongly believe a house will receive multiple offers.
An escalation clause states that the buyer will pay a certain amount of money above the highest offer the seller receives. It generally includes a ceiling cap to make sure the buyer doesn't agree to pay more money than they can afford.
An Escalation Clause Scenario
Let's say a seller has listed their property at $295,000 in a seller's market—one in which there's great demand for homes and prices are rising. The home has all the bells and whistles a buyer could possibly want, and it's located in a desirable neighborhood on a quiet cul-de-sac.
The listing agent has advised buyers that all offers will be presented to the seller on a certain day at a certain time. That's a clear indication the agent expects to receive more than one offer on this plum property.
The seller receives offers of $290,000, $295,000, $305,000, and $310,000. The fourth buyer's offer includes the following escalation clause:
Buyer agrees to pay $1,000 more than the highest offer received by the seller, not to exceed a sales price of $315,000.
The buyer has now agreed to pay $1,000 more than they would have without the escalation clause but they may be able to buy the house for $4,000 less than the maximum they were willing to spend. And they have ensured no one could have outbid them among the initial offers.
Drawbacks for the Seller
If the seller accepts the offer with the escalation clause, they can no longer issue multiple counteroffers to the other interested parties nor can they continue to negotiate with the highest bidder. If the buyer was actually willing to pay $315,000, the seller lost that $4,000.
A seller who accepts an offer with an escalation clause will never know exactly how much higher the final price for the home might have gone.
Making Counteroffers or Raising the Price
It could be in the seller's best interest to issue counteroffers instead of accepting the bid with the escalation clause. Depending on the state, a seller can make a different counteroffer to each buyer or sometimes to just one or two buyers.
The seller might find the third buyer has decided they're willing to spend $325,000 on such a prime property and so the seller will get $30,000 more than the listing price.
Another option for the seller is to not make counteroffers but instead to raise the sales price of the home to $325,000 and start the bidding process all over again.
Consulting a Lawyer
If a buyer is considering making an offer with an escalation clause, he should contact an attorney. The clause should be written by a lawyer, not by the buyer's real estate agent.