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Escalation Clauses - What are they? How do they work?

July 14, 2021

We are currently in the midst of a nationwide shortage of homes on the market due to COVID-19 and the aftereffects that have caused havoc in Real Estate.    Many sellers are over the panic of COVID-19, but they are hesitant to put their home on the market because they fear they won't find anything to buy after their home sells.  So, when a property does hit the market, there are usually multiple buyers trying to purchase the same home and this results in a multi-offer situation.   As a buyer, that is not an enviable position to be in.  How do you make a bid on a home and get the seller to take yours?   There are a few different strategies you can employ to make your offer stand out above the rest.  Let's take a look at one: The Escalation clause.

The Escalation clause is a strategy some agents will recommend to ensure their buyers win the mini auction but also make sure their client doesn't pay any more than they have to.   How it works is you write a lower bid but put in a maximum you will pay and indicate that your bid automatically adjusts to an amount over and above the highest bid on the table (up to your maximum) and the seller just has to prove a bid was submitted for whatever the high bid ended up being.     For example:

Asking price $180,000
3 bids in
$175,000
$186,000
$177,000 (with an escalation clause of $1,000 over your highest bid up to $190,000)

So, in theory, the seller would accept the $177,000 bid and it would auto adjust to $187,000 ($1000 over the high bid).   Even though the $177,000 bid was in 2nd place, the escalation clause caused it to be the high bid.

There are some caveats when using this strategy.  For one, there can be more than one bidder doing the escalation clauses and they can automatically cause all the escalation amounts to trigger to the max.   The other problem with escalation clauses is you can end up bidding against yourself.   Let's say your offer of 300,000 cash no contingencies looks great to the seller and they would have taken it.   But we have an escalation clause up to 315,000 on your offer.  Meanwhile, the sellers have this other offer on the table of 314,000 but it has contingencies and caveats and the financing is FHA.   Instead of taking your 300,000 cash offer, they simply apply your escalation clause and now they get you to pay 315,000 cash and you lose 15,000 by having that clause in there.  There are some ways to avoid this scenario if your escalation clause is carefully worded.  Talk to your Real Estate expert about the different ways an escalation clause can be worded. 

Also, keep in mind that when dealing with private sellers who are on the MLS, they usually do not have to accept the high bid.  There are various factors that a seller can weigh in deciding on the ultimate bid they accept.  Possession date, Closing date, Contingencies, Type of Financing, etc. can all factor in.   I’ve seen a bid much lower than the “high” bid get accepted because it gave the seller the flexibility he needed to complete the sale with minimal hassles.

That said, there are many sellers who will ultimately just take the high bid and an escalation clause can put your offer in that position!   Talk to your Real Estate expert about the pros and cons and their experience with them and ultimately decide for yourself if this is a strategy for you!


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