A low supply of homes has led to a significant number of our listings seeing multiple offer situations. To make things even more tricky, many buyers are now resorting to using escalation clauses in their contracts. We’ve put together this primer on escalation clauses to help you understand what they are used for and some potential risks involved.
What is an escalation clause?
Think of it in terms of eBay. An escalation clause allows a buyer to make an offer on a property saying that they are willing to pay X for a property, but if another offer comes in, their offer is escalated to Y. How it goes from X to Y is set in terms of increments within the offer. Typically, the escalation clause will have a cap on it as well.How does it work?
Say your buyer makes an offer on a property for $100,000. They add language in the contract that will increase their offer, in increments of $2,000, up to a cap of $110,000, over the next highest bidder. Therefore, if there is a competing offer at $105,000, the buyer’s offer now becomes $107,000. This escalation will continue until their cap of $110,000 is met. But if it doesn’t become a multiple offers situation, their offer remains at $100,000.Does a seller have to accept a contract with an escalation clause?
No. A home seller can state that they will not consider or accept an offer with an escalation clause in it. This should be dictated by desires of the seller, not the REALTOR®.Why was my offer with an escalation clause not accepted?
Some sellers don’t want to negotiate with a contract that has an escalation clause, so it’s possible that it wasn’t even considered. Keep in mind that price is just one term of the contract; any number of terms and factors may carry more significance for the seller. So if possession date is the term that has the most significance for the seller, they may have chosen to accept another contract with a more favorable possession date.What do I do when I receive multiple offers with more than one escalation clause?
Advise your client to look to the other terms of the contract, as well.Who can draft the escalation clause?
Be careful of the unauthorized practice of law. Remember: you are not an attorney, so you should not be drafting or adding any language into a contract. Only a licensed attorney should be doing so. If your client wants to move forward with an escalation clause, it is best that they seek legal advice beforehand.What are some potential issues with escalation clauses?
- Disclosure issues: buyers may not want their offer being disclosed to other bidders to prove that they are the next highest bidder.
- No caps: keep in mind that the property will need to (in most instances) be appraised, so contracts with no caps may not be reasonable.
- Multiple escalation clause offers: This is only one term, so the seller may need to focus on the other terms of the contract.
- Loss of negotiating power: by putting your cards on the table from the get-go, you are losing out on negotiating power, as the seller now knows your top number.