Using an Escalation Clause: Benefits, pitfalls and best practices

Spring has sprung, meaning prime home shopping season is upon us! If you haven't been home shopping recently you might be realizing just how competitive this market is. Home values continue to go up, mortgage rates are on the rise (3 more rate hikes projected for 2018) and with first time home buyers and baby boomers competing for the same 2-3 bedroom home presenting the highest and best offer can be quite tricky.

Enter the "Escalation Clause" or "Elevator Clause" as some call it. Imagine you've found the perfect home. Its a 3 bedroom 2 bath, centrally located in town and move in ready. Perfect right? Now, imagine so have 5 other people! Two might be tire-kickers. They might not be pre-approved with a lender, may not have funds for a down payment and closing cost or may have done all of those things but because they are new to the market they haven't yet learned that underbidding rarely works. The other 3 have done all of these steps and are serious contenders. They each write solid offers for close to asking price, at asking or above it. They shorten the inspection period (typically 17 days in California) and even offer to close earlier than the customary 30 days and or provide seller rent back to allow the seller more time to find a replacement home. To a seller any one of these things can make a sweet deal depending on the sellers motivations. A good real estate agent knows this.

So how do we make your offer stand out as the highest and best? We add an addendum to the original offer that offers to meet and exceed the "highest and best" offer someone else might have placed. This is typically referred to as an "escalation clause". Say last minute another buyer comes in over your offer price, maybe even 2 other offers come in over yours. With the escalation clause attached to your offer you've automatically agreed to beat out the other offer by $1000.00 or more. Pretty nice, huh?

Of course there are some basic rules to properly implement a clause like this. For instance......... how much are you willing to pay before you walk away from a bidding war? A solid escalation clause would have a cap on the amount one is willing to spend. For instance "buyer to pay $5000.00 over highest and best offer with an amount not to exceed $xxx over originally offered purchase price."

What if there isn't really another offer on the table and the seller or their agent makes one up? Although I hope this would never happen as it is a clear ethics violation, I recommend in the escalation clause adding verbiage that requires proof of the other offer such as "Seller to furnish pages 1 and 9 of competing Residential Purchase Agreement" to protect yourself from being a victim of such a fraud.

As you can see the escalation clause can be a very useful tool to give a buyer an edge on the competition. But how do the sellers and their agents view it?

As primarily a listing agent myself acceptance of one of these offers would depend on a number of factors. 1. Is the buyer paying with cash or a loan? Cash isn't such a big deal, but when a home is being financed the lender always requires an appraisal..........so the next question is: Am I confident the home will appraise at the settled price? Keep in mind if the home doesn't appraise a buyer will likely be re-negotiating with the seller for a lower price unless they have the ability to kick in extra cash for the difference and don't mind buying a house that doesn't appraise.
The second factor to consider would be that due to the escalation clause as a sellers agent I now know the buyer wants this house, and is willing to pay $xxx above asking price in order to get it. Why not just counter offer for more or even the maximum price they can go? There are many factors to consider........the most pressing would be if the property would appraise.

In a recent poll I participated in with agents and brokers from across the US the opinion was largely divided with half of the listing agents saying they'd advise their clients to accept, and the other saying they'd advise them to counter. Ultimately it is up to the seller to decide how they'd like to proceed considering their own unique situation.

As always, If you have any questions feel free to call or text me. 

530.628.SOLD

Until next time,
Jennifer