What's An Escalation Clause?
With the market facing an unprecedented inventory shortage, more and more buyers and their agents have been using escalation clauses to get an edge on their competition. But is it helping or hurting?
What is an escalation clause?
An escalation clause is a conditional offer that automatically increases based on other offers, with terms like "...the purchase price of this contract shall automatically increase to an amount that results in proceeds to Seller equal to $1,000 more than the highest Competing Offer, except that in no event shall the adjusted purchase price exceed $XXX,XXX".
So for example, if there are multiple offers on a property, my buyer could submit an offer for $100K, with an escalation clause that will push that price $1K over the next highest offer up to $120K. If the next highest competing offer is $105K, the escalation would push my buyer's offer up to $106K. If the next highest competing offer is $118K, my buyer's offer would go up to $119K. If the next highest competing offer is $125K, my buyers offer would max out at $120K.
Any escalation clause should include conditional proof of the next highest offer that triggers the increase (for example, a copy of the competing offer with names redacted to maintain privacy). Without this provision, there is nothing stopping the seller from asking for the ceiling price of the escalation without any accountability.
For this reason, it is also a good idea to specifically discuss the terms of the escalation clause with the listing agent so there is no misunderstanding. Either way, a good listing agent will always reconfirm the final escalated price with the buyer and buyer's agent before moving forward with a winning bid.
Why is this a useful strategy?
For the buyer, the most obvious advantage to the buyer is that it directly competes with other offers without overpaying more than necessary. It also holds the listing agent accountable by requiring another real offer to justify raising the offer price, and keeps the offer in consideration when multiple offers are on the table.
For the seller, it raises the purchase price of the home by automatically triggering increases with more offers, and is especially helpful when the home is priced well for competition.
How could this be a harmful strategy?
Put simply, the escalation clause is showing your entire hand. Specifically, you are letting the seller know the highest number you are willing to offer, without actually offering it. For this reason, escalation clauses can come off as offensive to some sellers, and many listing agents do not entertain them at all. In fact, listing agents have begun to reject the escalation clause altogether and instead, counter with the highest escalation number.
Escalation clauses have their time and place in bidding wars, and the key to knowing when they are appropriate is first asking the listing agent how they feel about them. The only appropriate time to use them is when there are multiple offers on the table, and when this is the case, many agents/sellers prefer one best and final offer without hypotheticals.
No matter what, being well informed on the benefits and risks is necessary for all buyers before adding an escalation clause to any offer.