In hot markets where homes sell fast and receive multiple offers, the escalation clause is one way buyers try to beat their competition. In a purchase contract, an escalation clause allows the buyer to say “I will pay X price for this home, but if the seller receives another offer that’s higher than mine, I’m willing to increase my offer by Y amount at a cap of Z.” But is an escalation clause a good idea? It can work for or against the buyer or seller, so decide what’s best for your given situation. Let’s breakdown the specifics of such a clause.
The escalation clause, which is an addendum to the contract, needs to state:
∙ The original purchase price offer.
∙ How much the price will increase above any other competitive bid.
∙ The maximum amount the price can reach in the case of multiple offers.
For example, let’s say buyer Smith offers $150,000 for a home and includes an escalation clause that states he’ll increase his bid $1,000 higher than any other offer up to a cap of $160,000. Buyer Jones comes along and offers $152,000. Smith’s offer now automatically increases to $153,000. Buyer Anderson submits an offer of $155,000. Now Smith’s offer automatically increases to $156,000. If no other offers came to the table in whatever time period was outlined either by the seller or the buyers, Smith, in theory, would be the highest bidder and possibly the chosen buyer for a price of $156,000.
Here’s where the outcome might be different than expected.
You’ve shown your cards. Using an escalation clause shows the buyer’s hand upfront on how high he’s willing to go. A seller doesn’t have to accept the terms of the escalation contingency. She can simply reject it and counteroffer at the buyer’s stated maximum price or any other price.
The buyer can change his mind. The escalation clause states increments of increase rather than a final price, which requires a counteroffer to finalize the contract. If the buyer changes his mind, the seller possibly loses that buyer and any other buyer who was part of the multiple offer, who may have moved on to the next home.
The seller might choose other contract terms over highest price. In the given scenario, $1,000 over the highest bidder may not be as important to the seller as better terms that matter to her. Another buyer might bring any of the following to the table: better financing, an offer of more earnest money or non-refundable earnest money, no seller concessions, shorter or longer closing time, and more. Highest is not always a guarantee of being the best.
Not all sellers are willing to accept escalation clauses. They’d rather buyers submit their highest and best offer upfront. This seller strategy motivates buyers to bid higher in hopes of getting the home. The process can vary. Some Realtors® who know multiple offers will come designate the day the house will be on market and how many days after that all offers will be reviewed with a final decision. Other buyers will accept escalation clauses and take a back and forth approach until responding to the top offers by asking for their best and final offer.
Buyers in particular should know exactly how high they’re willing to go before entering into any multiple offer or escalation clause situation. Be willing to walk away if the price range escalates beyond your comfort level.