In a market with more buyers than sellers, you are going to run into competition on homes you try to purchase.
That is, unfortunately a fact of being a home buyer in a seller’s favored market.
You may even run into a hot home in a slow market that has multiple offers.
So how do you win? There are many ways.
One of them is called the escalation clause, or escalation addendum and it is made part of a contract paperwork to offer to the seller to purchase their home.
This guide will generally tell you a bit more about this clause and how it is used.
But first, let’s look at how they are used to automatically bid over your competition.
The Real Estate Escalation Clause in Action
Getting right into it, hopefully these will shed some light on how escalation works. I will go into further tips after this.
The two examples below show 2 hypothetical situations each with 3 separate offers.
You probably noticed they are the exact same, except for 1 critical number, highlighted in red, on offer 3. This also changed the final offer price.
|Offer #||Offer Price||Escalation Clause||Offer Increase Amount||Final Offer Price|
• Who will “win” in example 1?
I wish it were that easy. The winner will be whoever the seller picks, obviously. If this all the offers were completely identical in other terms, then a seller would most likely choose offer 3, because it offers the seller $1,000 more in their pocket at closing.
All Terms of The Offer Matter
The escalation clause in a real estate offer is just one piece of what you are presenting to the seller. Here are other element that are common that sellers often look at:
• Home inspection contingencies and length.
• Financing type, contingency and length.
• Appraisal contingency and length.
• Closing date, rent back if needed.
• Local lender, large bank or web based lender.
• Down payment amount.
• Amount of any earnest money deposit.
There are other terms as well that could be important.
So back to the question of example 1. Who will win? Hypothetically, if offer 3 had the best terms to go along with the best price, that offer should be chosen.
Now, let’s say offer 2 had better terms. For example no appraisal contingency, no home inspection and a quick close. Would a $1,000 difference make up for that piece of mind of stronger terms? Most of the time, no.
Offer 2 could still win if it had better terms.
|Offer #||Offer Price||Escalation Clause Max||Offer Increase Amount||Final Offer Price|
Ok, so I only changed 1 number. I promise this is for ease of review and not laziness.
In this case, offer 3 has stated that they will beat any other offer by $6,000 instead of $1,000. So they beat offer 2’s max of $538,000 by $6,000, bringing offer 3 to $544,000.
Again, the other terms of other contracts will obviously play a roll. But $6,000 starts to tip the seller toward offer 3 even if the other terms are not quite as favorable.
Every offer situation is fluid. But the more money you beat the other offers by the more likely you will be to win even if another offer has more favorable terms for the seller.
In a real estate transaction, it is all about risk vs reward and the escalation clause is no different. Better terms represent lower risk to a seller of having to go back to market and other intangibles. A higher price represents more reward.
The risk is a deal with worse terms could fall through or cause the seller to change their plans. The reward the seller gets more money at closing.
Elements of the Escalation Clause
Let’s break it down a bit further.
This is technically not part of the escalation clause, but is part of the real estate contract and affects it. This is your initial offer price. If no other other offer comes in to “trigger” your escalation clause, this will stay your final offer price.
Escalation Clause Max Price
The maximum you will go. You will beat other offers, up to this price.
You do not always have to hit your max, if another offer only triggers the clause partially, and not to the top of your max.
Keep in mind, a seller could send a counteroffer without regard to what amount another offer triggered your clause.
Escalation Increase Amount
This is the difference you will bid between the offer that you are competing with and your escalated price.
The higher that this number is, the stronger your offer becomes over a competing offer (but the more money you will pay, obviously).
Some real estate escalation clauses may have language about the appraisal. Does your escalation clause keep the language that is in the contract, or does it modify it?
This is why reading the paperwork and going over it with a good real estate agent is critical to knowing what you are agreeing to.
Competing Offer Info
Your clause may have a place for the listing agent or seller to give you information about the offer that “triggered” your escalation.
It may even stipulate that they will provide you with a copy of that offer so that you can verify.
In a perfect world, you would not need to verify. But obviously, the world is not perfect.
Pros to the Escalation Clause
Here are some of the top reasons why agents and buyers might use the escalation clause.
• Great for bidding wars
Multiple offer situations are common in all real estate markets, even a down market will have a hot home from time to time. The escalation clause makes sure that your final voice is heard on how much you are willing to pay for the home.
• Potentially can save you some money
If you beat other offers, you can still get the home below your max escalation price. As long as you did not escalate to the top and the seller does not decide to counter you anyway.
• Hedges against wishing you offered more
The escalation will allow you to put your highest and best toward a home, without being concerned about it suddenly getting snatched up when you would have paid more if you had the chance.
Cons to Using the Escalation Clause
There can be some drawbacks to going this route. Each situation is different so come up with a strategy with your agent.
• Encourages the seller to get other offers
Let’s say you are not in a bidding war type of situation or are one of the first offers to be submitted on a home.
The seller and their agent have an incentive to wait and solicit other offers on the home, because potentially it could bid up your escalation clause and net the seller more money.
• Shows the seller your max price
The seller can plainly see, in writing, what the most you will pay for their home. Some sellers (not all) conceivably could just send you a counter back at your max escalated price.
The seller does not need a competing offer to send a counteroffer. You could reject it, but again, you have already shown the seller your highest intentions.
• You might still get beat on other terms
Do not focus so hard on your escalation price to the detriment of your full offer package. It is just one piece of the puzzle.
When Should I Use an Escalation Clause?
The escalation clause is best used when there are multiple offers on a home and you do not think that there will be a time for any more back and forth with the seller.
These clauses and addenda are much more common in seller’s markets with more buyers wanting to buy than homes for sale.
I have been through multiple very hot markets in Northern Virginia, and most offers written contains an escalation addendum. I have heard the same from friends selling real estate in other states.
Escalation clauses would not really make sense if you are the only offer. And they may not even make sense if there is more than one offer. It depends on a lot of different factors of both the market and that specific property.
Your agent, their knowledge of local real estate contracts and knowledge of the market is what you should lean on when deciding whether to include or exclude an escalation clause.
Review Rules for Your State
The escalation clause, how it is written and how it is executed will vary state by state. So make sure you know the nuances of your state before you start looking for homes.
That way, you will be ready to unleash it if needed confidently without having to play catch up.
The escalation clause is an important part of the real estate contract, especially if you are looking for homes in a market where multiple offers are common.
Have questions about buying a home in Northern VA? See this guide, or reach out to me below.