Escalation Clauses …

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Escalation Clauses … Just One Tactic in the Multiple Offer Battle

An escalation clause is a contract provision where you as a buyer promise to pay a certain amount over the highest purchase price offered by any competing buyer.

While escalation clauses are common these days and sometimes necessary, they can have negative side effects. This is true for several reasons:

    1. While an escalation clause potentially makes you the best offer in terms of price, many other factors can come into play in a seller’s decision — possession, post-closing occupancy, closing date, financing vs. cash and appraisal waiver being just a few. Being the highest priced offer is no guarantee that the seller will accept your offer.
    2. Escalation clauses typically state a maximum price that you are willing to pay. The seller can use that information to wrangle that same price out of a competing buyer that has other, non-monetary benefits that the seller likes better.
    3. Your escalation clause can be used to force you to a higher price even if the competing offer is weak. Example: A competing buyer offers a high price but has shaky credit and needs to sell another house first. You are a strong buyer that is putting 20% down and don’t have another house to sell but you are offering a lower price. Even though the seller would not take the offer from the weak competing buyer, she can invoke the escalation clause to force you to match that buyer’s higher offering price.
    4. Many escalation clauses offer an allowance over the purchase price of competing offers without taking seller paid closing costs into account. The competing offer may be $375,000 with the seller paying $5,000 of the buyer’s closing costs, netting the seller $370k. You may be willing to go $1000 over the highest offered purchase price in a competing offer but are not asking the seller to pay any closing costs. As a result, you are stuck paying $376,000 per the terms of your escalation clause — $1,000 over the $375k of the competing offer. The seller ends up being better off by $6,000 when your intention was only to reward the seller with an extra $1,000.

The good news is that many of these drawbacks can be addressed in a well-crafted clause. At CHR, we have developed a great one for those times when it is needed.

At the same time, we think about alternative strategies that might be more effective, either alone or in combination. For example, it always makes sense to talk with the seller’s agent to see what the seller might want other than just the price. The seller may want a quick closing or may want to stay in the house for a while after closing. A seller might take a lower price to get these conveniences.

Another effective strategy can by judiciously waiving all or a portion of some contingencies in the contract related to appraisal or loan approval.

These alternative tactics can win the day without facing the drawbacks inherent in escalation clauses. We are always looking for that right combination of incentives to get the seller to agree to sell you the house you want – the combination that gets the job done while giving up as little as possible.