When Should You Use an Escalation Clause and What Is it?
When you’re deciding on a price to offer on a home, the circumstances may call for a single price or, in some cases, an escalation clause. What is an escalation clause?
What is this escalation clause?
An escalation clause is a contract in real estate, sometimes called an escalator, that lets a Denver home buyer state “I will pay y price for this home, but if the seller receives another offer that’s higher than mine, I’m willing to increase my offer to x price.” In theory, an escalation clause is pretty simple. In practice, there are a lot of details involved.
How does an escalation clause function?
While escalation clauses vary infinitely, the general escalation addendum has some basic parts:
What is the original offer of the purchase price?
How much will that price be escalated above any other competitive bid?
What is the ceiling of the purchase price in case of multiple offers?
For example, buyer Joe offers $200,000 for a home. His Realtor adds an escalation clause that, in the case of a higher competing offer, will increase Joe’s offer in increments of $3,000 above the competing offer. His escalation clause goes up to a maximum of $230,000.
If no other offers are submitted, Joe’s offer remains at $200,000. If buyer Sally offers the seller $203,000, then Joe’s offer would automatically escalate to $3,000 above that, bringing Brown’s offer to $206,000. If buyer Cedric offers $235,000 for the home, then Joe’s maximum of $230,000 will be eclipsed, and Cedric will have the top offer.
Will the seller accept an escalation clause?
Some Denver home sellers state that they will not accept offers with escalation clauses. They would prefer that every Denver home buyer submit their “highest and best”. Sellers often prefer this method because it motivates buyers to outbid one another from the get go. It also streamlines the paperwork and simplifies the decision-making process.
There definitely be multiple offers?
Escalation clauses should only be used when the buyer is confident that there will be multiple offers, or when the buyer plans to pay an escalated price. If a buyer submits an offer with an escalation clause, they’re laying all their cards on the table: The seller knows immediately how far the buyer will go to secure the home.
If that offer ends up being the only offer submitted, it technically remains at its original price. A Denver Seller’s Agent will know, however, to counteroffer to the buyer’s agent at a higher price, since the buyer is clearly willing to pay more. While there’s no guarantee that the buyer will agree to the higher price, it is highly likely that they may. A buyer gives up a lot of negotiating power and potentially leaves money on the table when using an escalation clause that goes unmet by a competitor. Therefore it is wise to request verifiable contracts when adding an escalation clause.
Has the seller’s agent clearly stated a one-day review or multiple rounds of offers?
In Denver’s hot market, there’s a wide variety of offer-review processes these days. Some state that the property is going on the market on Saturday, and all offers will be reviewed the following Monday. The seller and their Realtor will make a final decision that Monday. This situation can be ideal for the escalation clause, when a buyer knows it’s an all-or-nothing offer.
Other sellers prefer to take a back-and-forth approach. They may collect offers from Denver buyer’s agents for one week, and then respond to a handful of the best offers by saying “Send us your highest and best offer.” This technique is particularly disliked by many consumers and professionals for its lack of clarity, but it’s important to know it may be coming in a hot market.
Prior to writing an offer, a buyer’s agent in Denver should inquire and make sure the buyer is prepared to walk away. Writing an escalation clause on the initial offer in a multistage situation could put the buyer in a weak position during the second round. It’s perfectly legal for a seller’s Realtor, with the seller’s permission, to reveal to all potential buyers agents what the top offer on the table is and to ask everyone to beat it. In this case, the escalation clause would flesh out that buyer’s maximum, and they would lose the competitive edge.
Bid with confidence and realize that each situation is unique
If you’re contemplating using an escalation clause, your Realtor is probably knee-deep in researching the situation surrounding the seller’s process of reviewing offers. The Denver Realtor’s knowledge of normal practices and probable outcomes in the Denver real estate market will make your offer much more likely to succeed.
Escalation clauses can cause a lot of extra stress for home buyers, but when they’re boiled down to the basics, they’re fairly straightforward and can save the Buyer’s some money. Remember to be realistic and comfortable with how much you’re willing to pay, and to confidently go after a home at that price. Buyers shouldn’t be tempted to raise their purchase price above what they are comfortable paying. At the same time, they should realize that low inventory and low-interest rates, and aggressively pursuing a good home at a good price is necessary to win in a super competitive Colorado market. Potential real estate buyers who are only looking to get a steal often end up not getting a home at all.