Buyers Use Escalation Clauses to Win Bidding Wars
February 21, 2018
Home buyers locked in heated bidding wars are increasingly turning to escalation clauses to keep their offers in play, The Wall Street Journal reports.
Escalation clauses are addendums to real estate contracts in which a prospective buyer is able to submit an offer but then raise his or her offer in increments to a maximum amount if others submit competing offers.
In competitive real estate markets where homes are fetching multiple bids, real estate professionals are finding escalation clauses a useful tool to eliminate the back and forth of offers and counteroffers. It also helps buyers avoid getting caught in a frenzy where they may end up paying more than what they intended.
“A buyer can think of an escalation clauses as a ‘have your cake and eat it too’ clause,” David Reiss, a Brooklyn Law School professor who specializes in real estate, told The Wall Street Journal. “But in real estate, as with cake, it is hard to have it all.”
Reiss says a concern of escalation clauses is that buyers may be giving an advantage to sellers. With these clauses, buyers are indicating the maximum amount they are willing to pay for the house and revealing to the seller how much higher they are willing to go.
"Sellers get more money than they ever thought they would have," Carrie DeBuys, a real estate professional with Realogics Sotheby's Realty in Seattle, told The Wall Street Journal.
But an escalation clause is not always advantageous to a seller either. For example, The Wall Street Journal described a scenario in which a house is listed for $1 million and there are three bidders: “Buyer A offers $950,000. Buyer B offers $975,000 with an escalation clause that could go up to $1 million in $5,000 increments. Buyer C offers $980,000. In this scenario, the seller would get $985,000 from Buyer B after the initial offer escalates over Buyer C's offer. But, had the seller not relied on the escalation clause and instead asked the bidders for their best and final offer, he might have sold the house for $1 million.”
Housing experts say that before using an escalation clause, buyers should see if it could affect the type of mortgage available to them in the event the appraisal does not match the escalated price. Buyers also will want to be specific about the type of documentation the seller must provide before the escalation clause kicks in.
Source: “Escalation Clauses: A Little-Known Bidding-War Strategy,” The Wall Street Journal (Feb. 14, 2018) [Log-in required.]
Updated: February 19, 2019