One of the most incredible tools the real estate gods gave us was an escalation clause. I have no idea why a seller would not accept an escalation clause even in a sellers market. I don’t think the question should be “should I accept an escalation clause?” the question should be “why the hell wouldn’t I accept an escalation clause?”
What is an Escalation Clause in Real Estate?
Let’s start out with the definition of an escalation clause. An escalation clause is an amazing tool that really does benefit both parties. It is a clause that is put in additional provisions. It basically states if there are multiple offers the buyer will “escalate” their offer at a specific value above the closest competing offer. In other words the escalation purchase price starts at $800,000. The biggest and most important part is the cap. So you then say the cap will be $900,000. That is the maximum amount the buyer will pay. You then state the increments. That is anywhere from $1,000 to whatever you are comfortable with. Usually at that price point $10,000 is a good increment. So then the next highest competing offer is $850,000. That means the escalation offer is now $860,000.
How Does an Escalation Clause Benefit the Seller?
How does the escalation clause benefit the seller? Well it’s simple. The seller now gets $860,000 for property instead of $850,000. It is understandable that a seller wants to get as much money for their home as they can get. There is a few problems with going too high over list and starting a bidding war. The obvious problem is the majority of home buyers are still getting a loan. If the buyer does not want to waive appraisal and pay the “appraisal gap” you run the risk of the home not appraising so this always keeps sellers in check.
How Does an Escalation Clause Benefit a Buyer?
Well that’s easy. A buyer pays more than they may have with a straight out offer and less than they would have paid. Everyone is happy. It is important to understand buyer phycology when selling your home. You are not selling a pack of gum or even a car. Where the margin of error on the buyer’s decision is minimal compared to an $800,000 home (that is about the average home value in our market). A buyer is more willing to go higher on an escalation cap than a straight up offer. If you are not accepting escaltion clauses and not going to counter offers (we have seen that in our recent market) then you are minimizing your offers you will receive and not getting the maximum for your home. For example many buyers might use a cap of $900,000 and only make an offer of $850,000. No buyer wants to pay more for a home than someone else.
Summary of an Escalation Clause:
So to summarize an escalation clause it really does benefit both parties. The seller gets a maximum amount for their home and a buyer makes an offer higher than they might on an open offer scenario. They also do not pay that much more than the rest of the market. This is important for appraisals. In a crazy seller market like we have now most appraisors will ask the listing agent if there are multiple offers. If this is the case they take this into consideration. In a hot seller market there is at least a 30 day lag in comparable they can find. An appraisal is the market value at a snapshot in time. If there are 5 offers that close to contract price that helps prove the value the market thinks the home is at.
This is not legal advise on escalation clauses. You should also always listen to your agent as they know your situation better than this blog post. It also varies from state to state. You should always seek legal advise or advice from your real estate agent.