The Pros and Cons of Escalation Clauses

In today’s Seller’s market, it is common for a Seller to get multiple offers for a home. One of the tools you can use to get your offer on top is the escalation clause.  It can create an edge for your Buyer - or it may not.  There are pros and cons to using an escalation clause.

Typical Language
An escalation clause states that you are willing to outbid any other offers on the home by a certain amount, up to a ceiling price. The ceiling is also referred to as a “cap price” or the most you are willing to pay.  The ceiling price allows the buyer peace of mind that they will not overpay and allows a buyer – from the buyer’s perspective - to put their best foot forward.
Typical Escalation Language
In the event of multiple offers, Buyer agrees to increase the purchase price by 
$________ (net to seller) over any other offer presented to the Seller with comparable terms and conditions, so long as the other offer is a bona-fide, arms-length transaction and is presented to Buyer before the offer deadline date.   In no event shall the Buyer pay more than $_________. Listing agent agrees to send a copy of the competing offer to the Buyer’s Agent. Upon receipt of the comparable offer, Buyer agrees to execute an addendum to this offer reflecting the increased final purchase price and amount of closing costs.  Comparable terms and conditions shall mean similar financing contingency requirements, similar requests for seller concessions and similar time frames for closing.

Pros and Cons of an Escalation Clause
Pros
1. Stress relief that another buyer won’t make a better offer.
2. The price bumps up only if other buyers are willing to pay the same price, so the buyers are not overly worried that they are overpaying for the property. 
Cons
1. The listing agent and the seller may not understand how an escalation clause works. Other offers may come in without escalation clauses without yours being considered. Confusion and frustration may drive the Seller to consider only traditional offers.
2. By revealing the highest price you are willing to pay you are showing your hand.  The Seller does not have to work with the escalation and may simply counter-offer at the cap price without other offers on the table, essentially jumping over incremental price increases which may or may not have existed.  
3. Escalation clauses can increase the confusion of multiple offers. In a recent situation there were 14 offers, some with escalators.  The Seller has to play chess, choosing the best strategy:  What’s the best bid and how does it change if we choose the one with the escalator?  What if there are competing escalators?  What if the escalator odder also has a financing contingency with a low down payment?  Maybe someone else is a stringer buyer. The Seller may just get frustrated and focus on the traditional offers coming in. It’s easy to see how the situation could quickly become hard to deal with.  Even worse, Sellers might reject your offer of escalation because they don’t trust you.  They may believe you should have offered your highest and best in the first place.
4. Appraisal issues.
Lenders use appraisals to determine the market value of the home, and will not lend buyers more than the appraised price.  If the escalated price is higher than the appraisal, you may have won the battle but lost the war.  The buyer would likely have to pay the difference in cash at closing (plus the down payment required by the lender), walk away from the deal (if allowed by the terms of the contract) or convince the Seller to reduce the price (ha!).

Find Out What the Seller Wants. An Escalation Clause Only Addresses Price.
Other terms could be equally important to a seller. Last week’s Broker Corner addressed many other terms that can win the sale.  Closing dates (shorter or longer), possession dates, waiving inspections, cash sales, waiving financing, earnest money amounts and even personal letters (no pictures please – fair housing concerns) should be considered.  Strong communication with the listing agent to learn what the Seller wants is always a smart play.  You can learn what the Seller wants by just talking with the Listing Agent. Give the Seller what the Seller wants and you’ll win the sale.