Buyer’s agents: Stop Using Escalation Clauses Immediately!!!! Here’s why:
In recent years, I’ve seen escalation clauses become more and more popular. Just the other day, I saw a Facebook conversation between agents where one agent asked the group “How do I win in multiple offer situations?” Almost every agent responded with escalation clauses. Sure, many had additional advice but then they’d say, “and definitely escalation clauses!!” I couldn’t believe it! In the way that most agents use them, they are one of the worst ways for a buyer to win an offer. I hate them for buyers. And here’s why…
But first, the obligatory disclaimer. I am not a lawyer. This is not to be construed as legal advice. I am a licensed real estate broker in the state of Colorado. This is my opinion based on my experience in real estate dating back to 2003. Please contact your real estate attorney for legal advice regarding the benefits and consequences of using an escalation clause. If you need a few good references for real estate attorney’s in Colorado, give me a call!
OK. Now that I’m covered we can get back to talking about how terrible escalation clauses are!
Let’s start by covering what an escalation clause is. For those who don’t know, an escalation clause is typically something thrown into a contract when there are competing offers for the same property saying something to the effect of, “I’ll pay $_____ over the highest offer up to $_______ price with evidence of the competing offer.”
Here is one written by our office attorney:
“The Purchase Price will automatically be raised by $__________ over the “Net Purchase Price” offered by any higher, bona fide, arm’s length offer, upon Buyer’s receipt of a copy of the higher offer. “Net Purchase Price” means the purchase price offered by the bona fide purchaser less any and all concessions, or other credits which reduce the proceeds received by the Seller. However, Buyer’s purchase price will not exceed $__________. Buyer may allocate the additional purchase price between new loan and cash at Closing as directed by Buyer’s lender. Additionally, both Buyer and Seller agree to execute an Amend/Extend with the new Purchase Price if required by Buyer’s Lender. Once the Buyer and Seller are under contract, this clause terminates and is removed from the Contract.”
The attorney’s clause is a bit more complete and written for the Colorado Contract to Buy and Sell Real Estate, but you get the gist. Since you’re automatically raising the purchase price (like automatic bidding on eBay), it is escalating the price, hence the name.
So, what’s wrong with that? On first glance, it looks like a great way to beat the competition without paying more than you have to!
First, let’s talk about the obvious. You just told the seller the max you’re willing to pay. Why wouldn’t the seller just counter at your max price? “Because they have to provide a copy of the higher offer”, you might reply. And I’d say, “says who?”. You see, an offer is just the start of negotiations. No one has agreed to anything yet. So, before you got an agreement from the seller that they’ll show you the other, higher offer, you went ahead and told them the max you’re willing to pay. As a seller, you can just counter back at the max price while removing the escalation clause altogether. And if the buyer really wants the house, they’ll sign every time.
On top of that, the price is not everything. It’s certainly one of the biggest things. But there are many other aspects to a strong offer that a seller could find more appealing. Another buyer might be putting more money down or have a more ideal timeline or they might be waiving the inspections or perhaps they’re covering a low appraisal with cash or maybe they’re all cash. There are a number of reasons another offer might be appealing to a seller other than just the price. So, in these cases, a seller might only be willing to accept your less-than-ideal offer if you’re willing to go up to your max price!
Of course, I also know agents who don’t care if there’s another offer or not. They’ll counter at the max price and even lie to convince you that you’re competing with other buyers. These agents are few and far between, but by giving away the top dollar you’re willing to pay certainly won’t protect you from these unscrupulous agents.
The only way to combat these issues is to remove the cap altogether. The risk here is that you might end up paying WAY more than you anticipated! While this takes away a lot of the power the seller has to use against you, you’d better be a gambler because I’ve seen hot homes sell for tens of thousands over list price and that may not be in your budget. It’s rare for me to find buyers willing to play at this level and with that much risk.
And, even without the cap, there are sellers who just don’t want to play games. All they want is a straight forward offer. I’ve had sellers choose a slightly lower offer just because the buyer wasn’t playing games and wrote up a clean offer.
If they’re so bad, why are agents using escalation clauses? In the Denver market, good agents have become wise to the pitfalls and have stopped using them. I can only assume other agents don’t understand the negatives or they don’t care. This is the lazy way to negotiate an offer for a client. If you’re lucky, the other agent will honor the instructions you gave them and your buyer doesn’t have to pay the max price. However, that’s a huge risk considering you just told them what your top dollar is!
If you understand the consequences, have talked to a real estate attorney, and you’re fully informed, an escalation clause without a cap can certainly win you your dream home! But you may not be happy with the results or the price. And a great negotiator, like myself, won’t have to lean on a tool like this to win the deal.
So, how do you win in multiple offer situations without the use of escalation clauses? Perhaps I’ll share a few of my tactics in a future blog. But until then, you hire me!
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