Your real estate agent has been forwarding you offers on your home all day. You’re thrilled but also confused. Why do some offers have one price on the purchase agreement and another price on the escalation addendum? And what’s an escalation clause, anyhow?
In competitive seller’s markets, some buyers will strengthen their offer with an escalation clause. It’s a strategy for beating competing offers when multiple offers are commonplace, and the buyer doesn’t know the details of those competing offers.
The escalation clause increases a buyer’s offer to a stated dollar figure above the highest competing bid. Let’s say you receive two offers on your home. The first buyer offers $250,000. The second buyer offers $220,000, along with an escalation clause. The clause stipulates that the buyer increases their bid by $5,000 above the highest competing offer. In effect, the second offer would become the higher of the two at $255,000.
An escalation clause typically benefits sellers since it automatically increases a buyer’s offer without negotiation between the parties. But even in a strong seller’s market, mishandling offers with escalation clauses can backfire.
For advice on how to navigate this potentially tricky offer situation, we spoke with Scottsdale real estate pro Lisa Roberts, who was recognized by the Scottsdale Association of Realtors® as a Top 40 Under 40 agent. Here are her five tips for handling escalation clauses:
1. Understand the three major components of an escalation clause
Before evaluating the offer, you’ll want to identify the different sections of the escalation provision to weigh the offer against other bids. Escalation clauses generally contain three common elements:
An escalation amount
An escalation amount is the incremental dollar amount the buyer is willing to pay above the highest competing offer. For example, the escalation clause could state that the buyer is willing to pay $2,000 more than the highest competing offer. If the seller receives a competing offer of $300,000, the escalation clause would increase the first offer to $302,000.
A bona fide competing offer to trigger the escalation
Offers with an escalation provision generally establish a floor, or minimum offer price. A higher competing offer then triggers the escalation clause, increasing the original offer.
What exactly constitutes a “bona fide offer?” According to the Cape Cod & Islands Association of Realtors®, a bona fide offer is an offer that is made in good faith that’s also legitimate and enforceable. An offer your friend submits to escalate the purchase price doesn’t qualify. Your buyer may even require you to send documentation of the competing offer.
An escalation cap
The buyer will generally specify a maximum purchase price. Without a cap, the buyer could end up bidding a much higher purchase price than they’re willing or able to pay.
2. Weigh the overall strength of the offer — and the buyer’s commitment
While Roberts says the net purchase price is often the primary factor when selecting an offer, sellers should evaluate the overall strength of the offer, along with the buyer’s commitment to completing the sale.
A major pitfall to be aware of is buyer remorse. In a competitive market, buyers can get caught up in the bidding process, offering more money than the home is worth. “Buyers sometimes just want to win,” says Roberts. But when a seller eventually accepts their offer, some buyers have second thoughts.
This could be the case when a buyer’s escalation clause reaches its cap, and the buyer is paying the top of their budget.
“You’ve got to really figure out, ‘Who is the most serious to get to the finish line?'” Roberts advises.
“You don’t want to lose the first buyer … and then lose momentum with the other buyer later.”
Here are some signs that a buyer is committed to following through with their offer:
- Substantial earnest money: Buyers who put down a larger-than-usual deposit may be more committed to buying your home. If most buyers in your market are depositing $5,000 as earnest money, a $10,000 deposit indicates a strong desire for the home.
- Non-refundable earnest money: Roberts says making a portion of the earnest money deposit non-refundable makes it harder for the buyer to walk away if their offer is accepted. “It shows that they’re a little more serious than maybe someone who says, ‘well, I want to get through inspections first.'”
- Cash offers versus lender financing: Cash offers are considered the strongest offers because the buyers can close quickly without relying on a lender. In the absence of a cash offer, borrowers with a loan pre-approval are in a stronger position than a buyer with a pre-qualification letter. With a loan pre-approval, an underwriter has reviewed the buyer’s income and asset documentation. A pre-qualified buyer, on the other hand, hasn’t been through the verification process; the lender hasn’t reviewed their financial documents.
- Waiving contingencies: Serious buyers in a competitive market may strengthen their offer by waiving contingencies. Forgoing contract contingencies limits the buyer’s ability to back out of a contract without forfeiting their earnest money deposit to the seller. Common contingency waivers include appraisal, inspection, and financing.
- Seller leaseback: Another factor to consider when reviewing offers is your move-out timeline. Serious buyers who are eager to have their offer accepted may sometimes offer a seller leaseback. With this contract provision, you’d be able to stay in your home for an agreed-upon period after closing. The leaseback would give you extra time to pack and transition to your new home.
3. Keep the appraisal top of mind
If your top offer happens to be a cash buyer, skip this tip. Cash buyers can request an appraisal, but it isn’t required.
On the other hand, when a buyer finances a purchase, the lender generally requires an appraisal to determine the property’s market value. This valuation protects the lender’s interests, assuring the lender that it can recoup its investment if the borrower defaults on the loan.
So if you accept an escalated offer well above your asking price, just know that your home will need to appraise for the offer price. The appraisal can be a sticking point in intensely competitive markets where buyers offer more than a home’s present value.
If the home appraises for lower than the offer price, the lender may not approve the buyer’s requested loan amount. To go through with the purchase, the buyer would need to either:
- Increase the down payment to cover the difference between the appraised value and the proposed purchase price
- Attempt to renegotiate the price with the seller
- Back out of the agreement
Roberts points out that when reviewing multiple offers and escalation clauses, sellers often opt for the highest net price, “as long as [the buyer is] putting a substantial amount of down payment.” A buyer with the financial resources for a large down payment is more likely able to bridge the gap between the escalated purchase price and appraised value if the value comes in low.
4. Request buyers bring their highest and best
If you receive multiple offers, including offers with escalation clauses, you don’t necessarily have to accept one outright. Roberts advises negotiating terms with all of your serious offers before choosing the best one.
The price cap on an escalation clause reveals the maximum amount a buyer is willing to pay for your home. Roberts encourages sellers to use this information to leverage higher offers from competing buyers.
For a more straightforward negotiation process, you can simply reveal that there are multiple offers and request that buyers submit their “highest and best” offers for final consideration.
5. Ensure final offer terms are clear — and in writing
Negotiations can happen quickly in multiple offer situations. When accepting an offer at an escalated price, you’ll want to ensure that all clauses and revisions are clearly worded, particularly if changes occurred during the negotiation process.
“You definitely don’t want any gray verbiage,” says Roberts. Lean on your real estate agent for guidance, and reach out to your attorney if you need legal advice about the language in your contract. Doing so can help prevent confusion and potential legal battles down the road.
When accepting an offer at an escalated purchase price, you’ll need to provide documentation of the competing offer to the buyer, per your contract terms. A buyer- and seller-signed addendum or counter-offer detailing the final escalated price also helps to avoid confusion, says Roberts. For example, in the state of Washington, the Northwest Multiple Listing Service publishes an escalation addendum notice that clarifies the final purchase price.
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