What is an Escalation Clause in real estate and does it work in a multiple offer situation?
Escalation Clause
This post covers the escalation clause that is provided in the Northwest Multiple Listing Service forms. Forms, contracts and practices vary from region to region. Please seek the advice of your broker and legal counsel with any questions about this or any other form in your offer for your particular situation. This post was updated on June 5, 2020.
Here in Olympia, WA, an Escalation Clause is sometimes added to an offer when a buyer is competing with other buyers on the same home.
The Escalation Clause tells the seller:
1. what the maximum price the buyer is willing to pay for the home, and
2. how much the buyer is willing to escalate their offer against the other offer(s).
For example, a property is listed for $200,000, and there are two buyers making an offer.
Buyer One includes the escalation clause in their offer which states the maximum price they are willing to pay for the home is $225,000, and they will offer $2,000 over the other offer.
Buyer Two does not include an escalation clause but offers $220,000.
With everything being equal, the seller would choose Buyer One’s offer because their offer would be at $222,000 ($2,000 more than the other offer but still under their max price of $225,000).
Does this strategy work?
Sometimes. For buyers, using an escalation clause can be a double-edged sword:
Negotiating leverage diminished
As a buyer using an Escalation Clause, the buyer is revealing to the seller how much the buyer is willing to pay for the home. This takes away potential leverage down the road. The seller knows the buyer wants this home, knows how much the buyer is willing to pay for this home, and this could potentially harm the buyer in future negotiations with the seller, such as negotiating for repairs. The seller could be less likely to agree to repairs, for example.
Misunderstood Clause
This can backfire for buyers as sellers and even agents may not fully understand the Escalation Clause and how to use it. For example, I represented a buyer and we knew we were competing. We decided NOT to include an escalation clause and just write our best offer. The seller chose our offer, even though I learned later the other buyer’s escalation clause would have netted the seller more money. The reason: the seller felt the escalation clause was a negative tactic and felt “icky.” Our offer was “clean.”
Yes, an escalation clause can feel that way if the parties don’t fully understand the purpose.
Sharing the Competing Offer
Sellers may not want to provide the winning buyer with the competing offer. In order to reach mutual acceptance (having a binding offer), the seller must provide the complete copy of the competing offer used to escalate the purchase price.
Why Listing Brokers May Not Like the Escalation Clause
Many listing brokers do not like escalation clauses for several reasons.
First, the NWMLS does not recommend the use of this form and they clearly state that in our broker documentation. This warning can be enough for brokers to exclude this form. And many times listing brokers will advise their sellers to counter and remove this form from the offer.
Second, it can be very challenging to calculate the final sales price on the winning offer.
For example, a property has received five offers. Not all five offers may have an escalation clause; one offer is raising the purchase price but asking for the seller to contribute to the buyer’s closing costs; another buyer is getting VA financing and is asking the seller to cover their escrow fee; another offer is asking the seller to pay for a home warranty; another offer is asking that the refrigerator is included in the sale (and how do you determine a dollar value for the refrigerator?), etc. The listing broker must ensure the winning offer’s final sales price is calculated correctly and is properly compared with the other offers.
Can a Contingent Buyer include an Escalation Clause in their Offer?
No. Per our NWMLS Escalation Addendum, a buyer who is contingent upon listing and selling their home cannot use the escalation form. However, a buyer who is contingent upon closing on their home (they already have a buyer and are under contract), they can use the escalation clause.
The reason why a contingent buyer cannot use the escalation clause is because the clause defines what a competing offer is as an offer that can close within a set time. A contingent buyer who does not have their home under contract yet does not know when their current home will close and sell.
Buyer’s Remorse
This is a common theme with buyers who are competing for a property (with or without an escalation clause). In my experience, in the frenzy of competing with other buyers and including an escalation clause sometimes leads to buyer’s remorse. Once the dust has settled, some buyers may start to re-think their offer. And even others will terminate their offer.
Buyers who decide to include an escalation clause need to be prepared to pay the maximum price they are offering.
Then why use an Escalation Clause?
The Escalation Clause attempts to keep the seller engaged. If a seller is presented with multiple offers, many times, the seller will not counter, and they will just choose the best offer. Since the buyers most likely won’t know the terms of the other offers, the Escalation Clause can elevate the offer over the others by stating how much the buyer is willing to go over the next best offer.
Do I use Escalation Clauses?
Typically I do not. Again it depends upon the situation, the brokers involved, and the buyers and sellers. My advice to my buyers is to write their best offer and not to depend upon a seller countering back. My buyers may only have one chance with a seller.
In a busy market with more buyers than inventory, buyers need to be ready to write strong, compelling offers that sellers just can’t refuse!
Read more about how to be successful in a seller market.
Note: This post does not contain legal advice. The Escalation Addendum that brokers in the Northwest Multiple Listing Service may use is a complicated form that requires extreme diligence to protect the parties. For questions about your situation, please contact your broker and legal counsel so you can make informed decisions.