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The Debate Over Escalation Clauses - The Fiduciary Duty Lies with US

By
Real Estate Agent with Savvy + Company (704) 491-3310 228209

The Debate Over Escalation Clauses - The REAL Fiduciary Duty Lies with US

 

Which Offer will we choose?We’ve exhausted the discussions of pocket listings and drone photography so, I suppose it’s time we move on to the next hot topic!  Recently we have had many heated debates over Escalation Clauses.  Escalation Clauses are widely used in many states - especially those in hot real estate markets.

 

I don’t recall the first time I utilized an Escalation Clause but, I can tell you, for my Buyers and Sellers, they’re the next best thing to sliced bread!  And with the Charlotte real estate market heating up, bidding wars becoming more prevalent and our extremely low inventory, buyer demand is at a peak.  Winning in bidding war situations is imperative to some Buyers who have absolutely GOT to find a home and Close in a sort timeframe.

 

Whether a sweet letter with a photo of our Buyers is included or an extremely strong pre-approval letter or financial statement is provided, buyers simply need an advantage - and that remaining advantage is PRICE.  An Escalation Clause to a Contract is perfectly legal if penned by an attorney in North Carolina.  

 

My personal take on agents who refuse to accept Contracts with an Escalation Clause for their sellers is that they simply do not understand the process.  I also believe the same goes for agents representing Buyers.  The process, however, is incredibly simple.  

 

How Does An Escalation Clause Work?

 

A buyer presents an Offer on a property at X price; a clause is inserted into the Offer to Purchase (OTP) stating that the Buyer will increase their price by $X above competing Offers UP TO $X.  

 

Here’s an example:  Property List Price:  $500,000.  Buyers present OTP at $500,000 with an Escalation Clause that states they will pay $2,000 above competing Offers UP TO $527,000.

 

How Does This Benefit The Buyer?

 

Buyers have a better chance of ‘winning’ the bidding war by submitting an Escalation Clause.  They may be okay going significantly higher but, question the validity of the claim of other Offers.  Requesting name-redacted proof of a competing Offer, gives them the confidence that they will not be taken advantage of by false claims of multiple Offers.

 

As well, Buyers could only need to improve their bids minimally due to the competitors’ bids.  For instance, our latest Escalation Clause won them the bid by only $5,500 following highest and best presentations, when they had been willing to go up to $25K above their original Offer price.  

 

How Does This Benefit The Seller?

 

Here’s an example following highest and best for a home listed at $500,000:

 

Buyer 1:  $510,000

Buyer 2:  $517,000

Buyer 3:  $500,000 with an escalation clause offering $2,000 above the highest competing bid, UP TO $527,000.

Seller takes Buyer 3’s Offer and the final sales price for the Buyer is $519,000.

 

Yes, that sales price is $8K below Buyer #3’s highest possible bid (UP TO $527K) BUT, would buyer #3 have been willing to go above $515,000 without the assurance of the name-redacted Offer, showing the competing highest bid?  One never knows but, in this scenario, both parties win - the Buyer wins the home of their dreams and the Seller sells their home for an additional $2,000.

 

Is the negativity surrounding Escalation Clauses due to the lack of understanding of them?  Is the corporate negativity surrounding these clauses due to the fact that brokers fear that agents may pen their own clauses?  

 

Escalation Clauses are a win-winAs mentioned above, North Carolina agents (provisional brokers) and brokers are not permitted to pen any clauses in a Contract, including an Escalation Clause.  However, this very short, simple clause can be provided to a brokerage by their corporate attorney for use by their agents.  

 

Some argue that sharing an ‘Offer’ is a privacy issue - as per our Escalation Clause, the Offer is name-redacted when presented to the Buyer who has presented the Offer with the Escalation Clause.  I assure you, there is no breech of privacy.

 

If in doubt of the benefits of utilization of Escalation Clauses, perhaps a short class on them is in order!  They’re simple and a win-win for both parties.

 

© Debe Maxwell | The Maxwell House Group | SavvyBroker@me.com | The Debate Over Escalation Clauses - The REAL Fiduciary Duty Lies with US

Comments (35)

Jeanne Dufort
Coldwell Banker Lake Country - Madison, GA
Madison and Lake Oconee GA

I have yet to see an escalation clause in my market, but your explanation is terrific, and I will likely look it up if/when I have a situation where my buyer would benefit from it. Thanks!

Mar 05, 2015 08:39 PM
Gabe Sanders
Real Estate of Florida specializing in Martin County Residential Homes, Condos and Land Sales - Stuart, FL
Stuart Florida Real Estate

Very interesting, Deb.  I have yet to see this used in our area.  Though, I will check with my local real estate attorney for potential implementation of this clause.

Mar 05, 2015 08:55 PM
Martin E. Kalisker, Esq.
Natick, MA
Real Estate Law From A Practical Perspective

Boston is probably one of the "hottest" markets in the country and fortunately escalation clauses are not supported by the REALTOR community. In your example, if your buyer can afford $527,000, then that is what the seller would counter act - no discussion. We don't have time time go back and forth with negotiations on most transactions up here. Buyers typically get one shot. I recently heard of a mid price 2 bedroom condo in Cambridge ($500,000 range) that had 65 offers in the first weekend of showings. The agent's instructions were to "peel the onion" as much as possible for the seller to make a decision. I can almost guarantee you that there were no escalation clauses in any of the offers that were reviewed in detail by the seller.

The other problem with escalation clauses is that if the bid goes over asking or over appraised value, the buyer's agent needs to tip the cards to show that the buyer has funds to cover any short fall.

Glad to hear that they are working for you though!

Mar 05, 2015 09:37 PM
Martin E. Kalisker, Esq.
Natick, MA
Real Estate Law From A Practical Perspective

As a follow up to Tammy's comment #3 and your attorney's comment in #10, MA law does not require a seller or an agent (fiduciary of the seller) to disclose competing offer information. So yes, it is very likely that you will never will know what the previous highest offer was and many buyer's agents will submit their offers with a confidentiality clause that prevents a seller or their agent from ever disclosing such information!

Mar 05, 2015 09:46 PM
Richie Alan Naggar
people first...then business Ran Right Realty - Riverside, CA
agent & author

many ways to skin the Real Estate cat...this be one of them...good posting here

Mar 05, 2015 11:05 PM
Roy Kelley
Retired - Gaithersburg, MD

This is an excellent explanation for home buyers and home sellers. 

The pressure is on home buyers to be prepared for multiple contract competition.

Mar 05, 2015 11:44 PM
Christine Smith
Buyers Brokers Only LLC - www.BuyersBrokersOnly.com - Canton, MA
Exclusive Buyer Agent & Attorney, Canton, MA

I have used them before. As stated above, it's a pretty hot market in the Boston area.  The key is to of course advise our clients of the pros and cons and let them make a decision. Our clause requires the other side to provide a copy of the other offer. I also put an appraisal clause in my offers as well.  I generally wouldn't advise a buyer to go up to a certain amount if I thought the house wasn't worth it. But again, that's up to the Buyer to decide.  One time, however, I tried to use one - and the Seller wouldn't consider it.  She didn't think it would be "fair" and just insisted we give a final number.  My clients still got the house. 

Mar 06, 2015 12:46 AM
Denise Hamlin, Broker/Owner
Cardinal Realty ~ 319-400-0268 - Iowa City, IA
Helping Happy Clients Make Smart Choices

I've used the escalation clause in offers a few times here in Iowa City. Like you Debe I think it's a win-win for buyers and sellers. I was surprised to see there's some debate around them, but then I'm always surprised how quickly people debate something that they have no clue about!

Mar 06, 2015 01:39 AM
Elizabeth Weintraub Sacramento Broker
Elizabeth Anne Weintraub, Broker - Sacramento, CA
Put 40 years of experience to work for you

We are advised not to use escalation clauses in Sacramento because they are not a sales price. They also tend to benefit the buyer more than the seller, so as a listing agent, I would not advise a seller to take such a thing when we have multiple counter offers to use instead. It's how a $500K offer, and a $517K and a $519K offer can result in an accepted offer for the seller of $530K. Why limit yourself as a seller, is my advice.

Mar 06, 2015 06:03 AM
Todd Miller
Nevada Realty Solutions - Las Vegas, NV

This is flawed on so many levels I am not able to begin to describe them.  Escalation clauses are ONLY good for buyers.  They do not benefit sellers at all.  My wife and I have closed over 2,500 listing sides and we have seen all of these type of tricks buyers use.  Let me explain:

First of all, in the bidding example, the MOST the seller gets is the "escalation" value above the 2nd highest bid.  That's the most.  Maybe they don't even get that.  I will explain later.  So this was shown to be "good" for the seller because he got an additional $2,000 more then the #2 offer.  

But something called "Game theory", the process of decision making with imperfect information, shows that doing this hurts the seller, all other things being equal.

In this specific case, the buyer is actually willing to pay $527,000 but his "escalation clause" reveals the amount of the offer he really cares about, the other highest offer other than his.  Instead of maybe taking a chance and offering $525,000, he get to sharpshoot the system and only pay $519,000 which is less.  So the seller really doesn't benefit.  The seller gets less for his house, and they buyer saved $6,000 by not just offering his highest and best.

So many people will say "But what if they only offered $510,000?  Then this escalation clause got more than the other offer.  Also this is false reasoning.  If they really only would offer $510,000 and that's the most they are willing to pay, they aren't going to move forward with a transaction in which they actually might have to pay more. 

Keep in mind that these offers are an attempt to find out what the current highest offer is, and once they have that knowledge, they use it to their advantage, and not the seller's.

The fact that this represents a legal offer in some states is not really what is at odds.  It is the seller asking everyone to come up with the most they are willing to pay, absent the knowledge of the other offers, and especially in this price range, we have almost always seen the higest offer to be at least $5,000 or more than the 2nd highest one.  Letting them off for the escalation difference, when they can always say "That's too much I changed my mind" doesn't benefit the seller at all.  

The more information about the offers that are given to the buyers will be used by them to pay as little as possible and still get the house.  In this $500,000 price range example, I'd be shocked if 10% of our sales the difference in the #1 and #1 offer were only $2,000.  At least $5,000 if not much more.

Odds are that if you just let the system work the way it is supposed to work, you will get more for your seller.

 

Mar 06, 2015 07:00 AM
Debe Maxwell, CRS
Savvy + Company (704) 491-3310 - Charlotte, NC
The RIGHT CHARLOTTE REALTOR!

As a response to the 'Disclosure' comments, the attorney explained it that once a buyer is notified that their Offer was rejected, that Offer is dead and no longer a competiting bid; therefore, it is not a 'live' Offer and not subject to Disclosure laws.  

As for the comment about not being good for the Sellers - If your buyer is offering above list price and offering to pay $2K above the highest competing Offer that is also above list price, your $2K going into the pocket of the Seller IS, indeed, a benefit to the Seller.

Escalation Clauses are not an attempt to find out what the other Offers are; they are an attempt to "win" the bidding war in the end.  The buyers only find out what price they have to pay above the single, highest competing bid.  All other parties are notified prior to notifying the winning bidder that their Offers were rejected.  Then, the name-redacted highest Offer is shared with the buyer with the Escalation Clause in their Offer, along with the counteroffer from the Seller, with the final price.  There's no back-and-forth following the presentation of the counteroffer.  

Praful Thakkar I believe Dan Tabit said it best - walk away with that happens!  If they're not playing fair, let them squirm and take less because they wouldn't be above-board with their response!

Mar 06, 2015 02:36 PM
Mark Don McInnes, Sandpoint-Idaho
Sandpoint Realty LLC - Sandpoint, ID
North Idaho Real Estate - 208-255.6227

Good job Debe,  First time back in a while and you did indeed hit a hot topic.  I lean towards the buyer advantage side.  

Mark

Mar 07, 2015 02:34 AM
Ginny Gorman
RI Real Estate Services ~ 401-529-7849~ RI Waterfront Real Estate - North Kingstown, RI
Homes for Sale in Southern RI and beyond

So interesting Debe Maxwell & I am glad I caught this..I have done 2 in the last month (escalation clauses) and one agent was haughty and did not understand it...the seller lost $4k at closing because the agent was ignorant to them.  However, now my current buyer wants to run 'wild' with them!  Certain situations dictate it.  Here we do put them into the contract since attorneys do title & closing but we do all the rest...thanks

Mar 07, 2015 07:18 AM
Michael Jacobs
Pasadena, CA
Pasadena And Southern California 818.516.4393

Hi Debe -- definitely a gold star worthy post with lots of interesting comments.   Escalation clauses have been used in our market for a while but you're right not everyone is on the same page(as evidenced by some of our comments here as well).   

In any market, it's good to know the options available(for both sellers and buyers).   Finding the right home is just a part of the sales process -- it's getting that offer accepted and closing that turns a buyer into a homeowner.  

Mar 07, 2015 08:19 PM
Jim Paulson
Progressive Realty (Boise Idaho) www.Progressive-Realty.info - Boise, ID
Owner,Broker

Even before I got into real esate 24 years ago, I used an escalation clause to buy my home in Northen Virginia.  Many agents still don't understand them.  Todd Miller brought up some good points.  The best way for an auction system to work is having multiple bidders, so I need to start elaborating instead of just doing a multiple counter offer form, I should offer each agent an escalation clause form to utilitize if they want.

Mar 09, 2015 03:31 AM
Debe Maxwell, CRS
Savvy + Company (704) 491-3310 - Charlotte, NC
The RIGHT CHARLOTTE REALTOR!

Ginny Gorman - yes, the thoughts that EC's don't work for Sellers are beyond me as evidenced by your buyer's recent experience.  I think it's lack of understanding on the part of many.  As Jim Paulson mentioned, they've been around a long time - they have been proven useful for decades. 

Michael Jacobs, thanks and I totally agree!

Mar 11, 2015 02:16 PM
Debb Janes
Nature As Neighbors - Camas, WA
Put My Love of Nature At Work for You

We couldn't win without the EC. I'm a big fan and use it often in multiple bid situations. Glad to see you know their power too, Debe. 

Jul 21, 2015 12:39 AM
Debe Maxwell, CRS
Savvy + Company (704) 491-3310 - Charlotte, NC
The RIGHT CHARLOTTE REALTOR!

Debb Janes, it's a shame that we have to fight for something that works so well for both sides.  In my opinion, it's really up to the buyers and sellers - what type of Offer they prefer to make and accept!

Aug 04, 2015 12:36 AM
Inna Ivchenko
Barcode Properties - Encino, CA
Realtor® • GRI • HAFA • PSC Calabasas CA

In CA, we use this kind of the escalator clause: Into the purchase agreement goes language like this:

“Purchase price shall be $1,000 more than the next highest offer, up to a maximum price of $xxx,000. Buyer shall have the right to verify the legitimacy of all competing offers, with Seller to disclose competing offers to Buyer.”

Dec 13, 2016 08:34 AM
Debe Maxwell, CRS
Savvy + Company (704) 491-3310 - Charlotte, NC
The RIGHT CHARLOTTE REALTOR!

I like that clause - clear, concise and lets the sellers know that the buyers do expect honesty with the final number, Inna Ivchenko!

Dec 13, 2016 01:03 PM