What is an Escalation Clause in real estate and does it work in a multiple offer situation?
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.
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 other offers
Sellers may not want to provide Buyer(s) with the other offers. In order to reach mutual acceptance (having a binding offer), the seller must also present the buyer the full offer(s) from the other buyer(s). This is good for buyers because otherwise sellers could easily state untruthfully the facts about the terms of the other offers or even if there were any other offers.
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.
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!