Bidding Wars—Can you “Win”? The “Escalation Offer”
In our Northampton area, inventory of available homes is thin, especially this year. Many times, all it takes is an Open House to generate several offers. While this shows that the property has been priced well by the Realtor, it can be an uncomfortable situation for the buyer. Some buyers will shy away from any “bidding war” as too complicated and stressful, while out of the number of interested buyers who do submit offers, all but one party is sure to be disappointed. Only one party can “win”.
Escalation Clause Defined
An escalation clause is a term contained in the buyer’s offer. Typically the buyer identifies a fixed amount as the purchase price being offered. An escalation clause (or escalation addendum to an offer) alters the fixed price into a price that could increase.
The escalation provision states:
“Buyer offers to pay $____ for the property, but if the seller receives a bona fide offer that is higher, Buyer will increase the price to $____ above the amount of the other offer.”
While an escalation clause appears to be straightforward, it is complicated and requires
that many details be addressed. Therefore, the Massachusetts Association of Realtors®
recommends that the buyer consult an attorney before including an escalation provision. Realtors® representing buyers are cautioned not to draft escalation clauses.
Escalation Clause in Use:
Suppose Buyer One offers $400,000 for a property. Buyer One’s offer contains an
escalation provision that will automatically increase Buyer One’s offer by increments of $2,000 above any competing offer. Buyer One’s escalation clause also sets a maximum purchase price (“cap”) of $410,000.
If no other offers are submitted, Buyer One’s offer will remain $400,000. If Buyer Two offers to pay $403,000, then Buyer One’s offer would automatically escalate to $2,000 above that amount, bringing Buyer One’s offer to $405,000. If Buyer Two offers $406,000 for the home, then Buyer One’s offer will increase to $408,000. If Buyer Two
(or any other buyer) were to offer $411,000 or more, then Buyer One’s maximum of $410,000 will be eclipsed, and the other buyer will have the highest priced offer.
How Some Sellers Respond:
Some sellers will not accept an offer with an escalation clause. They prefer that every buyer submit an offer for exactly what the buyer is willing to pay. Many sellers believe that not allowing offers with escalation clauses leads competing buyers to try to outbid one another in their initial offer. It also streamlines the paperwork and the decision-making process, avoiding the need for the seller to provide documentation to a buyer that a higher competing offer is bona fide, i.e. legitimate.
When to Consider an Escalation Clause:
It is not recommended that an escalation clause be used, except when the buyer has concluded that there will be multiple competing offers. If the buyer’s initial offer is the only offer submitted, the price in the initial offer remains unchanged.
Because escalation clauses identify the maximum a buyer will pay, such clauses reveal much more than the traditional offer. The seller will know the highest price the buyer is willing to pay for the property. Rather that accepting an offer with an escalation clause,
the seller could decline the offer and propose a counteroffer at or above the maximum price in the escalation clause. Therefore, the cap information in an escalation provision could jeopardize the buyer’s bargaining position with the seller.
Credit to Robert S. Kutner – Partner, Casner & Edwards for legal aspects of this article.