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By Brenda Richardson
October 20, 2020
Rangely Garcia for Money

In today’s strong seller’s market, potential homebuyers had better be willing to step up their game. To edge out competing bids, some buyers might want to consider something known as an escalation clause.

An escalation clause is an addendum to an offer for a home that automatically increases the bid by a predetermined increment if a competing bid comes in. According to data from brokerage Redfin, 17% of offers the firm makes include escalation clauses. Such clauses can be particularly useful in a low-inventory market. When a buyer uses the clause, they are signaling that they want to make a more attractive offer, ultimately driving up the price.

Real estate agent Tye Stockton of The Stockton Group of LIV Sotheby’s International Realty in Vail, Colorado, currently has three-properties under contract where an escalation clause sealed the deal. In multiple bid situations, he said escalation clauses often come into play in hopes of winning a home.

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“The market we’re in right now in Vail is unprecedented in my 20 years in real estate,” said Stockton. “It is a pandemic gold rush. And it’s been interesting watching how it’s not just Vail, it’s really all these mountain resorts, Vail, Aspen, Sun Valley, Jackson Hole, Telluride—you name it. People are so committed to buying a house that they will pay anything to own it.”

How to write a strong escalation clause

An escalation clause allows a buyer to ensure that they won’t be outbid on a home, up to a set maximum price. A well-written clause is broken down into three main components — I’m offering to pay this, I’m willing to pay this if somebody else comes in, and I max out at this.

“When potential buyers really want to own a property, and they put an escalation clause in their contract, they want to outbid the other competitors for it up to a certain point,” said Stockton.

The clause typically increases an offer by a certain amount or percentage over the highest offer received by a seller. For example, Buyer A offers to buy a home for $100,000. Her real estate agent includes an escalation clause that will increase her offer in increments of $2,000 above the competing offer up to a maximum of $110,000. If no other offers are submitted, Buyer A’s offer remains at $100,000. If Buyer B offers the seller $103,000, then buyer A’s offer would automatically escalate to $105,000. If Buyer B offers $111,000 for the home, then Buyer A’s offer of $110,000 will be exceeded, and Buyer B will have the top offer.

Some buyers start negotiations thinking they can offer just a dollar more than the next best bid. But Stockton warns, “You want to make it meaningful because if someone outbids you, is it really worth offering a dollar more?”

For example, in June, Christian Henriksen and his girlfriend bought a three-bedroom ranch home in West Chicago, Illinois, after house hunting for about a month. His escalation clause came into play when out of nine other offers, his offer was the only one that stated he would be willing to match competing bids and go $1,000 over the highest offer the seller received. “We submitted the offer on a Sunday, and we found out on Monday that our offer was accepted,” he said.

Should sellers accept bids with escalation clauses?

Each selling situation is unique. Sometimes there are terms that are more important to the seller than price, such as a quick closing or no contingencies.

“Sometimes I’ve seen sellers bypass an escalation clause that would pay them more money at closing, if they don’t like the other terms of the deal,” said Stockton. “When you’re representing a seller, you can go back and counter a buyer with an escalation clause and say we’ll accept your escalation clause, but we also are going to counter you with these terms because we like these better out of another offer.”

Christian Ross, managing broker of Engel & Völkers Atlanta, advises sellers not to accept escalation clauses because they can give buyers the upper hand. “Sellers could leave money on the table by accepting an escalation clause,” she said. “Eliminating the option for a buyer to submit a bid with the clause helps sellers get the highest price possible.”

For example, if Buyer A offers her maximum price of $500,000 and Buyer B makes a counteroffer of $500,000 with an escalation clause stating he will pay $1,000 over the highest offer, up to $515,000, then Buyer B will have a winning offer of $501,000.

On the flip side, Ross prefers the escalation-clause scenario for buyers she represents who are involved in a bidding war. “Hopefully, they can get the home for less because someone is putting in an offer that is not as much, and we can go up by $1,000 and win the deal,” she said.

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