Deciphering escalation clauses

Ask Phyllis: a blog series of frequently asked real estate questions.

Dear Phyllis,

I always look forward to your real estate advice. Especially considering my daughter and her husband’s recent experience in writing an offer for a home in Thousand Oaks. Surprisingly, despite the existence of eight offers, the sellers accepted an offer that included an escalation clause. This left my daughter as the backup buyer. As this topic hasn’t been previously addressed, I would greatly appreciate further insights on understanding escalation clauses, as they appear to raise concerns about fairness for buyers.

Jenna

Dear Jenna,

Escalation clauses have been used for years. I am surprised the seller’s agent didn’t issue a counteroffer to all the buyers with the escalated amount. In this scenario, let’s assume the successful buyer wrote an offer for $2,000,000 with an escalation of $10,000 more than any other offer up to $2,250,000. Consequently, the listing agent might have simply countered every buyer at $2,250,000 or the highest and best price.

Pros:

1. By including it in your offer, you demonstrate seriousness and competitiveness, which shows the seller that you are truly committed to purchasing the property. Moreover, this action conveys your willingness to outbid other buyers, potentially making your offer more compelling and distinguishing it from numerous competing offers.

2. Simplifies negotiation process: With an escalation clause, you don’t have to engage in back-and-forth negotiations whenever another offer comes in. The clause automatically increases your offer by a predetermined amount above any higher competing bid.

3. Sets a price cap: Including a capped amount ensures that you don’t exceed your predetermined budget. Once the bidding surpasses your cap, your offer will no longer increase, protecting you from overpaying for the property.

Cons:

1. Seller’s perception and motivation: Some sellers may view an escalation clause negatively, perceiving it as a sign that you were initially willing to pay more and wondering why you didn’t offer the higher amount outright. This perception could affect their motivation to negotiate with you.

2. Possibility of multiple counteroffers: However, the seller may issue a multiple counteroffer, which includes your capped price and requests for other favorable terms. Furthermore, this could result in a more complex negotiation process and might not necessarily guarantee that you secure the property.

3. Listing agent preference: While some listing agents may be open to escalation clauses, others may prefer buyers to present their best and final offers upfront, without relying on such clauses. In instances where the listing agent dislikes or discourages escalation clauses, this could leave a negative impression that might ultimately influence the seller’s decision.

I hope this explanation helps. By the way my sister got her dream home by being a backup offer. Best of luck to your daughter and son-in-law.