BuyingCommentarySelling April 30, 2024

Escalation Clauses in Offers to Purchase: a Double Edge Sword

Escalation clauses are sometimes included in offers that essentially state that if the offer being presented is outbid by another competing offer that the buyer will raise their number by a set amount over the higher competing bid. Sometimes they are clever due to the confidential nature of closed bids in New York real estate, but they are not the cure all that some agents think they are.

The first escalation offer I can recall was a sale I made in 2012. The house was a rare offering and the market was, at long last, recovering, and the winning bid promised to be $2500 higher than any superior offer. The listing was sold for about $40,000 over asking, and that clause made the difference for the buyer who ended up getting the house. That buyer was paying cash, so it was a particularly strong proposal in the terms category as well as price.

When the market heated up around 2020, escalation clauses became far more common. Not many listing agents understood them well enough to properly convey the message to their seller clients as effectively as they could have, but by 2021 most agents grasped the mechanics.

Unfortunately, some agents know them a little too well.  Yes, escalation clauses are no longer viewed as obscure or a gimmick, but they aren’t always the answer. Here are a few scenarios where they just don’t work the way the presenting agent thinks they will:

  • Multiple escalation clauses. If a property has multiple offers and more than one has an escalation clause, it can create too much noise for the seller. Yes, one escalation clause can promise $10,000 more than the competition whereas others are $2500 or $5,000, but that does not negate other terms. Speaking of other terms…
  • When other terms like down payment are not competitive. If the seller of an $800,000 house has a $825,000 cash offer and a competing offer has an escalation clause of $10,000 over best but their down payment is only 5 or 10%, that bump up may not help because the certainty of a cash buyer is superior to that of a highly leveraged loan contingency. To say nothing of…
  • The house may not appraise. And if the buyer is cash poor, they may want the seller to eat the difference if the appraised value come back low. The lower the down payment, the less punch the escalation clause will pack.

It has gotten to the point where some listings will state that no escalations will be entertained. We recently had a multiple offer situation on a listing where the winning bid was chosen because it had a high down payment and waived the appraisal contingency. An offer with a VA mortgage came in with an escalation clause, but VA mortgages are 100% financing, or 0 down. That might have gotten the seller an additional $5,000, but the risk of going to contract with a buyer with no cash to cover an under appraisal was not palatable for the seller. The buyer agent was unhappy about this, and I do appreciate the uphill battle VA buyers face, but that agent did not have an answer for the possibility of an appraisal problem.

Escalations can indeed make a difference. But they aren’t the panacea that some think they are because of the law of unintended consequences connected to other terms, and agents need to educate their clients that the clause isn’t a magic wand.