How to Use Escalation Clauses to Land Competitive Real Estate Deals

by | BiggerPockets.com

Because Denver is a seller’s market—meant to distress, if not torment, the lives of first-time buyers—it’s important to consider all your options for having the winning contract. To this point, I discussed the advantages of appraisal gap coverage last week, and this week will discuss how first-time home buyers (or any buyers) can use an escalation clause to their advantage.

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What is an Escalation Clause?

An escalation clause is a clause you can add to your offer on a home. It more or less frees you from setting your price at a static number and instead allows you to set a range. It also helps prevent overpaying. When you submit an escalation clause, your contract comes in with a baseline price, but allows you incremental bids above your competition. So, you only pay as much as you need to beat out the other offers.

Related: How I Landed a Solid 4-Plex in Denver, One of the Hottest Markets in the Country

Real World Example

Huh? What am I talking about? It’s probably easier to understand in a real world example. My clients in Colorado Springs this weekend wanted a 3-bedroom house a mile from downtown. We knew there were five other offers on the property because of its excellent location and views. This information is both a blessing and a curse—you know you need to be aggressive to get the place, but you don’t want to be ridiculous because you’re excited about the place and pay $20,000 more than you need to.

To prevent that, they used an escalation clause. Their baseline price was $345,000, with an escalation clause up to $380,000, beating out any competitive offers by $3,000. So, what this means is they put in an offer at $345,000, and another offer came in at $355,000. Per the contract, my clients would have only paid $345,000 if no other offers above theirs came in. Since another offer did come in (at $355,000), my clients were now offering to pay $358,000 ($3,000 above the other offer, per the agreement). And they were willing to go as high as $380,000 if the competition demanded it. As it didn’t, they are now under contract on a 3-bedroom for $358,000.

Why Would I Use an Escalation Clause?

Escalation clauses are helpful in competitive markets where there are a lot of offers. It’s a tool to help prevent seriously overpaying for a property because you don’t have all the information on the other offers, and you still really want the place. It allows you to decide the most you would pay for it without actually forcing you to do that.

sell-your-home

Related: 4 Actionable Ways to Find Real Estate Deals, Even in a Red Hot Market

Why Would I Not Use an Escalation Clause?

Some seller’s agents want “clean” or “best and final” offers. When they say this, they are saying they don’t want to go back and forth on offers; you get one shot and that’s it. This limits the amount of back and forth the seller’s agent has to do and potentially drives up the price based on buyers’ fears and emotions. If there’s no bargaining tool, and they know there are multiple offers, the buyers have to come in really strong (i.e. possibly significantly over market value).

These tools absolutely make a difference in bidding wars, and can help you secure the property of your dreams without paying too much. This clause should be used strategically and hopefully helps you secure your next home. Good luck.

Have you ever used escalation clauses?

Comment below!

About Author

Erin Spradlin

Erin Spradlin co-owns James Carlson Real Estate. She loves working with first-time homebuyers for their enthusiasm and excitement, and loves working with investors because she’s a fellow spreadsheet nerd. She and her husband own three properties in metro Denver and are currently in the process of acquiring a duplex in Colorado Springs. You can find Erin’s blogs here: https://www.biggerpockets.com/renewsblog/author/erinspradlin/ and her airbnb video series here: https://www.youtube.com/playlist?list=PLgSUZKLPRI9tK3Vd-qpH3Sk2Rh-_pIrNN.

26 Comments

  1. Ken Virzi

    I can’t bieve I have never heard of this as this is something I have even hinted at, thanks for the great info!

    Are you ever concerned about manipulation on the part of the listing agent though? What would prevent them from having a friend submit a higher offer to max you out?

    • Dhaval Sheth

      Hi Ken, I had the similar doubt and I asked my agent about it. He said that if a person is using the escalation clause addendum, the listing agent is legally bound to show buying agent the highest offer and that may expose the gimmick!
      But there is also a logical reason. Suppose for $200,000 house, I am starting my bid at $195,000 with my maximum offer of $205,000. Let’s say that the listing agent is manipulating the offer to max me out. So I am paying $10,000 more for the property. So at 3%, the increase in the listing agent’s commission will be $300. Do you think any agent is going to risk the sale and risk losing his real estate license for that much gain? 🙂

      • Erin Spradlin

        That’s a great point. The state would look unfavorably on an agent that got caught doing that and it’s really not a ton of money for them to risk their licensing or reputation on. You can also just prevent this by requiring proof of the other offer.

      • Gabe Hall

        I’ve had it happen to me. I had set my increment numbers completely odd: 2325 or something and my max was also odd. But somehow magically an offer appeared from a buyer which was exactly one notch below my max. Amazing!

        There is no negative for a buyer to submit an offer like this – they lose no money and are not obligated to pay any price since its below the escalator offer. The listing agent has no fiduciary duty to keep these numbers secret, nor are they restricted from calling other bidder’s agents and asking them to submit an offer at a specific price. “I’m sure this price will get you in”.

      • Scott Matthew C.

        @DHAVAL, I’m interested to know if the agent is an attorney.

        I’m not convinced the listing agent is bound by law.

        The Listing Agent/Broker being “bound by law,” owes fairness and honesty to the Buyer(customer) only!

        If the Seller tells the Listing Agent/Broker to accept the offer with an “Escalation Clauses” without a legitimate prior offer, then Listing Agent/Broker has committed fraud under misrepresentation as well as the Seller.

        If the Seller(Principal) agrees’s to a Purchase Agreement(PA) regarding “Seller agree’s to furnish prior offer to affirm/confirm agreed sales price due to another offer,” then yes, the Seller must perform and show the prior offer.

        Without another clause in the PA to state “Proof,” the Seller and the Listing Agent/Broker may be able to skirt lines when the buyer request for proof.

        How?

        Purchase Agreements/Contracts are enforced by “statute of frauds”. If something is missing from the Purchase Agreement, it is not enforceable, in most cases.

    • Erin Spradlin

      Great question. I put into the clause that we need proof of the other offer for the clause to hold. Once I have that, I then call the agent with the supposed other offer and confirm that they did put in the offer and were willing to go that high.

  2. Dhaval Sheth

    Hi Erin, the word escalation clause is fresh in my memory because I used it for the first time just two days ago. I live in Mechanicsburg, PA and it is definitely the seller’s market here too. I came across one property, and just from the look of it, I knew it is not going to be on market for very long. The seller had renovated the whole house and it was ideal for me to use as the primary residence for a couple of years and later use it as a rental property. My REA also liked the house and he suggested using escalation clause on the property. You are right on that account that not many agents like to use escalation clause just due to the complexity and for more paperwork going back and forth. This seller’s agent was open to the escalation clause and we entered our offer with maximum bid 3k above the asking price! We were sure that we are going to get the house.
    The seller received 3 offers in a day and unfortunately, all 3 offers had escalation clause on it and one offer was with the maximum bid of 5k above the asking price. From what I understood, if you get more than one escalation clause offers on the same property, the maximum bid of the higher bidder automatically qualifies. The sad part about the escalation clause, at least in this case, was that you only get one chance. Thus, I didn’t get second chance to make a counteroffer. So I ended up on the losing side but still, it was something new that I learned recently.

    • Erin Spradlin

      Yeah, it’s also important to think about what number for the escalation works. When I first started I would do $1000, but that’s not actually that much incentive if the other offer is cash/has better financing/there’s some emotional reason to go with others… so I usually tell my clients to do $5K. You don’t feel it that much in your mortgage and $5k is a lot for a buyer to walk away from.

  3. Man, I am glad I live in an economy that isn’t messed up enough for houses to be that expensive. How can a person justify paying well over $300k for just one house? Won’t they be heartbroken when the next market crash happens and people stop scrambling to pay so much for what’s probably less than $80k in materials? Why not just get great views on YouTube or something?

    • Erin Spradlin

      People have a dream of homeownership… and in Denver/Colorado Springs, the price dictates that (and, frankly, well above that.) And there are a ton of markets that support those kind of rates: San Fran, Seattle, Portland, Boston, New York, etc. so even though it’s a lot, it can still be a really good investment.

        • What motivates people to live in areas that are so expensive? I mean, a sandwich must cost $30, and I can only imagine what your utilities must cost. That’s a MESSED UP economy imo. I’ll stay in my $25k place in the hood of Nap Town.

    • Deanna Opgenort

      Hi Moo.
      What normally motivates people to pay more for housing is usually “Location”, which comes with either Lifestyle, Opportunities (aka “Jobs”), or both. I might pay 2x as much in rent, but if I make 3x in income I’m ahead. If I were really, really into hiking and skiing it might be worth it to me to live in Denver, where I could do those things easily and often. Also, utilities sometimes cost LESS in expensive areas. In San Diego most months I pay $0 in heating or AC. It’s simply not that cold in the winter, and we just open windows for all but the hottest days in summer, whereas AC in the Phoenix summer or heating in the midwest winters can easily top $200/mos.
      That said, if I were on SSI or retired I would certainly need to consider somewhere with cheaper rents, since I would no longer have the benefit of higher wages to offset the higher housing cost.

      • Erin Spradlin

        Yeah, Denver right now isn’t a great place for investors either. It’s very, very difficult/almost impossible to find anything that clears the 1% rule, much less 2%. Totally understand why people want to live here (because it’s my favorite place in the world and I’m surprised it took this long for it to become so popular), but it’s not the right place for certain goals.

  4. As a seller in a hot market I have used these clauses in a different way. I have countered the strongest, cleanest offer with their maximum limit. I did not invoke the escalation provision and use other offer escalation maximums – I went higher because I now knew what the potential buyer would pay. If they balked, I planned to go to the next strongest offer and do the same. Buyer’s agents did not like this strategy but I had every right to simply counter someone and disregard escalations. Just make sure that appraisals are waived and the potential buyer has resources to close. In the author’s example I would have sold for 380K. My agent did not have to disclose details of the other contracts.

  5. Jerry W.

    I don’t see what keeps the seller from just sitting back and waiting and only accepting the highest offer? If the seller doesn’t accept the offer in writing and waits for a few days and lets others know the best bid he could maximize his profit more. just because an escalation clause is in the offer doesn’t mean he must accept it.

  6. I’m with Cheryl above. As a seller, you are under no compulsion to accept an offer with an escalation clause. In a hot market, I received an offer on a house for sale with an escalation clause. I countered with a firm price just below the maximum escalation amount. Everyone knew there was a ton of interest in the property, and the buyer accepted my counter-offer. Everyone was happy — I got more than anticipated and the buyer got the house they wanted at the price they were willing to pay. As a seller, use the information the buyer is giving you — and set the firm counter-offer price accordingly. As a seller, there is no reason to accept an offer with an escalation clause. Just counter-offer with a firm price.

  7. Peter Welch

    There are times to use an escalation and times to make a standard offer. It really depends on what you are trying to accomplish and the heat of the market. One of the pros of using an escalation is the listing broker is required to share the other offers with you if they accept the escalation, on the flip side of that there is nothing saying they can’t reject your offer and any others and just counter directly to whoever had the highest escalation, why not, they already know what you were willing to go up to. It’s not very ethical, but it’s not illegal. Ultimately sellers are just wanting to get the most that they can. I’ve found that escalations work alright for owner occupied homes, but as far as investment property it can shoot you in the foot. But as long as you know your numbers and stick to your range, you should be just fine.

    • Erin Spradlin

      Yeah, Peter- it’s definitely a concern I have at times- will they run up the cost? I haven’t experienced that yet and I have beat out a few offers with this strategy, so it’s worked for my clients so far. Great thoughts though on the pros/cons.

  8. Dillon Hall

    Erin,

    Love what you said about the escalation number… $1,000 just isn’t enough anymore. A good LA helps his/her sellers look for value in offers beyond purchase price. There is tremendous value in terms, and in my market (SoCal) a cash offer (or an offer with no appraisal contingency) would likely have more value than a conventional finance offer for $5,000 higher…not to mention the potentially longer escrow.

    Great article.

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