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.
How to Invest in Real Estate While Working a Full-Time Job
Many investors think that they need to quit their job to get started in real estate. Not true! Many investors successfully build large portfolios over the years while enjoying the stability of their full-time job. If that’s something you are interested in, then this investor’s story of how he built a real estate business while keeping his 9-5 might be helpful.
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.
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.
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?