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The Almighty Escalation Clause

The escalation clause. In a hot seller’s real estate market, such as North Idaho, where inventory of homes is low and the number of buyers is only growing, we see a lot of them. What are they and when do you use them?

An escalation clause “escalates” the buyer’s initial offer a certain amount over the higher competing offer up to a maximum price the buyer is willing to pay for a home or property.

For example, if a home is listed at $500,000, and the buyer’s agent suspects multiple offers will be made on the home, they may help their buyers beat the other offers by adding an escalation clause document (in Idaho it’s called the RE-34) onto their offer. The buyer may offer $515,000 in the initial offer, but then attach the RE-34 Escalation Clause which states they will pay $2000 over the highest offer up to $550,000.

Sounds like a great tool, right? And it can be—as long as buyers are aware that they may actually pay that highest amount for the home.

Here is where it gets more interesting… Because the seller can now see how much the buyer is truly willing to pay for the home (or property), the buyer loses negotiating power. The seller now knows they can write a counter-offer for that highest price, and in that counter-offer, they can remove the escalation clause. The buyer usually signs the contract because they assume there is at least one other high offer, and at this point, they don’t want to lose the house if they turn and counter the count-offer. The seller does not have an obligation to share any information about the other offers they received.

An escalation clause is a strong sign that the buyers really, REALLY want the home. By the time the offer is written, all buyers are typically involved at an emotional level and are willing to sign any counter offer, even at their highest price point. And sometimes that is what it takes to get into the house they desire.

Also, take heed, if you are not a cash buyer, the home will need to appraise at or above sales price, so the buyer should be prepared to pay more cash out of pocket to fill in the gap between appraisal and sales price, should that happen. If the home does not appraise for the contract sales price, one of three things can happen to resolve that issue: the seller agrees to lower the price, the buyer pays the amount necessary that their loan won’t cover, or the deal falls through. If the seller received other strong offers, chances are they will not lower the price. Keep that in mind. Your agent should be able to help you write a solid offer that will meet appraisal, using their knowledge of the market.

So what to do? Know your options. Would you rather use an escalation clause or a highest and best offer? Your agent should be able to sniff out enough information to know if other offers are being submitted on the property. How badly do you want the property? Keep your emotions in check to ensure that any unnecessary desperation isn’t the only thing that is driving you into a bidding war.

An escalation is one tool in the toolbox of strong offers, but understand it and use it wisely.