Pros and Cons of Escalation Clauses when buying real estate
Buyers are asking about escalation clauses with increased frequency in Brookline, Cambridge, and Boston, especially when they expect to be competing against other buyers for a hot property. Although gaining in popularity, these clauses are still rare in this market - I’d estimate less than 5% of offers include one.
Escalation clauses typically include at least these three components:
- Initial offer price (e.g. $1 million).
- How much the price will automatically increase based on another bona fide offer. (e.g. $5,000 over any other bona fide offer).
- The maximum, or cap, that the buyer is willing to go. (e.g. up to $1.1 million)
For example, a buyer might offer $1,000,000, with an automatic increase of $5,000 above any bona fide offer the seller receives, up to a maximum of $1,100,000.
On the surface at least, this seems attractive to many buyers as a way to be competitive without paying much more than necessary to win the deal.
There are, however, risks and challenges that the buyer should understand when using an escalation clause. For example, how can the buyer verify that the other offer the seller received was a legitimate, bona fide offer? For example, what if the seller gets their uncle to write an offer purely for the purpose of triggering your escalation clause, or what if they make up an offer altogether? (That would be unethical of course, but not everyone is so ethical.)
The seller is not obligated to share the other offers, and when they do, they usually redact the personal information of the other buyer anyway. Even when they share the other buyer’s information, that’s someone you are competing against, and they are unlikely to cooperate with you so you can steal their deal.
The seller might also decide they don’t want to play along. Instead, they might make a counter-offer at the max cap price in the buyer’s escalation clause. From the seller’s point-of-view, the buyer disclosed that they feel the property is worth up to that maximum price…so that’s the price they should be willing to pay.
A buyer might try to prevent that outcome by not including a cap in their escalation clause at all. Instead, they will make an offer with no cap, but subject to their approval. Without a cap, though, it’s not a real, reliable offer that the seller can count on. In reality, the buyer is asking for a free right-of-first-refusal. Occasionally the buyer might get away with this, especially on the first round of a bidding, but the seller would do better to reject it and insist on a real offer.
Escalation clauses are another tool buyers can use in crafting offers, and should be considered in the overall context of the house, the agents involved, the other bidders, etc. Having a knowledgeable buyers agent is invaluable for situations like this and for understanding the risks and possible benefits of opening negotiations in this manner.
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AVI KAUFMAN is a top broker who lives in Brookline, Massachusetts and works there and surrounding communities, assisting buyers and sellers of residential property. He is building a unique practice dedicated to serving the best interest of his clients - see how he's different.