Even in this slower real estate market, you will sometimes face competition when you are bidding for a house. The days of frenzied bidding wars are largely past, but competition does still take place. Right now, we are seeing a number of offers that sometimes compete below the list price. When faced with competition, you need a strategy to win the bidding process, but at the same time not overpay in the heat of the moment. Adding an escalation clause to your offer is one strategy that you can use when competing with another bidder.
The Escalation Clause
Real estate offers are a closed bidding process, so most often you will know little to nothing about the price and terms being offered by the other parties. I have yet to meet a buyer who isn’t at least slightly uncomfortable with competing against another unknown bid, and allowing your offer to escalate gives you an opportunity to raise you bid, but only slightly past the other bidder.
The way an escalation clause works is that you specify an initial bid for the home, and then state that your bid will escalate above a competing offer up to certain limit. As an example, you may offer $450,000 for a home, with an escalation clause that beats a competing offer by $2,000 up to $475,000. If your competitor bids $460,000, your offer becomes $462,000. If your competitor bids $475,000, your escalation stops and both offer prices are equal.
Tips for an Effective Escalation Clause
An escalation clause can be a useful strategy to raise your offer price, while not overpaying compared to the next closest bidder. Here are some tips for effectively adding an escalation to your offer.
- Determine your highest bid – Whenever you are competing with another bid, you have to decide what the maximum price you are willing to pay. Don’t get caught up in the competition and stick to your bid so that you don’t end up overpaying.
- Make your escalation more compelling than your competitor – If you only beat the competing bid by $1,000, your offer will be evaluated based on other terms because the price difference is negligible. Let’s say that your bid is $450,000 with an escalation that beats a competing offer by $1,000 up to $475,000. If your competitor bids $460,000, your bid is only $461,000, even though it escalates higher than that. You should pick a larger dollar amount that makes your offer materially different than your competitor, at least $2,000-$3,000 higher than the competing bid in the example I just gave, sometimes higher.
- Hold back your escalator – Remember, it is the job of the seller’s agent to play competitors off one another and obtain the highest possible bid for their seller. If you play your cards too early, the agent will encourage higher bids from your competitors. I like to hold the escalator until shortly before the offers are reviewed, giving a bare minimum amount of time for the seller to use it against me.
- Ask to see the competing offer – In a normal real estate bidding process, competing offers are not shared with you. However, when you use an escalation clause, there is an obvious opportunity for sellers to game the system and claim that there is a competing offer that doesn’t actually exist. The escalation contract that we use requires the seller to show a copy of the competing offer before they can invoke the escalation clause.
Why Shouldn’t I Use an Escalation in My Offer
On the surface, it would seem that an escalator is a great way to compete on price without paying too much more than your competitors. However, it is not a guarantee to winning a bidding process.
- Banks don’t accept escalators – If you are bidding on a bank-owned house, you can forget escalation in your offers. Banks won’t review offers that contain an escalation clause, so don’t bother with it. You will be asked for your “highest and best offer,” which means you need to pick a competitive price that you are comfortable with and stick to it. If you get the property, great. If you lose the competition, remember that there will always be another house coming on the market.
- Sellers don’t always like escalations – I have lost more than one bid that contained an aggressive escalation clause. Sometimes the initial bid amount is too low, and sellers take that as an insult. Sometimes you appear to be a less serious buyer than a bidder who doesn’t need to escalate their offer to get to a competitive price.
- Price escalation cannot make up for weaker terms – If the other terms of your offer are weak (low down payment, multiple contingencies, long closing time), the small premium in price that your escalation gives isn’t the most compelling offer. Money usually is the deciding factor on house offers, but when bids are close to one another, sellers often opt for the offer that looks like a sure thing.
Adding an escalation clause to your offer on a home can be an effective strategy to compete on price while minimizing the risk of paying too much, but think carefully about the situation before you use one. Sometimes putting your “highest and best” offer forward may be the right approach.