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Don’t Leave Your Clients High and Dry: What Real Estate Agents Should Know Before Using an Escalation Clause

The pandemic has made just about everything more difficult—including buying a home. In an extremely competitive market, hopeful buyers are looking for any strategy to gain an advantage and increase their chances of making a successful offer. One option your clients may want to consider is the inclusion of an escalation clause in their offer. But what exactly is an escalation clause—and how do your clients know if it’s the right choice for them?

The concept of an escalation clause, or escalator, is simple—it’s a clause in a real estate offer that states that, if a higher offer is made by a competing party, the prospective buyer’s offer automatically increases by a certain amount until a specified maximum price is reached.

An escalation clause can be structured to meet a variety of objectives depending on the circumstances, but here’s

Essentially, an escalation clause keeps your client in the game to purchase the house by automatically increasing the offer. That sounds great—but there are several factors your clients should consider before including an escalation clause in their offer .

Seller Perception. One of the most important considerations is how the seller may view the escalation clause. On the one hand, an escalation clause shows that your client is a determined buyer. On the other hand, the escalation clause immediately alerts the seller of your client’s best offer. All of your client’s cards are placed on the table at once, which will weaken your client’s negotiating position if no competing offers are made. It’s also important to ask the seller’s agent if the seller will consider an offer with an escalation clause. Some sellers will not accept such offers.

Appraisal Gaps. Another major consideration is the appraisal gap. If your client decides to include an escalation clause, he or she needs to a set a cap that’s within his or her budget and must understand how escalation can widen the appraisal gap. What happens if the cap is reached and the offer is accepted,  but the home appraisesfor less than the contract price (which is very common)? In that case, your client will need to be willing and able to cover the difference in cash. If the seller anticipates an appraisal gap and feels your client will be unable to cover the difference, the seller may balk at your client’s offer.

Offer Review Process. You should also ask the seller’s agent to confirm the deadline for submitting offers. Will the seller accept an offer from those that are submitted in a single day, or will can offers be submitted on more than one day?  Escalation clauses are typically more advantageous to buyers if a one day review process is being used.

Price versus Other Factors. Your client should also consider whether price really is the most important factor for the seller. It well may be—but other factors may make you’re your client’s offer more appealable, such as an expedited settlement date, waived inspections, or even a letter describing the sentimental or personal appeal of the home to your client. Instead of simply throwing more money in the pot, these factors may be a more effective way for your client to boost the value of his or her offer.

Likelihood of Other Offers. Perhaps the single most important factor you client should consider before including an escalation clause in his or her offer is the likelihood that other offers will be made. An escalation clause is only valuable if your client is competing against other offers. Otherwise, your client will show his or her cards for nothing. However, if there are other offers, the escalation clause could help your client win the hand. Communicating with the seller’s agent and assessing the situation ahead of time is key to ensuring your client is well informed before and offer is submitted.

So, what do you do if your buyer client wants to submit an offer with an escalation clause? There is not an easy answer because there are lots of factors to consider. You must be prepared to have a well-informed discussion with your client, and you must ensure that any escalation clause your client includes in his or her offer is tailored to the needs and objectives of your client and the specific circumstances at play. Your McBrayer attorney can guide you through this process.

Zachary Webster is an Associate of McBrayer Law. He works in the firm's Lexington office as part of the real estate and litigation practices. He can be reached at 859.231.8780, ext. 1228 or by email at zwebster@mcbrayerfirm.com

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