Escalation Clauses – Watch Out for the Trap!
When there are multiple offers, buyers will be advised by their agent most likely that they need to put in their escalation. So, what is an escalation?
Escalation is the statement written into a purchase offer that automatically increases your purchase price by a certain amount above competing offers, until the offer reaches the maximum price you are willing to pay for the home. An escalation clause only goes into effect when there are competing offers. Basically, you want to think of it like Ebay. For example, if you ever bought anything on Ebay, you put in a bid, but you put in your max bid, and Ebay behind the scenes has the software that will bid between you and other bidders against each other. If you bid high enough, it will bring you as the winning bidder.
Here in the DC Area – this is how it works. What you want to do is put together pieces of information for your agent and you will work on this together. You will need a starting price; you will need an escalation factor and then you need the CAP.
- Starting price – is where you want to start the bid.
- Escalation factor – the amount that you want to go up.
- CAP – the top price that you’re willing to pay for this property.
People give this a lot of thought, there’s a lot of psychology behind it where they try to figure out what to do and where to start but no reason to start anywhere other than list price. Some people have tricks they think work, like starting higher or starting lower – it doesn’t matter. What matters are price and terms.
The escalation factor is the amount that you want to put between you and the next bids. All that is great if it works the way it’s supposed to work. The problem is that the other offer, maybe they have something that is a lot more appealing about their offer.
Basically, what you want to know here though is if you have to craft something that is appealing. Now, for the factor, I don’t really recommend ever doing anything like a thousand because of the possibility that other offers might be more appealing than yours though your bid was higher than the others. You really want to make sure that your offer is far enough ahead of the other offer so there is potentially something about your terms that they don’t like or your closing date maybe they don’t like, you may be able to have them say “Well, for an extra x amount of dollars, I’m willing to deal with whatever this may be.”
Repeat after me: Price and Terms. You in back!
Should I put in an escalation? Yes – it’s silent. You won’t know what the other parties are bidding. You have absolutely no idea, they don’t know what you’re bidding, nobody sees everything except the seller’s agent and the seller. I personally think this is stupid. Let’s just all say what we will pay and be done with it. The reality is I almost feel like this might work out better for sellers because as soon as people know that there are other bids at a certain price, they may not necessarily say “I’m out”, they make keep going. The idea of bidding against the unknown, sometimes traps people and then they think, “I don’t know how far I have to go with this so I’m not gonna keep going.”
The seller and the seller agent know what you’re willing to bid. These escalations may work behind the scenes when they’re reviewing offers, and as someone once said, “don’t I get a second chance to take a bite at the apple?” no. Not always. No one owes you anything. Sometimes they come back and ask for a best and final, but they don’t go back to all parties. They tend to just test which offer is the best and what matches most of what they want.
Here’s what happens – Don’t have to show the other offer in a best and final / highest and best. Whatever they call it, you should see the big giant alligator with his jaws open waiting to catch you in his trap, because THIS IS A TRAP! So best and final, what they are hoping for is that everybody removes their escalation. I’ve even heard listing agent say that “my seller doesn’t want to do the escalation.” Of course, they don’t! because here’s how it works, the escalations all bid against each other and then they only get the final price that’s the incremental value beyond what the other person put in their offer. So, if the winning bid is I’m going to pay $10,000 over the highest bid of this point, they’re only getting that to $10,000 but what if the winning bid went up another a hundred and fifty thousand? The seller sees that, and they get greedy. That’s understandable. If you know that you’ve got a house that somebody’s willing to pay more for, you may want that money.
In this area that means they want you to remove your escalation. DON’T DO THIS! Bid the way it’s supposed to.
Here’s what the seller and their agent hope: you just remove the escalation and go straight to the cap, thinking well I was going to pay that anyway, so that’s fine. They assume you’ve emotionally gotten comfortable with the idea that it could go to the cap, so you’ll just remove it and go straight there.
Why don’t you want to do this?
- Because you don’t want to be the idiot that paid thirty, fifty or a hundred thousand more than all the other bidders had decided was the right price of the property, but;
- Once you remove an escalation, at least in the DC, Maryland, Virginia area, the other side is no longer obligated to show you the front page of the other contract or just close with that offer was, that was second in line.
And you could have bid way over and you just played right into their hands by removing the escalation.