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6 Ways to Use Escalation Clauses in Hot Real Estate Markets

Angie Shipe July 12, 2013 0

360training Q3 blog 2If you’re buying a home in a competitive market, you need an edge.

Buyers these days have to leverage all the tools at their disposal to compete in sellers’ markets. Inventories are down by about 16 percent from last year. Prices are rising. New listings in hot markets such as San Francisco, Seattle, Phoenix and parts of Florida are seeing dozens of bidders.

In multiple-offer deals, escalation clauses let a bidder match competing bids up to a specified maximum dollar amount. It’s a lot like an auction, and whoever has the highest bid usually wins. If a buyer can pony up the extra cash if the purchase price ends up higher than the appraisal, he or she will be better positioned to get the house.

How does it work? Suppose interested buyers put a $300,000 bid on a home. They could have an escalation clause that says they will beat all other offers by $500 up to $310,000. Suppose another bidder puts in a bid of $305,000 and no other bids are made. The seller can then accept a $305,500 from the first bidders.

Escalation clauses can save buyers money. They work because buyers usually don’t know what other bids are being made. Instead of putting in a bid that is too far over the list price, an escalation clause improves your chances of having the highest bid without committing to a huge overpayment.

If you are a buyer considering an escalation clause, make sure do the following before and after the sale:

  1. Make sure you have the financing available to make an escalated offer. Your mortgage lender needs to know your strategy if you’re planning to use escalation. He or she will tell you what loan you qualify to take.
  2. Do not tell the seller or the seller’s agent how much you’re qualified to borrow. If they know you’ll match a much higher bid (and that you’re qualified to borrow that much), they’ll pull out all the stops to find a competing bidder.
  3. Make sure your escalation increments are high enough to give you an edge. Price isn’t the only factor sellers are looking at. If the other components of your contract are weak, outbidding someone else by $500 won’t guarantee the seller will choose you. Increments of at least $1,000 could make your bid more attractive.
  4. When setting your bid limit, don’t get auction fever. Decide on the price you are comfortable paying and stick with it.
  5. If your escalation clause is activated, ask the seller for a copy of the competing bidder’s sales contract to prove they actually have a higher counteroffer.
  6. Make sure you have an appraisal contingency in place. If the appraisal comes in low you may be able to use it to negotiate a lower price or even walk away.

If you’re not in a competitive market or if you aren’t comfortable handling a home purchase like an eBay auction, escalation clauses may not be right for you. Most analysts say nationwide inventory will expand in the years to come, that mortgage rates will rise and that investor interest in real estate will wane. When the buying frenzy in hot markets inevitably cools down, concrete offers without the escalating counter-bids will be more likely to win the buyer the home of his or her dreams.

If you’re an agent in one of these competitive markets, you can learn about your state’s real estate regulations regarding escalation clauses by getting your real estate continuing education classes.

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