This one is for all the naïve buyers and sellers out there who think an escalation clause is a good idea. We’re not trying to shame you or say you’re wrong, but let’s just tell it like it is. It’s wrong for most residential contracts. That’s right, I said it.
An Escalation Clause is wording in a contract that states the potential buyer is willing to go above a certain amount. For example, a buyer may agree to pay $1,000 more than the next highest offer received by a seller.
An escalation clause is basically designed to strengthen a buyer’s offer in a multiple offer situation. In theory, it is fairly simple. The buyer offers a certain price for the property, but if the seller receives another offer that is higher, this buyer is willing to increase their offer up to a point. Escalation clauses are a tactic used by some buyers to make their offer more appealing and ensure the seller will choose their offer.
It might sound like a good idea for a buyer trying to win in a bidding war and an even better idea for the seller looking for the highest sales price. Sellers welcome buyers willing to pay more than anyone else. So why does the Texas Association of Realtors strongly discourage the use of escalation clauses? Why are they frowned upon by so many real estate industry leaders?
Let’s dive deeper. I’ll get my swimsuit.
So much can go wrong with an escalation clause in a real estate contract and inherent problems frequently surface when buyers and sellers use them. Some examples of the problems with escalation clauses are:
- An escalation clause is akin to a buyer opening their wallet and saying ‘Help yourself’. Most buyers want a cap on the escalation offer to keep from paying more than they are willing for the property. Often the buyer will state they are willing to pay X dollars more than the next highest offer not to exceed $Y. In that case, why wouldn’t the seller just counter the offer at that capped price? It would take the guess work out of the equation. In my experience, the seller sees the capped offer price and that is what they now want to get. The seller’s expectations become established once the buyer has disclosed how much they are willing to pay for the property.
- Contracts are confidential to the parties named in the contract. If another offer is received, the terms of that offer may not be disclosed without written consent from buyer and seller. Realtors are allowed to disclose when there are multiple offers, but not allowed to reveal the amounts to other parties. It is unethical for a seller or their agent to reveal the terms of a contract without permission from that buyer. Which brings us to the next issue. How does the buyer know what they are truly competing against?
- Proof of another offer becomes tricky. The buyer with an escalation clause offer doesn’t really know if the next highest offer is legitimate. Are they really competing against another bona fide offer and not just a phony offer solicited by the seller to raise the price for their property? It could be impossible for the buyer to verify that another offer is sincere or genuine and not just a friend or relative of the seller. The buyer basically has no assurances and is stuck outbidding something they can’t confirm.
- The seller’s agent has a duty to get the best deal for the seller. If multiple offers are received on a property, they may ask all interested buyers to resubmit their highest and best offer. If one or more offers includes an escalation clause, at what point do you have a specific dollar amount offer that represents the highest sales price that could be obtained? Hopefully the parties include a deadline for determining the sales price.
- An exact sales price must be agreed upon at some point. When buyer and seller accept a contract with an escalation clause, the sales price could be $1,000, $10,000, $100,000 or more over the buyer’s original offer. Both buyer and seller become locked in to the contract when it is executed. The sales price and terms should be clear so both buyer and seller can rely on it.
- Sellers should realize that until the contract is finalized and executed, a buyer’s offer with an escalation clause is really just the buyer requesting a free right-of-first refusal. This is why most savvy home sellers will not accept an offer with an escalation clause and will only consider an offer with an exact dollar amount and clear terms.
Some folks start feeling regret from a bidding war before the ink is dry. If the buyer has an option period, they may use that to terminate the contract if they feel stuck with a higher purchase price than they had planned. Then the seller is back to square one with hopes of fielding other offers. Home sellers are wise to remember that the best offer is not always based on purchase price alone.
The opinions expressed are of the individual author for informational purposes only and not for the purpose of providing legal advice. Contact an attorney for any particular issue.
Lydia Blair (formerly Lydia Player) was a successful Realtor for 10 years before jumping to the title side of the business in 2015. Prior to selling real estate, she bought, remodeled and sold homes (before house flipping was an expression). She’s been through the real estate closing process countless times as either a buyer, a seller, a Realtor, and an Escrow Officer. As an Escrow Officer for Allegiance Title at Preston Center, she likes solving problems and cutting through red tape. The most fun part of her job is handing people keys or a check.