What is an escalation clause and what are the risks?
- A buyer’s offer is automatically increased by increments to beat competing bids
- But it also indicates you are willing to go higher than your original offer
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Looking to buy a new apartment or brownstone? You may have heard about buyers using an escalation clause—or maybe you lost out to another buyer who did just that. Although not commonplace, it’s a strategy to ensure that you have the winning bid even when competing offers come in, especially in a competitive real estate market.
An escalation clause works by automatically increasing your offer by a certain amount (such as $5,000) each time another buyer makes a higher offer. It’s the real estate equivalent of bidding in an eBay auction and essentially eliminates the back and forth of offers and counter offers. So long as a higher offer doesn't exceed your maximum bid, this tool can potentially help get you the apartment you want.
It’s not foolproof—it also comes with specific risks for both parties. For buyers, you basically reveal your hand to a seller by indicating you are willing to go higher than your original offer. And if your top bid ends up exceeding the appraisal value, you might not be able to get financing at the higher price.
Sellers could wind up landing at a lower price than what might be generated by simply waiting for other offers or asking for a buyer’s best-and-final offer from the get-go.
There’s also the risk that a top offer might exceed the appraisal value, and you might not be able to get financing at the higher price. As a seller, you risk selling at a price lower than what might be generated by simply waiting for other offers or asking for a buyer’s best and final offer.
[An earlier version of this article was published in April 2021 and has been updated with new information for March 2023.]
Kobi Lahav, director of sales at Living New York, says he’s never used the strategy himself though he knew other brokers rely on it during the highly competitive NYC real estate market in 2015. At that point, buyers were constantly outbid and brokers got increasingly desperate to close on properties. He's also seen it used more recently, during the Covid sales boom in late 2021 to mid-2022 when inventory was low.
Ultimately, though, it’s not something Lahav would ever recommend. “It seems counterproductive to the idea of a meeting of the minds," he says.
How do escalation clauses work?
An escalation clause might come into play when the seller’s agent tells the buyer's agent about interest from several buyers. The buyer’s agent could then recommend that the buyer include an escalation clause with the initial offer.
If the seller is willing to accept the clause (by no means a given), the real estate contract will reflect that by stating that a prospective buyer has made a bid on a property but will pay a certain amount above each new bid, up to a capped amount.
Here's an example: Let's say you are a seller who has listed your apartment for $1 million and a prospective buyer makes an offer of $950,000, with an escalation clause that will raise that bid in increments of $5,000 over any other bids that come in above $950,000, up to a maximum of $1 million.
If someone else were to bid $980,000, the clause would automatically raise the first prospective buyer’s bid to $985,000. If no one else bids above that, the first bidder gets the apartment for $985,000. But if there's a bidding war and another buyer offers $1.1 million, the first bidder loses out.
Does your real estate lawyer get involved in the maneuver?
The answer is no. “It’s really a brokerage-side strategy,” says attorney Shaun Pappas, a partner at Starr Associates. He says he would advise a client on the process and risks, “but ultimately once the contract is signed, the price is fixed.”
That's because all the terms of a deal are non-binding until a contract is signed, meaning a buyer could potentially back out of the deal if they are not happy with the final offer.
"However, that would certainly not sit well with the seller and brokers involved, so I would not advise it. Real estate is still very much a word-and-handshake business and I would only entertain this strategy if both parties were willing to abide by the terms agreed upon," Pappas says.
What are the risks to buyers?
The biggest risk of an escalation clause for a buyer is that once you suggest this strategy, you’ve shown your hand and disclosed you’re willing to pay more than you’ve put on the table.
Knowing this, the seller’s broker can make counter offers to other buyers or even tell those buyers your top offer—and ask everyone to beat that number, which could up the price. In that scenario, you could lose out on the property because technically you gave up your negotiating power.
Then there's the problem of validating if additional offers are legit. “How do we know they don’t have an offer from a relative posing as a buyer?” Lahav asks.
You might try and specify the type of proof in the contract, such as requiring that other offers be in writing and include the names of the potential buyers and what they’re willing to pay. But again, not all sellers are going to be on board with this maneuver.
What are the risks to sellers?
It may not always be in your best interest to accept an escalation clause as a seller. In the example above, for instance, you potentially lost $15,000 that could have come by waiting for a better offer from someone else. Or by asking for a best-and-final offer from the initial prospective buyer, who (unbeknownst to the seller) was willing to pay up to $1 million for your place, and possibly more.
Therein lies the rub: The seller who accepts an offer with the escalation clause will never know the buyer's highest bid amount. Maybe that buyer would have gone up to $200,000 over the asking price.
And at least for some sellers, price isn’t everything. It might be more important for you to close quickly, in which case you should think twice about accepting an escalation clause and instead see what other types of offers are out there. You might find getting an all-cash deal with no contingencies at a lower price is more favorable to one with financing at a higher price.
What are alternative strategies?
Lahav points out there are plenty of other tools a buyer can use instead of employing a strategy as risky as an escalation clause.
For example, you could do an option to show your commitment by paying $10,000, and if you exercise the option it goes towards the deposit.
Or you can stick with a tried-and-true approach: Lahav says some seller-brokers have asked that he use the clause on the buy side, but he prefers to do a best-and-final offer—"otherwise, it’s a slippery slope." And he had some buyer-brokers offer the clause when he was on the listing side, "however in those cases I recommended that they just come with a best-and-final instead of that ping-pong of bidding everyone higher."
And if you really, really want the apartment? "Sometimes you have to overbid,” he says.
Earlier versions of this article contained reporting and writing by Donna M. Airoldi.
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