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Home-Buying Tips on Escalation Clauses

Q. We put written offers on two homes after starting our search this summer. Each offer contained an escalation clause, and in both cases we discovered that the homes we bid on sold beneath the top price we were willing to pay, one by $20,000! At best, we feel like there was some sort of insider trading going on, and at worst that our offer wasn’t even shown to the seller. What are we missing?

A. Without knowing the details of your process, the first rule of the escalation clause comes to mind: you are only as good as your increment, but for anyone who may not be familiar with it, let me briefly explain what an escalation clause is and how it works.

An escalation clause allows you to start with an initial offering price and specify how much you are willing to pay above the next best offer. For example, you may start with an offer at a list price of $850,000, but specify that in the event of competing offers, you are willing to go up in increments of $5,000 above the next best offer, to the maximum you are willing to pay. In this case, based strictly on price, if you are highest, and the next best offer is $914,000, then the escalation clause would be triggered, and your offer would escalate to $919,000.

The process of using an escalation clause is similar to bidding on eBay, though I’ve yet to see a real estate closing that involved PayPal, and have rarely seen a competing bid accepted solely on price.

I believe strongly that the other terms of your offer, the four or five components that every seller should pay attention to in an offer, should not be overlooked or taken for granted. I routinely see sellers, advised honestly by their agents, accept a lower bid than what’s on the table, because of other terms that indicate how likely cash will be waiting on settlement day.

$20,000 is a big difference between a low winning and high losing bid for a seller to swallow, but I’ve seen bids accepted for as much as $35,000 lower than another based on terms.

If you think about it, results like these fly in the face of back room shenanigans, since those are most often money-driven. Most escalation clauses call for the seller to provide evidence of the price, the terms of the bid that triggered the clause and how it pushed the winning bid to its max. This should happen quickly in most clear-cut cases.

As for your offer potentially having been hidden from the owner, I’d say that while the bidding process in a seller’s market is rife with opportunities for people to act like people sometimes act, it’s important to understand what a listing agent stands to lose if caught acting unethically. I’ve met very few long-time, successful agents who are willing to risk that.

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