Escalator Clauses – Things You Need to Know
The trend of adding “escalating” clauses to offers continues and it is important to take a step back before immediately helping a buyer write up an offer that says “$1000 more than any competing offer …” Escalation clauses are not illegal in Missouri or Kansas, but I saw this a few weeks ago where two buyers used these clauses on the same property which resulted in a problem because in theory each offer would just trump the other all the way to infinity (if there was no cap) … So, they were right back to where the parties originally started. In addition, I think any buyer that would use an escalation clause, would need to strongly consider a cap so that it would not be used to go above what they were truly willing to pay.
In addition, from a pure negotiation standpoint, when you put in an escalation clause with or without a cap – you are telling the seller you’ll pay more. So a seller, even if there was not a competing offer, could reject and just counter at your cap or somewhere above your offer knowing you were willing to go up more. Think about it, if I offer $250,000 but then use an escalator clause of $1,000 and capped at $260,000 – how do you think the seller is going to respond? $250,000, $251,000 or $260,000 + ….? The risk is that a seller doesn’t have to honor your original offering price or the escalator clause itself, they can always just reject it outright, even without multiple offers and counter more because they now know what the buyer is really willing to pay. Another trap is that agents sometimes fall into competing just on offering price and not the actual net to the seller. Two offers of $200,000 could be very different if one is asking for a lot of seller concessions or seller pre-paids, so an escalation clause should be based on the ultimate net to the seller, not just the purchase price on the contract. Otherwise, the buyer could have their escalation clause kick-in and to go to 201,000 but they were already the better offer based on seller net. Also, appraisals haven’t always caught up to the heat of the market, so no matter what the price of the contract was with an escalation clause, property still has to appraise for this increased amount. Bottom line, there are a lot of things to consider and think about before you just slap an escalator clause into a contract – even in a seller’s market.
