Be careful with an escalation clause
Have you ever wanted to own the property next to yours? Maybe it would allow you to protect a beautiful view. Maybe it would allow you to bring your aging parent closer so you could provide more support. Maybe you just love that property and would rather have it as your primary residence instead of the one you currently inhabit. Whatever the reason, if you’ve ever thought to yourself, “I sure would like to own that property,” here are a few things you should know.
You can use an escalation clause when you make an offer on a property to let the sellers know you are willing to go to unusual lengths to acquire their property. When I first heard the term “escalation clause,” I thought it was referring
to the common practice among landlords increasing the cost of rent over time, either according to cost-of-living scales or according to some other predetermined schedule. But no, this escalation clause is different. Here’s how it works.
When you make an offer to purchase a property, you can tell the seller you are willing to pay more than the highest other bidder; for example, you’ll pay $1,000 more than the highest offer. To prevent paying way too much (like paying $1,000,000 for a property that’s only worth $250,000), you can put a cap on the total amount you’re willing to pay. On the face of it, this may seem like a great way to assure you get the property you want, but there are some significant risks to consider.
As a reminder, I am not a lawyer. If you choose to embark on an offer that includes an escalation clause, I highly recommend you consult with a skilled real estate lawyer to avoid inadvertently signing a binding agreement that puts you in an untenable position. A good lawyer can help you put safeguards in place.
So, what are the downsides to offering a little more than the other guy? Why the need for safeguards? Well, although you may be willing to pay a small premium, you probably don’t want to pay a large one. It’s important to be sure you are not being manipulated into paying too much. However, if you state a cap, you’ve shown your cards to the sellers, letting them know how high you’ll go. This is not considered a wise negotiation tactic.
One way to make sure you are not getting manipulated is to include language in the escalation clause that ensures you can review all other offers on a reasonable timetable—first, to make sure those offers actually exist, and second, to make sure they are legitimate (not just a friend or family member bidding up the price of the property so the seller can get top dollar from you). Unless there is some specific language written into other offers, the terms of these offers are not confidential. Be aware that there is nothing preventing others from including an escalation clause as part of their offer, and then the bidding never ends.
My advice is to avoid the risks associated with an escalation clause and simply make a purchase offer based on what you can afford and what the property is worth to you rather than trying to save a few bucks. It would be unfortunate to lose a property because someone else pays less than you would have but more than you offered.
Because escalation clauses can cause all sorts of grief, many Realtors strongly discourage their clients from using them. In the end, the client is in the driver’s seat. If you want an escalation clause, you can have one and your Realtor is obliged to present your offer according to your wishes. However, your Realtor can insist that you sign a written disclosure stating that you are acting against their recommendation.
If you have questions about property management or real estate, please contact me at rselzer@selzerrealty.com or call (707) 462-4000. If you have an idea for a future column, share it with me and if I use it, I’ll send you a $25 gift certificate to Schat’s Bakery. To see previous articles, visit www.selzerrealty.com and click on “How’s the Market.”
As a reminder, I am not a lawyer. If you choose to embark on an offer that includes an escalation clause, I highly recommend you consult with a skilled real estate lawyer to avoid inadvertently signing a binding agreement that puts you in an untenable position. A good lawyer can help you put safeguards in place.