Escalation Mania?

Escalation is back. Sellers are delighted to get offers sometimes thousands of dollars higher than their initial listing price. And buyers are often frustrated when they lose out on their dream house to a higher bidder.

How does escalation work? Let’s take this example. Sellers list their three bedroom house for $450,000. Their real estate agent has done her homework and believes it is a fair price. There is an open house on Sunday, and 20 people show up. Two couples express an interest and each submit an offer. In the Washington metropolitan area, it is customary for a buyer to submit an offer, and the seller has three options: accept the offer, reject the offer or counter the offer with different terms.

Since each of the potential buyers are represented by either a different real estate broker or an attorney, they should have access to a form dealing with escalation.

The first potential buyers offer $450,000, with a contingency for obtaining an 80 percent loan, but adds in the escalation form that they are prepared to increase their offer by $1000 over any other offer, but in no event shall the offer exceed $460,000. The specific language in the form states: “in the event the Seller receives one or more additional bona fide offers to purchase the Property with terms acceptable to Seller…” which results in the net proceeds greater than Seller would get under the present offer, “then the sales price stated in this Offer shall automatically increase to an amount which generates net proceeds of sale to Seller equal to $_______ (the “Escalating Factor”) in excess of the highest net proceeds of sale generated in such Other Offers.”

What happens if the Seller accepts the higher price? The form provides three options for the seller. First, the 80 percent loan will remain the same, but the buyer will pay the increase in cash at settlement; second, the loan will automatically increase to be 80 percent of the new sales price, or third, the loan will increase by a smaller amount and the buyers will pay the difference in cash.

The form also requires the Seller to provide the Buyer with a copy of sufficient documentation to justify the Sales price increase. What exactly does this mean? Does the Seller – through his real estate broker – have to give the escalating buyer a copy of any sales contract offers showing that the price has already been escalated? Is this a potential invasion of privacy of the other potential buyer?

Buyers should be very wary of escalation clauses. They are asked to sign a legalistic document typically late on a Sunday evening, after they have spent the afternoon viewing numerous houses. No lawyer has reviewed any of the legal documents.

Here are some suggestions buyers should consider when confronted with any real estate transaction – especially one which involves a possible escalation.

  • Make sure you have proof that there is, in fact, another contract offer higher than yours. While rare, I have heard of unscrupulous sellers falsely claiming higher prices with out producing “sufficient documentation”.
  • Make sure you will qualify for a higher loan if you have to escalate your offer. It is a good idea to get a preliminary assessment from a mortgage lender, before you even start your house hunting, so that you will know the range of your potential purchase. But, for example, if your lender tells you that you can qualify to buy a $500,000 property, don’t let anyone know about that until after you sign a contract. I have seen too many over-anxious buyers tell the potential seller (or seller’s agent), I can qualify to buy a house up to $500,000. Clearly, with the information, the seller will want to push the buyer up to that dollar mark.
  • Make sure you have a contingency giving you the right to back out of the contract if the lender’s appraisal is lower than your contract offer. Currently, appraisals are coming in quite low and lenders are reluctant to challenge any erroneous valuations.
  • You must have a contingency for a home inspection. Brokers may tell you that the seller will not accept such a contingency. If that’s the case, walk away. I know of too many buyers who did not have the home inspected, only to discover thousands of dollars of needed repairs after they went to settlement. A home inspection contingency benefits the seller, also. Should a buyer complain about a problem after settlement, the seller usually says. “You had an inspection, and could have walked away from the contract. If you have a problem, sue your inspector.”
  • You must have a contingency for obtaining financing. While mortgage rates remain historically low, lenders have become very cautious and are requiring credit standings (FICO scores) to be much higher than in the past in order to commit to a loan.We lawyers are taught in law school that “real estate is unique.” That may be true in a court of law, but in the real world, if you can’t buy that escalated home, you will soon find another one that you may even like better. When you buy a car, you usually have a three-day cooling off period. Unless you include the contingencies recommended above, once you have a signed real estate contract, it is difficult – if not impossible – to cancel.Don’t get caught up in the frenzy of the escalation process.

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