Using An Escalation Clause
What you need to know before using an escalation clause
As the housing market continues to sizzle, buyers often feel tempted to offer more for a property, or remove conditions that are intended to protect them. One tool buyers are considering is an ‘escalation clause’.
Escalation clauses, also known as ‘escalator clauses’, are designed to edge out competing offers by automatically raising the offer price by a pre-set amount when a higher bid comes into play. There are numerous variations of this type of clause. Some identify a maximum price, others may not. It can become particularly cumbersome if more than one offer contains a form of this clause. Escalation clauses are certainly on RECO’s radar, and we’ve been receiving a number of questions from registrants about how to deal with them.
An escalation clause may seem like an effective way to get a leg up on the competition. Although there are no specific regulations related to escalation clauses, there are general rules and regulations which still apply.
RECO will review and investigate complaints related to escalation clauses and, if warranted, will take appropriate action.
How it works
Let’s say for example you have two buyers: Stan and Fred. Stan’s initial bid is $550,000, while Fred’s offer is $600,000.
However, Stan’s offer also includes an escalation clause, which will increase Stan’s offer by increments of $2,000 over any competing offer that comes in. Stan’s bid rises to $602,000. Stan’s representative also included a cap, which means when a competing bid reaches a certain number – in this case $700,000, the escalation clause won’t increase the offer price any higher. So if a third buyer named Richard put in an offer of $750,000, Stan’s offer would stand at $700,000. It’s then up to the seller to decide which offer to pick.
That’s a simple example, but if two buyers who have both included escalation clauses in their offers, there could be additional issues.
Imagine that both Stan and Fred included escalation clauses in their offer, with $2,000 increments. If Stan has a cap of $700,000 and Fred’s cap is higher, then there’s no problem—Stan’s offer would stand at $700,000 while Fred’s would escalate to $702,000.
But what if they both have the same cap, or both have no cap at all? In this case the seller’s representative may ask both Stan and Fred to remove the escalation clause and submit a final, best offer.
Protecting your buyer
The rules and regulations that govern your conduct apply when you recommend an escalation clause or submit one as part of an offer.
You have a duty to look out for your clients’ best interests, and to provide conscientious and competent service, while demonstrating reasonable knowledge, skill and judgment. Before submitting an offer with an escalation clause, the buyer must fully understand the implications and provide informed consent. There are a number of questions you should ask before you proceed.
For example, are you confident that the home will receive multiple offers? Does the buyer have flexibility in their budget to allow for a higher purchase price? Be sure your client understands that when this clause is in effect, they could be locked into a bidding war until their maximum bid has been reached.
Here are some other key tips when dealing with escalation clauses:
- You must take all practical steps to verify your client’s approved borrowing limit. Ideally they would be able to provide a commitment or pre-approval letter from a financial institution. Make sure your client understands that the lender may require an appraisal after the offer is finalized. There is no guarantee that financing for the purchase price will be approved.
- A cap or provision for stopping the escalation is required to protect the buyer’s interest.
- A seller may choose not to accept an offer that includes an escalation clause.
- The seller may not always choose the highest offer.
Escalation clauses can cause added stress to a buyer during a bidding war, especially if they don’t fully understand how it works. Communicate with your client to make sure they know what to expect, and always remember that your first duty is to the client’s interest.
Courtesy of RECO - For the Record
About the RECO
The Real Estate Council of Ontario (RECO) is responsible for regulating real estate professionals in the province on behalf of the Ontario government. We protect the public interest through a fair, safe and informed marketplace.
Since its establishment in 1997, RECO has been committed to enhancing professionalism and increasing consumer confidence in the real estate industry. Learn more at: RECO.ON.CA
About Royal LePage Vision
Founded in 2003, Royal LePage Vision, in Toronto, is a multiple award-winning brokerage with a strong contingent of high-performing agents. Our strength over the past 13 years is rooted in technology and how innovation translates to exceptional service.
From top to bottom our brokerage is built on making it easier for our Realtors to succeed in real estate while staying consistently connected to the office. With a strong emphasis on training, for both our support staff & Realtors, each one of our Realtors has the support and tools to be effective in their market.
If you would like to learn more about the difference VISION makes, please give us a call at 416-321-2228 or visit moveuptoroyallepage.com.