The Cat is Out of the Bag: Escalation Clauses are Everywhere

The Cat is Out of the Bag: Escalation Clauses are Everywhere

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elvin the cat

This cat has not quite made his way out of the bag. But soon….

Consider this an open letter to listing agents and agencies who have the policy of “not accepting”, “working with” or “presenting” offers that include escalation clauses–there are surprisingly more than a few.

When I first began to realize that my predictions for this spring’s real estate market were coming to fruition, I wanted to find a tool that would provide an edge for my clients.  By mid-February, anytime something came to market with a remotely decent price-tag the offers would pile up at the doorstep.  I’d heard that in 2003 and 2004, a lot of folks were writing into their offer that they would pay $XX,XXX more than the next best offer.   I’d rather not get into the specific details of how my particular addendum is scripted, but it is not just a sentence on the offer page, but rather another full page addendum.  One of its stipulations is that, should the seller accept our clause, they need to provide the buyer with a copy of the other offer–feeling free to redact the other buyers name or any sensitive financial information.

I was hesitant to even discuss my use of the clause because I didn’t want to tip off the competition.  But as I said, everyone is doing it now and the cat is out of the bag.

I have obviously used it as a buyer agent, but I have also seen it on the seller side.   They come in all shapes and sizes.  Some are a little more elaborate, some are pretty bare-bones.  But they all have the same thing in common:  their spirit!

Ideally, the nature of the clause is to provide a win-win for both the seller and buyer.  Provided that no other buyer exceeds the escalation cap, the seller gets more than any other buyer can bring to the table.  The buyer, while paying more than anyone else, doesn’t have to pay MUCH more than anyone else.  I actually had a transaction this year where the clause saved the buyer $35,000.  They were prepared to simply offer higher, but we employed the escalation.  The other competing offers came just shy of our starting point and saved us from paying any more.

On a few occasions this year, I’ve had listing agents tell me that they don’t work with these types of clauses.  Until last week, all it took was a well-meaning and thorough explanation to convince the agent (and seller) that this clause represented a win-win for all parties.  Then I encountered an agent in the Somerville/Cambridge area who flat out told me, after the deadline for offers had passed, that they “don’t accept escalation clauses”.  While I asked, she offered no real explanation why.

For me, for my clients, this was unacceptable.  Essentially what they were saying was that they, the agent/brokerage, could dictate the terms of how they’d prefer the buyers write offers.

Here’s a blip from the Massachusetts law code on professional practice:

Professional Standards of Practice – violation of any of the provisions of 254 CMR 3.00 may result in the suspension, revocation or discipline of a license.

(11) Conflicts of Interests: A broker or salesperson must act honestly and ethically and in the best interests of their client at all times.

(a) A broker or salesperson shall not buy, sell, rent, mortgage, or acquire any interest in, or represent a client in the buying, selling, renting or exchange of real property in which the broker or salesperson or his/her kin has a personal financial interest unless the broker or salesperson shall fully disclose in writing to all parties to the transaction the nature of his/her interest and unless the parties shall provide the broker or salesperson with written acknowledgment of such disclosure.

(b) A broker shall not take an option, either directly or indirectly, upon real property for the lease or sale of which the broker has been approached by the owner to act as a broker without first disclosing that such broker is now a prospective purchaser or lessor and no longer acting as a broker for the owner.

(c) A broker or salesperson shall not accept a “net” listing from an owner or landlord for the sale or rental of real property in which the commission is unspecified.

(d) Conveying Offers. All offers submitted to brokers or salespeople to purchase or rent real property that they have a right to sell or rent shall be conveyed forthwith to the owner of such real property.

Section (d) states that a broker must convey all offers.  I could write an algebraic equation on a napkin, have my buyer sign it, staple it to a deposit check and the listing agent has to present it.  They DO NOT have to understand it.

Just to be clear, I called an investigator at the Division of Professional Licensure this morning and asked him.  What he said was that any agent or brokerage is violating the licensing laws by telling an agent they’ll refuse to present an offer.  They are not, however, breaking any laws if they advise their clients not to work with an offer of this nature.

It has been an interesting conundrum trying to figure out the best use of the escalation and when it doesn’t make sense.   I asked a few successful listing agents what they thought of the escalation clause.  I got some interesting responses.  One agent felt that by putting an upper limit,  in a way,  it exposes the buyers’ hand.  So if the upper limit was $500K, but the next best offer was $455K and the escalator called for $10K more, the winning buyer pays $465K.  But now the seller is thinking, “jeez, these guys would have paid as much as $500K”.  That can damper the rest of the transaction.  The buyer who is paying $465K but would have paid as much as $500K is now asking the seller to reduce the price another $4000 because the inspection revealed a bum sill or a cracked waste-line.  The seller is thinking “take a hike!  why don’t you pay me another $40K and I’ll discount for the waste-line.”

Another agent had a differing take:  She thought it while it’s not always easy to gauge the seller’s reaction, she thinks that a buyer is more likely to push the ‘cap’ to a higher limit than with just an ordinary offer.

I think that it only helps to temper the market.  There have been a few occasions this year where the winning bid has blown all the other offers out of the water, paying sometimes 5-10% more than the next best offer.  When this kind of ‘irrational exuberance’ takes hold, the market values mushroom uncontrollably and can have a detrimental effect on the overall market.  And while it doesn’t keep the crazy outliers from making their crazy bids, the escalation clause can temper the market somewhat.  The seller still gets more than anyone else and buyer doesn’t shoot him or herself in the foot by bidding against themselves in some cases.

All I know is that it’s worked very well for me on several occasions.  And if you’re a listing agent whose policy it is not to convey this, watch out; we won’t take no for an answer.

By: BJ Ray from The Boston Real Estate Blog

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