If you’re in the market to buy or sell a home there are two important terms or clauses you should know about and understand. These clauses are the Escalation Clause and the Appraisal Clause. Both clauses are typically added on to the offer to make it more appealing to the seller and to hopefully get the offer accepted. Let’s discuss the Escalation clause first.
I like to call this clause the eBay clause. That’s because it’s really similar to putting in an offer price and then adding on a “maximum” bid like on eBay. So, you offer the price you want to, then the escalation clause says that up to a certain price ceiling, you are willing to go X dollars over any other offer that is submitted at the same time as your offer. I think an example will help: You may offer $500,000 for a property and be willing to offer $5,000 over any competing offer up to $550,000. If another offer comes in at $530,000, your escalation clause will make your offer $535,000. Just a little side note, in a highly competitive market, i.e., strong sellers’ market where one can presume a multiple offer situation, the buyers may experience the request from the seller to submit best offers and exclude any escalation clauses. This keeps things cleaner and simpler for the seller who is trying to analyze the competing offers. That’s fine, because another thing buyers can do is add in an appraisal clause…
In a real estate market where prices are going up quickly, appraisal clauses can be useful to getting an offer accepted. This is because, by design, residential real estate appraisals are based on historical closed transactions. As such, there is greater risk that an appraisal will come out below the contract price in an upward moving market. This risk is theoretically mitigated when an appraisal clause is in place. In an appraisal clause, the buyer represents that in the case the appraisal comes out below the contract price, the buyer will add additional cash to the down payment to satisfy the difference, which would allow the loan to be approved and funded. So that’s a great segue to my next comment, “Cash is King!” If you have a cash offer, there is no risk of the appraisal coming out short, because there is no appraisal (unless buyer is requesting one, but then that also weakens the cash offer). If it is a leveraged transaction, an appraisal clause can strengthen an offer, if the buyer can financial do this, to reduce risk of the transaction falling through.
Keep this in mind: The buyer and seller both have different goals. So, the buyer and buyer’s agent are drafting the offer with these clauses to get their offer accepted, that’s their first task. Once that’s complete then they can move forward to do all their due diligence. But the buyers have contingencies or protections in case they don’t like something about the home. The sellers and their agent are trying to get to the finish line of closing the property. Keeping this in mind, each side are looking for different things and these clauses serve different purposes for each side of the transaction. Another way to put it is the buyer is using these clauses to make their offer look better. The seller is using these clauses to provide more assurance that they can successfully close. At the end of the day, the seller is best selecting the buyer who is truly sincere about their offer and really wants to close on the property versus getting the offer accepted and then, “we shall see.” There is no way the seller can be sure of the buyer’s intensions but there are things the seller or seller’s realtor can do to try to minimize the risk of the transaction falling out.
Ok so there you have it, escalation and appraisal clauses and how they work. In the words of the American Author, Rick Riordan, “You can’t control every contingency. You accept that. Let it scare you. Trust that it’ll be okay anyway.”
