Desperate times call for desperate measures. Nobody embodies that statement in Toronto right now more than home buyers. There’s seemingly not a week that goes by where my colleagues and I don’t hear a crazy story about a buyer going to ridiculous lengths to try and win a bidding war. In some cases, it’s obvious what the buyers are trying to accomplish even if it might not appear to be on the up and up, but some illicit strategies can fly under the radar in the guise of something legitimate. It’s the latter category that this new tactic falls under and it’s referred to as an escalation clause.
Technically, the escalation clause isn’t a ‘new’ clause. It’s something that’s been employed quite often in the American real estate market as well as in other business and contract negotiations. But it’s only been recently where isolated stories have been revealed (I’m part of a few large networks on social media with fellow Realtors) about Toronto sellers and their agents being confronted with offers containing this clause.
Let’s assume Miss L. Seller is selling her home and listed it at 1 million dollars. She and her agent have priced it in hopes of receiving multiple offers. John Q. Buyer is the first to submit an offer at 1.1 million with an escalation clause which might read as follows:
“In the event the seller receives more than one registered offer, the buyer agrees to pay $10,000 more than the top bid, with a cap amount for 1.5 million dollars. In the event there are no competing offers, this clause shall be null and void.”
So, in John and his agent’s minds there’s only one of three scenarios which can occur. The first is that John Q. Buyer is the only offer at the table. In this case the escalation clause becomes null and void and the original offer price of 1.1 million stands. This is the perfect situation for John but one he knows is highly unlikely to happen.
The second scenario is where the highest of the competing offers does not exceed John Q. Buyer’s cap amount of 1.5 million. For example, let’s say there were 7 offers including John’s and that the highest offered price was 1.4 million. John’s escalation clause now comes into effect as he anticipated. His offer will now go $10,000 higher than the current highest bid to bring it to a purchase price of 1,410,000. John is quite pleased because he secured the home and feels like he only paid a fraction more than what other buyers were willing to pay.
The final situation occurs when there are multiple offers and the highest competing bid to John’s is any amount over $1,490,000. If this occurs, John’s escalation clause becomes moot because his $10,000 escalation would exceed his 1,500,000 cap amount. John can’t believe it. He loved the home but even he has his limits. He’s glad he made the decision beforehand and didn’t allow his emotions to enter into the equation.
As you can see from the examples, there are certainly benefits to using this tactic no matter what the other buyers do. So that begs the question, why haven’t we seen this employed more in the Toronto real estate market? The answer is just one minor detail…it contravenes the rules which govern Realtors in Ontario.
John Q. Buyer and Miss Led Seller didn’t realize there was a final and more troubling scenario. It’s the same as the second scenario except this time a formal complaint is lodged by the buyer and agent who finished in second place, Anita Lawyer & Ang Rhee Agent. They caught wind that an escalation clause was employed and thus the private details of their offer were disclosed to a competitor, a major violation of our governing rules. Now all three parties’ lawyers are involved and who knows how that cookie will crumble. It won’t be cheap though!
Aside from being obligated to be fair and honest to all parties in respect to real estate transactions, in Ontario, sellers and their agents can’t disclose private detailed information of competing offers. In this case, the seller and her agent gave John a distinct advantage over the other buyers by disclosing information about the offering price of the top competing bid, Anita Lawyer’s offer.
With escalation clauses you’re also tipping your hand. In this case, assuming legality wasn’t an issue, the seller knows that John is willing to pay $1,500,000. So even if the sellers only get the one offer there’s nothing stopping them from countering for $1,500,000. If you’re John, you’re now likely going to have to pay more for the home than you would have if you submitted your offer for a lower price without the escalation clause.
Everybody is always looking for an edge and who can blame them in this market. However, you need to make sure your actions are at the very least above board, or your actions don’t break any rules otherwise you might find yourself with a huge headache and no home to show for it. If your agent suggests an escalation clause, tell them you know better.