A home-bidding tactic known as the escalation clause is currently ubiquitous in Denver's red-hot housing market. But while the clause may give folks a better chance to land the home of their dreams, a local broker says buyers can wind up financially over their heads if they don't use it very carefully.
"I've represented sellers where we've received uncapped escalation clauses, and I find that to be a little bit careless," says Re/Max agent Shonna Howell. "Yes, it's aggressive, but we need to do our job as agents in protecting our clients."
Meaning protecting them from themselves.
Howell's escalation-clause views came up during our conversation about two of her clients — desperate house hunters who sent a letter to 1,200 Park Hill owners whose homes weren't for sale in the hope of finding a property where they can start a family.
In the current market, Howell notes, "the mentality of every single buyer out there is, 'We have to at least pay list price' even if they initially go into a house and it feels overpriced" — and in those scenarios, wannabe buyers frequently bid thousands, or tens of thousands, above list in an effort to beat out fierce competition fueled by shortages in first-rate properties.
"Obviously, inventory's very, very low," Howell confirms.
With so many multiple-bid situations taking place at present, more and more agents are using escalation clauses, which Howell describes like so: "Say a house's asking price is $650,000. Rather than shooting yourself in the foot by taking a shot-in-the-dark guess — like, 'I think the top offer is going to be $670,000' — you can write an escalation clause that starts at the asking price and escalates up to any amount."
For instance, Howell continues, "you can say you'll pay $1,000 over the highest offer, or $1,500 over the highest offer, up to any amount you want. In this case, let's say $675,000."
The top price is known as the "cap" in real estate jargon, and Howell says that "usually, in any multiple-offer scenario" in the Denver area right now, "there's a capped escalation clause unless the agent representing the seller specifies, 'Just bring your highest and best offer. No escalation clauses.'"
These days, escalation-clause bans aren't commonplace — and with so many potential home buyers feeling frustrated after spending months looking for a home with no luck, the number of folks willing to push the clause's limits (and that of their budget) has risen.
Hence the increasing use of an uncapped escalation clause. In this scenario, the bidder promises to pay a certain amount over the top bid without any end point whatsoever — and this lack of a ceiling makes Howell nervous.
"I truthfully care about my clients' well-being, and I look at a home as an investment for them," she points out. "So I hate that I can't say what the future will hold for them. I wish I could say, 'Oh, yes, it's totally going to be fine.' But the Denver market has natural highs and lows, and if there's another dip, I want them to be in a position to ride out that wave. That way, they can wait to sell until property values rise again, so they won't be upside-down" and be forced to accept an offer for a lot less than they paid in the first place.
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Howell understands the risks involved in uncapped escalation clauses, in part because of her experiences during the early days of her real estate career.
"I started in 2008 as an assistant, and that was a terribly slow market," she recalls. "That's when we were seeing all the short sales and home-buyer tax credits to try and encourage people to buy. Now we get calls from people who say, 'I'd really like to find a short sale or a foreclosure,' and we have to tell them, 'Those don't really exist right now.' There are still some foreclosures, but banks aren't offering any bargains. They know what the market's like — so those don't really offer any more of a spectacular deal than any other individual sale."
Working as a broker in such a go-go environment is "stressful," Howell admits, "just in terms of making sure you're doing the best for your clients and not putting them at risk from the unknown."
And she feels that playing fast and loose with an uncapped escalation clause can do just that.