REAL ESTATE
Back-Up and Escalator Offers
As discussed in Chapter 7 of our publication When to Buy and When to Sell: Combining Easy Indicators, Charts, and Financial Astrology (available on Amazon), and several previous blogs, the purchase of a home may be one of the biggest decisions, and investments, to make in one’s lifetime. Over the last few years, it has never been more difficult for young buyers, with rising inflation, property prices, and property taxes/insurance, and the situation appears to be only getting worse, with an increasing number of defaults and loans coming due.
Most home owners, especially first-time buyers, are not in a financial position to purchase a property fully in cash. They require a mortgage to spread out payments over time, and must qualify to be accepted for a long-term loan anywhere from 15 to 30 years generally.
In highly competitive market conditions, especially when demand is much higher than supply (known as a “seller’s market), homes can be more difficult than usual to obtain. Multiple offers on any home that is worth purchasing, combined with over-bidding, inspection and/or appraisal waivers, and all cash buyers, can prevent a “normal” buyer from having their offer accepted.
This is where instruments known as “Back-Up” and “Escalator” offers are sometimes used to improve the chances of landing a property.
Back-Up offers are basically offers provided to the seller after they have already accepted an offer from another party. Many offers, usually presented in the form of a Purchase & Sales Agreement, are often filled with conditions and contingencies. It is not uncommon for an agreement to fall apart, if a property fails inspection, gets appraised lower than expected, or the buyer’s financing is not approved. In these instances, an official back-up offer will then be seriously considered by the seller.
Any back-up offer should be treated like the accepted offer, with the same conditions spelled out on a Purchase & Sales Agreement or similar document. Should the seller accept the back-up offer, it is then considered official, and is treated as a secondary contract to the primary offer. If the first contract fails, the secondary then moves up to the primary.
If the seller provides a counter-offer, and the prospective second buyer agrees, they will then need a release, unless they have also integrated an Escape Clause into the contract. Otherwise, the “back-up” is a contract that is legal and binding. A back-up offer can still be submitted without this obligation, giving the prospective buyer freedom to withdraw at any time, and/or place an offer on another property, so long as they do not accept the counter-offer. The downside is that there may be several “back-up” orders in play with no seller obligation to any of them.
On the seller side, it is allowable to respond to all additional offers to inform the prospective buyers that they are also being considered. The seller is then open to negotiate with multiple potential buyers. Sellers will commonly ask for the “highest and best” offer from all parties, to avoid any confusion during the process. A buyer may also consider putting a deadline on their “back-up” offer if they are not willing to wait for the process to play out.
An Escalator clause is a slightly different instrument, as it serves as a legally binding promise to purchase a property at a price above the highest bid. Specifically, the potential buyer will automatically increase their offer by a pre-set increment, if the seller receives a higher, bona fide offer, while also including a maximum price. These are commonly used in a “seller’s” market/multiple-offer environment.
If one chooses to present an escalator clause, there are a few details to consider…
1. Make sure to set the maximum price within the affordable loan parameters already documented in the lender’s pre-approval.
2. Consider setting a date deadline to prevent indefinite restriction from making offers on other properties.
3. Include an appraisal contingency to avoid a potential appraisal gap. Should the appraisal be valued at a lower price than the offer, the buyer would be required to make up the difference, most likely in cash.
Pros to this type of clause includes time saved in negotiation, keeping the offer competitive, and minimizing the risk of overpayment.
Cons include revealing the maximum amount the buyer is willing to pay, possible overpayment if the cap is set too lofty, and it can also trigger a gap in the appraisal.
If one chooses to present this type of clause, it may be wise to have it reviewed by an attorney in the property’s district, to avoid any misunderstandings. Remember, even most experienced brokers and sales agents are not attorneys.
Please visit the website www.augustassociatesllc.com for home values, listings, and professional assistance.
***As always, this information is not intended to be financial advice, or any specific buy or sell recommendation, but rather a guide to assist the reader in some further understanding of current economic conditions.
