Here’s the little secret to winning a bidding war that could totally backfire

Going up?

In a hot real estate market, buyers will often put in offers with an escalation clause – something akin to an auto bid in the event a bidding war breaks out. But there are drawbacks for those on both sides of the negotiating table, according to the Wall Street Journal.

An escalation clause is an addendum to a contract that automatically raises a buyer’s offer by predetermined increments up to a maximum amount.

But they come with risks. Namely, if a buyer says they’re willing to increase their bid up to a maximum amount, they’re tipping their hand to the seller as to how much they’re actually willing to pay.

“A buyer can think of an escalation clause as a ‘have your cake and eat it, too’ clause,” said David Reiss, a professor at Brooklyn Law School who specializes in real estate. “But in real estate, as with cake, it is hard to have it all.”

The seller can make a counter offer at the buyer’s maximum escalation clause price, but there are drawbacks for the seller too.

Say an owner lists a house for $1 million, and a buyer puts in an offer of $950,000 with an escalation clause that rises in increments of $5,000 to a maximum of $1 million. A second buyer comes along with an offer of $980,000, the escalation clause kicks in and the first buyer wins the property at $985,000.

If the seller hadn’t agreed to the escalation clause and simply asked for the best and highest offer, it’s possible the first buyer would have made their maximum bid of $1 million. The seller potentially left $15,000 on the table.

But while these kinds of clauses become more common in hot markets, they’re seen less often in high-end real estate, where the increments would have to be substantially higher. [WSJ] – Rich Bockmann