Survival Tips for Bidding Wars
Q: We are trying to buy a house or building lot in a very hot seller’s market where desirable properties sell fast and bidding wars are common. Prices often go way above the asking price. Any strategies you can suggest to help avoid a bidding war? Our real estate agent suggested we add an “escalation clause” to our offer. Is that a good idea? — B.G.
A: It’s no fun being a buyer in a seller’s market. You can avoid a bidding war by refusing to raise your bid but, of course, you may lose out on the property. Your best bet is to get your bid in very early in the process, even before the house is publicly listed if possible. If an open house is scheduled, make sure you get in 2-3 days ahead of time.
If you like the house, make a strong offer right away and put a 24-hour deadline on your offer. Make the offer close enough to the asking price that the seller is motivated to accept it or at least make a counteroffer. Or offer a little above the asking price if you think the house or lot is worth it. The sooner you act, the better your chance of avoiding competing bids or a bidding war.
For example, you might hear about a house coming on the market from friends or acquaintances. Contact the seller directly to see if they will let you view the property. By getting your bid in ahead of the others, you reduce the chance of there being multiple offers, the condition that can generate price wars.
If you make a strong offer with a good price and few contingencies, it may be accepted by the seller, who may be happy to avoid the hassle of preparing the home to sell, and showing the home to hordes of tire kickers. They may also need a quick sale to finance the home they are buying. You may also get your offer in before the house is listed with a broker, potentially saving the seller 5% or 6% of the sales price. In short, a quick and painless sale at a good price with favorable terms can be very appealing to the seller.
Some agents like these; some don’t. Some states, such as Texas, prohibit real estate agents from drafting this type of clause as it is considered legal work. Escalation clauses seem simple at first, but can get complex in practice, especially if there are a lot bids.
That said, escalation clauses are becoming increasingly common in very hot real estate markets where buyers are often competing against multiple bids and many properties sell for prices above the asking price. After getting outbid on a couple of properties where you thought you made a strong offer can be a frustrating experience for buyers.
Along comes the escalation clause to the rescue! This states that the buyer is willing to raise his bid in increments (say $1,000 or $5,000) above the highest offer up to a cap. The clause typically states that the higher offer must be a bona fide written bid and that the buyer has the right to see a copy of the bid. The escalation clause may contain contingencies for mortgage approval, home inspection, and other conditions.
How this plays out. Let’s say there are two bidders on a house with an asking price of $400,000. Bidder A bids $395,000. Bidder B bids $390,000 with an escalation clause that specifies $2,000 increments up to a total of $10,000).
The seller now has the option, but no legal obligation, to contact Bidder B (or their broker), send them a copy of the bid for $395,000, and accept the revised bid $397,000. However, the seller may not formally accept the bid for $397,000 as you imagined.
At that point, the seller’s broker, with the consent of the seller, is free to reveal the $397,000 offer to Bidder A to see if they wish to raise their bid to $400,000. Or the seller can counteroffer to Bidder B at $400,000. After all, that was the asking price and the seller now knows that Bidder B is willing to go as high as $400,000. By tipping their cards, the buyer has lost a lot of their negotiating power.
Most of this action takes place between the buyer’s and seller’s brokers, leaving the buyers largely in the dark. The bidding war you were trying to avoid just plays out a little differently.
If there are more than two bidders, and more than one has an escalation clause, it gets more complicated pretty quickly. If the not all the parties involved are up to speed on the escalation-clause concept, it can get sloppy and buyers may end up feeling manipulated or cheated.
A preferable process, from the buyer’s perspective is for the seller (or seller’s broker) to have only one round of counteroffers. The buyers inform the leading bidders that there are multiple bids and ask each to submit his “best and final” or “best and highest” bid. The seller may choose to disclose the current high bid to the other buyers, or not.
To make a strong but reasonable bid, you must have done your homework and know what a property is worth in the current market. In a market that is rising fast, this is challenging for all parties. The best education you can get is to look at a lot of houses (or building lots), and see how fast they sell, and at what price. Using “comps” or comparable properties that sold in the same neighborhood in the past few months is the main way that lenders, real estate agents, and appraisers determine a property’s value.
Pro & Cons of Escalation Clauses
For buyers, an escalation clause offers a way to come out on top without bidding more than necessary. In theory, the winning bid is just a little higher than the next highest bid. An escalation clause can give a bidder some peace of mind that they have a horse in the race without having to get over-involved in the bidding process. It happens more-or-less automatically.
The main downside is that the buyer has tipped his cards to the seller. The seller now knows how much the buyer is will to spend and can use that information to drive the price to that level or higher.The seller can
- disclose that maximum bid to other bidders to get them to bid even higher
- counteroffer at the maximum price in the escalation clause (if the bid is below the asking price) – or a little higher
- go back to the high bidder, even one with an escalation clause, to see if they will go even higher.
In some cases, the escalation clause does not prevent a bidding war, it just speeds up the pace.
An unscrupulous seller can even generate a bogus offer to max out your escalation clause by having a friend pose as a potential buyer. Remember the clause is supposed to triggered by a bona fide offer, but who’s to say what is a valid offer?
Because of their complexity and potential for abuse, some brokers don’t like escalation clauses and prefer that buyers simply make their best offer and then let the seller choose the most attractive ones and counteroffer if they wish – as they usually do. This is straightforward and easy to manage.
Also some sellers feel that the bidder using the escalator clause is cheating them – if the buyer is willing to go as high as $410,000, why doesn’t he just bid that much? Buying and selling property isn’t just about money. People’s emotions come into play as well.
Like them or not, escalation clauses are here to stay, and are growing in use in hot real estate markets, at least until the next big downturn in real estate.
Your Best & Final Offer
If you’re in a competitive market and want your offer to stand out, naturally the first thing is price – the higher the better. If you’ve been shopping for awhile and watching sales prices, you should have a pretty good idea of what things are selling for in your area. If you are working with a buyer’s broker, ask them what they think the house is worth and ask for a list of “comps” that have sold recently.
In addition to price, consider the conditions of your offer, which can sway a seller to go with your bid, even if it is a little less. A surprising number of pending real estate deals fall apart before closing due to contingencies in the offer or other contract clauses that are not fulfilled.
What contingencies you can do without and how flexible you can be? It’s hard to know in advance what the seller’s priorities are, but the fewer contingencies and hard deadlines, the more attractive the offer. Keep deadlines for inspections as short as possible. Some issues to consider are:
- Cash buyer. If you are buying cash, with no mortgage contingency, that’s a great plus. If you need bridge financing, consider using a HELOC (home equity line of credit) to pull cash out of the equity in your current home.
- Appraisal. Even if you are applying for a mortgage, you can drop the appraisal contingency. If you have been pre-approved (not just prequalified), it is highly unlikely that you will fall through. If the house does not appraise high enough to support the loan amount, you will have to make up the shortfall with cash.
- Inspections. There are usually multiple inspections: lead, radon, heating system, chimney, home inspection. If you are knowledgeable about construction, and have taken a good look at the house, you can usually rule out any high-ticket repairs. If you include inspections, keep the deadlines as short as is practical and consider defining failure as “major structural or mechanical defects” – not just a couple of missing shingles.
- Closing date. If you can offer flexibility with the closing date, or allow the seller a few days to move out after the closing date, that could help sweeten your offer.
- Personal letter. If you are working with a broker and therefore not meeting the seller, consider including, with your offer, a short personal note to the sellers. Tell them how much you like their home and neighborhood and how the house is a perfect fit for your family — include a family photo. This can influence some sellers on an emotional level.
If you are making an offer on a property listed by a broker (as opposed to a FSBO, for-sale-by- owner), find an agent who will represent you as a buyer’s broker. Some agents will want you to sign an exclusive contract with them, but others will be willing to sign a buyer’s broker agreement for just that house.
Tell the agent that you will certainly consider signing an exclusive buyer’s broker agreement in the future. However, you probably want to exclude for-sale-by-owner properties from the agreement as bringing along an agent can muck up the works with an owner trying to avoid paying a broker’s commission. Being represented by buyer’s broker is especially important in competitive markets with multiple bids, and essential if you are trying something fancy like an escalation clause.
Remember, unless you are working with a buyer’s broker, the agent helping you prepare your offer is legally bound to help the seller get the best price from you. Any information you share with the agent can and will be used to help the seller, not you. With a buyer’s broker, the tables are turned. The agent now has a legal duty to help you get the property at the lowest cost. When push comes to shove in a tough negotiation, this can be valuable.
Getting A Leg Up
As mentioned earlier, getting your bid in before the open house, and before a bidding war underway, can be a huge advantage to the buyer.
Definitely put out feelers to everyone you know in the area. If there is neighborhood online forum, post that you are looking to buy a house in the area. Cast a wide net and consider nearby areas that may be less costly and crazy.
If you are set on a particular neighborhood, you can always drop flyers in mailboxes that say: “Hi, I’m Amy. Our family is hoping to buy a home in this neighborhood. If you are thinking about selling in the near future, please contact me at xxx-xxxx.”
While this is a long shot, people have used this proactive approach successfully for years. The appeal to the seller is that they do not have to go to a real estate agent and give away 5% to 6% of the sales price. Equally important, they do not have to go through the grueling effort of getting the house ready for market and potentially showing it to hordes of people, most of whom are tire kickers.
Beyond that I don’t know any magic that can help a buyer in a seller’s market. Just look at enough houses that you know what’s a fair price and exactly what you want. When you find it, don’t hesitate. Pounce with an attractive offer and hope for the best. That’s about all you can do.