Escalation Clause? What Is That?

Have you heard the term escalation clause?  Chances are you haven’t unless you’ve been involved in a bidding war as either a buyer or seller in the last few years.  Today we are going to discuss the controversial subject of escalation clauses and what you should know.

What Is An Escalation Clause?

An escalation clause is a clause in the schedule of an offer which is designed to defeat competing offers by automatically increasing the Buyer’s purchase price by a pre-set amount over the highest offer.  Usually there will be some sort of cap placed on the escalation clause where the buyer won’t go over that amount should the best offer exceed it.

When Would An Escalation Clause Be Used?

An escalation clause would be used in a multiple offer situation (bidding war), where the buyer wanted to ensure they have the highest offer price.

How Would An Escalation Clause Work?

An escalation clause would state that the buyer agrees to pay a certain increment over the highest offer received.  For example, say there were 5 offers on a listing and one of them had an escalation clause, stating that they would pay $5,000 more than the highest offer received.  Suppose then that the highest offer was $500,000.  The buyer with the escalation clause would then agree to increase their offer to $505,000.  The logistics of how to accept the escalated offer vary, but the most common way would include the seller countering the buyer’s offer at $505,000 and having the buyer accept.

Why Is This Subject Controversial?

There are a few inherent conflicts with the inclusion of escalation clauses in bidding wars:

1. It hurts the confidence of buyers when submitting an offer.  Feeling that dealing with this sort offer is unfair, buyers may decide not to participate in these competitive situations.  That could affect the confidence of the market overall.  Some of these bidding war practices already have buyers feeling discouraged, so it feels like piling on.
2. There is a privacy issue.  The only people in a multiple offer situation who are supposed to see the contents of buyer’s offers are the listing agent and the seller.  In an escalation clause situation, inherently the price of the highest offer is disclosed to the buyer with the escalation clause – this really cant be avoided.  And this contradicts many RECO rules.

What Is Happening In The Market Because of Escalation Clauses?
Although not illegal, the escalation clause use has been frowned upon in the market in our experience.  Generally, we are seeing listing agents and sellers deciding not to deal with offers that include these clauses, and stating so right in the listing.  This eliminates the potential unfairness to prospective bidders and increases the confidence in the offer process.

What Do We Think Will Ultimately Happen To Escalation Clauses?

We think they will eventually be banned by the governing bodies.  The cons seem to far outweigh the pros in the market.  And real estate professionals have been banning them from their listings for a while now.

So there you have it readers.  Do you or anyone you know have any experience with escalation clauses?

Real Estate & Related Predictions for 2017

Happy new year everyone!  Hope you all had a great holiday season and are rested up for a busy 2017.  While the year is still young, we wanted to consult our crystal ball and take a stab at making some real estate predictions.  Here goes.

Interest Rates Edge (Modestly) Higher

Since interest rates are near all time lows, common sense would dictate that they don’t have anywhere to go but up.  We think this year that happens, albeit in a limited fashion.  With the combination of higher bond yields, and some of the government mandates coming down on the financing industry to curb runaway real estate markets in parts of Canada, this will finally be the year for higher rates.

Buyers Get Multiple Offer Fatigue

During 2016, it seemed like every listing had 5-10 offers on it and bidding wars ensued.  While the market dynamics forcing this are still in place, we feel a segment of the market is growing tired of the constant competition.  This will result in a lesser number of the crazy bidding wars we saw over the past year (hello 31 offers!).

Cap Rates Flatten Out

We remember back 6-7 years ago when obtaining an apartment building with a cap rate of 10%+ was common place.  Those days are long gone and prices have been bid up consistently since then, compressing cap rates.  Today you have a hard time finding an apartment building with a cap rate over 6%.  This dynamic has also been seen in retail plazas, office buildings, and other commercial properties.  We don’t see much more room to run on cap rate compression going forward.

Continued Sticker Shock On New Construction Costs

With new construction going through a boom in the last few years in our local market, builders and related trades are very busy.  Combine that with increased prices for land and imported material costs rising because of the low Canadian dollar, buyers will find their price range won’t get them as much when considering a new build.  We don’t see this subsiding anytime soon and if anything expect further price increases.

New Condo Projects Coming Online to Meet Demand

Build it and they will come.  It wasn’t always this way in our local market, as condo ownership was slow in being generally attractive to buyers.  But times have changed and the condo market may be the tightest of them all.  The market can now support more condo developments and developers will respond to this demand with multiple new projects in our area that we expect to be met with brisk demand.

Those are some of our predictions for 2017.  Time will tell if our crystal ball was right.  What are your predictions?

2016 Year End Real Estate & Related Observations

 As the holidays draw closer we are going to do a few posts wrapping up the year.  And what a year it has been for our real estate market and many other markets in Canada and the US.  Today we are going to discuss some observations we’ve made throughout the year.

The Year of Multiple Offers

Multiple offers seemed to be a way of life this year.  Bidding wars were everywhere, in all parts of town and all price ranges.  This even spread to the commercial market as some retail, multifamily, and industrial buildings had multiple offers.

New Construction Is Back In A Big Way

New construction was a bit of a tough business since the recession of 2008 in our market.  That changed in a big way as sales of new construction boomed all over the area.  Clearly there was some pent up demand from the last several years and that translated into huge numbers.

The Local Economy Is Finally A Tailwind

We deal with lots of business owners, and so many of them talk about having way more business than they can handle.  This applies across all industries.  The local unemployment rate has plummeted from being one of the worst in Canada to below average.  This bodes well for a continued buoyant, local real estate market.

We Need to Build More Condos

There are not enough condos out there to meet demand.  With an aging demographic, mixed with the  acceptance of condo living by Millennials, the once stagnant demand for condos locally is long gone.  We expect to see more new condos being constructed in the next few years with brisk demand to meet them.

Downtown Is Still A Sore Spot

The downtown hasn’t really been able ride the coattails of the improvements in the local economy and real estate market as much as it was hoped for.  We still need more people living down there to change the demographics to support more retail and attractions that people like to speak about.  Hopefully the University opening in the near future will be a catalyst, but time will tell.

Those are some of our observations from 2016.  What were yours?

Growing Trends for 2016 Real Estate: Bill 55

With the red hot real estate market we’ve had in Ontario for the last several years, inventory has been low, demand has been high, and bidding wars have become a normal occurrence. In these market conditions, buyers can sometimes feel helpless and end up paying more than they otherwise would’ve in a more balanced market. This has translated into some situations where buyers have complained about competing with “phantom” offers, or when a listing agent says they have another offer(s) and doesn’t, or doesn’t have as many offers as stated.

This activity has led to the creation of Bill 55, the Stronger Protection for Ontario Consumers Act. Rumor has it, it was created by an MPP that had a bad experience buying real estate in a similar multiple offer situation. Here is what you should know about changes Bill 55 has brought about:

• Offers must be made in writing. Please keep in mind that a written offer must be signed to be valid.
• A registrant cannot indicate that they have an offer unless they have a written offer.
• The seller’s brokerage must keep a record of all written offers that it receives.
• Unsuccessful offers must now be kept for at least one year. Successful offers will continue to be kept for at least six years.
• Consumers and registrants who placed an offer on a property may contact RECO to confirm the number of offers that were received.

So these changes were put into effect to protect buyers in multiple offers situations. In our opinion, this isn’t the best way to do this, as all the remedies for the buyer are after the fact. We’ve seen this situation addressed in offers, with a clause created by prominent Ontario Real Estate Lawyer, Mark Weisleder:

“This offer is being submitted on the basis that it is part of multiple offers. If the seller receives no other offer by 10 pm, the seller will notify the buyer or the buyer salesperson and the buyer will have 1 hour to revoke or revise their offer.
If the seller accepts the buyer offer, the seller will provide, within 24 hours, the name, address and phone number of the salesperson and brokerage company that submitted the competing offer.”

So there you have it buyers. Next time you are in a multiple offers situations you know your rights and what to expect.

Have you been in a bidding war and if so how was your experience?

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Russel Lalovich
russel@lalovichrealestate.com
Office: (519) 966-0444
Cell: (519) 995-5620