Question: I submitted an offer to purchase a home for $231,000, although the seller was only asking $229,000. My broker advised me that the market was "hot," and that multiple contracts were expected. The broker also suggested that I include an escalation clause, up to a maximum of $240,000 -- with incremental increases of $2,000. I was advised that the seller's real estate agent would provide me with a copy of any other offers to verify the need to increase my offering price.

I was then told that a higher offer had been submitted by another party, but the selling agent refused to provide me with a copy of that offer. Apparently, that agent became agitated when asked for this proof, stating that she "didn't do business like that".

My escalated offer was ultimately accepted, and settlement is scheduled to take place at the end of this month. Although I am happy that I was able to get the house, I still do not know if there was really another offer, and if so, what that price was.

Am I entitled to obtain proof that there was really another offer which triggered my escalation clause?

Answer: Although I recognize that during an active real estate market escalation clauses are often used by potential buyers, I am unalterably opposed to this concept.

Oversimplified, an escalation clause works like this: I make an offer to purchase your house for $231,000. Because I really want to purchase this house -- and because I believe that other potential buyers may also be making purchase offers -- I include a paragraph in my proposed contract which says that I am prepared to increase my offer by increments of $2,000 (with a cap not to exceed $240,000) should the seller receive any other offers which are higher than mine.

It sounds simple. But what does the real estate agent -- and the seller -- do when confronted with two or more identical offers? Which one will they accept? Should the seller make a counter-offer at a price higher than the maximum cap and hope that one of the potential buyers will accept that higher price?

More importantly, from the purchaser's point of view, what proof do you have that there really is a higher offer? What is to stop an unscrupulous seller (or real estate agent) from falsely advising you that there are higher offers -- solely for the purpose of triggering the escalation clause.

Finally, is the house really worth what you are offering? Presumably, when the house was listed for sale, the seller -- and the real estate agent -- priced it competitively. We all recognize that some real estate markets are quite active, and that prices in some cases have increased at unbelievable rates. But how long will it last? Real estate is not recession proof.

Home prices -- like the stock market -- fluctuate like a roller coaster. Sometimes they go up -- and sometimes they go down. There were many homeowners who purchased real estate at the peak of the market in the late l980s who learned this economics lesson the hard way.

Indeed, for many of these owners, their values declined drastically shortly after settlement, and it was not until the mid l990s that the price of their home finally began to be equal to their outstanding mortgage. I know of many homeowners who had to come up with cash when they sold their home during the early 1990s.

Will this happen again? Obviously no one can accurately predict the economic future of real estate. However, homeowners should understand that no home is worth the subsequent aggravation -- and the subsequent financial loss.

Federal Reserve Board Chairman Alan Greenspan warned stock market investors about "market exuberance" -- and look where we are today. In my opinion, real estate exuberance may produce similar results.

Psychologists have long cautioned about a symptom know as "auction mentality". We bid on a product -- whether at a local auction house or on the internet -- and get carried away with the desire to have a product, regardless of cost. We don't have time to sit back and analyze what we are doing. That is exactly what an escalation clause creates -- and thus it can be a dangerous financial tool.

However, if you really want to play the lottery -- which I equate to these escalation clauses -- at the very least you should be given proof that there really is a higher third party contract. Your escalation clause should include the following language: If seller receives an offer which is higher than the offer contained in this contract, seller will provide purchaser with a copy of that higher third party offer. Seller reserves the right to delete the name of that third party offeror to protect privacy. Seller represents and warrants that the third party offer is bona fide.

The direct answer to your question is that it is probably too late now to insist on proof that there was a higher third-party offer. The time to inquire was before you signed the contract at the higher price.

Whether or not you decide to use an escalation clause, it is important to remember that you are about to engage in what might be the most expensive investment of your life. Do not forget about all the other protections you need in your real estate contract, such as:

• A contingency to obtain satisfactory financing.

• A contingency to obtain a satisfactory home inspection, performed by an inspector which you have selected.

• The right to select your own mortgage lender.

• The right to select your own closing agent and/or attorney.

Finally, keep in mind the most fundamental principle in real estate: absolutely everything is negotiable.

For more articles by Benny Kass, please press here.

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Copyright 2001 Benny Kass. Posted by Realty Times with permission.

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Published: April 2, 2001

Use of this article without permission is a violation of federal copyright laws.