Escalation clauses can raise the stakes in an already frenzied real estate bidding process

Open this photo in gallery:

Many disheartened real estate buyers know the feeling of losing to rival bidders in Canada’s high-octane housing market.

But imagine the frustration of buyers who learn their bid was stymied by a competitor who declared they would pay $5,000 more than the highest offer at the end of the night.

The use of an escalation clause is rare, so Shawn Lackie of Coldwell Banker R.M.R. Real Estate was surprised when an agent in his office approached him at the height of spring madness to say a buyer’s agent wanted to attach one to an offer.

“This is just a land mine waiting for someone to step on,” he says.

An escalating bid is one tactic agents are grappling with – along with bully bids, sidewalk negotiations and back-to-back showings – as they deal with coronavirus protocols and an unharnessed run in sales and prices.

“Desperation breeds all kinds of new ideas,” Mr. Lackie says of rogue agents looking for an edge in a bidding war.

Some of those desperate people are Torontonians leaving the city and flooding into Oshawa, Pickering, Whitby and other parts of Durham County, where his firm does much of its business. In the past year, such buyers have helped push the average price up 37 per cent in Durham, an area that’s used to a much calmer market.

The Real Estate Council of Ontario, the industry’s regulatory body, says escalation clauses are not against the province’s Real Estate and Business Brokers Act, 2002. But it also does not endorse their use. Spokesman Brian Buchan says the council seldom receives complaints about escalation clauses and has not seen an uptick recently.

Typically the clause automatically increases the buyer’s purchase price by a preset amount until an upper limit is reached.

It’s a tricky scenario for listing agents to navigate because they are not allowed to disclose the substance, including the price, of any competing offers.

Mr. Lackie’s firm has decided to reject such deals.

Agents are told, “if you get an offer that’s got an escalation clause in it, you’re going to cross it out and send it back. Because that’s just dirty pool.”

John Pasalis, president of Realosophy Realty in Toronto, says he has seen agents discussing the use of escalation clauses on social media, but he hasn’t come across anyone attempting to use one this spring.

“It’s quite rare,” he says.

He says he believes the practice is a terrible idea for both sides of a deal.

Buyers attempting to use the clause surrender negotiating power because they either have to place a cap on the amount they’re prepared to pay or risk being on the hook for an unlimited amount.

“Either you have no max price – which is insane – or you’re basically revealing your top price anyway.”

For listing agents, their code of ethics, overseen by RECO, bars them from revealing how much other competitors have offered during the bidding process. But if a buyer with an escalation clause that rises in increments of $5,000 is told the final price they have to pay, they in essence know that the second-highest bidder offered $5,000 less than that amount.

“In the best-case scenario, the escalation clause is a work around the privacy rule,” Mr. Pasalis says. “It’s like a loophole.”

The listing agent is obliged under current rules to keep documents that provide a record of the number of bids they received, but not the amount of those bids. “If the seller got an offer that they say is irrationally high, they have no obligation to prove it,” Mr. Pasalis says. The buyer using the escalation clause “would just have to take their word for it.” (RECO does encourage listing agents in that case to keep a record of the second-highest offer as well, just in case a party decides to sue.)

Elise Kalles, a broker with Harvey Kalles Real Estate Ltd. in Toronto who concentrates on the luxury market, is not in favour of the escalation practice, and has never sold any of her own listings that way. “I don’t think it’s fair to the other people bidding,” she says.

Now that offers are made by e-mail, rather than in person, she thinks it’s easier for an agent to add such a clause. She has heard from agents who say, “My client will pay $50,000 over the highest offer.”

But in general buyers in the market tier of $7.5-million and up tend to be savvy in financial matters, she adds, and unlikely to use such a strategy. “They’re sophisticated buyers.”

Mr. Pasalis says a real estate firm is absolutely within its rights to refuse to work with escalation clauses. He wouldn’t want his own firm to touch one, and says he can’t imagine why a seller would entertain such an offer.

A deal could be held up because the number two bidder decides to take legal action or file a complaint with RECO, he explains. Whether those moves would be successful he doesn’t know, but they could provide unnecessary added complexity for the seller.

“Why would you even want to expose yourself to possible litigation?”

Your house is your most valuable asset. We have a weekly Real Estate newsletter to help you stay on top of news on the housing market, mortgages, the latest closings and more. Sign up today.