Tag Archives: bidding war

The Little-Known Escalation Clause

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The Wall Street Journal quoted me in Escalation Clauses: A Little-Known Bidding-War Strategy. It opens,

For home buyers locked in a heated bidding war, there is one weapon that may help ensure victory: an escalation clause.

It’s an addendum to a real-estate contract, typically when the offer is made, in which a prospective buyer says, “I will pay X dollars for this house, but if another buyer submits a verifiable bid that’s higher, I will raise my offer in increments of Y dollars to a maximum price of Z.”

These clauses are particularly useful in a competitive real-estate market where homes typically get multiple bids. If a bidding war erupts on a home, the escalation clause will automatically raise the buyer’s offer on the house by the predetermined increment, up to the maximum amount the buyer authorizes. It eliminates the back and forth of offer and counteroffer and helps the buyer avoid paying too much for a house by getting caught up in the frenzy of a bidding war. But they can be risky for buyers who use them.

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

One concern is that the buyer is tipping his hand to the seller by using an escalation clause, Prof. Reiss says.

By indicating the maximum amount he will pay for the house, a buyer is revealing important information—that he’s willing to pay more. For example: Seller lists the house for $1 million. The buyer bids $950,000 with an escalation up to $975,000. The seller can counteroffer at $975,000, knowing that the buyer can both afford it at that price and is willing to pay it.

“Sellers get more money than they ever thought they would have,” says Carrie DeBuys, a real-estate agent with Realogics Sotheby’s Realty in Seattle. In her market, it isn’t uncommon for a seller to receive “10, 15 or 20 offers on a property.”

On the flip side, an escalation clause may not be in the seller’s best interest, explains Prof. Reiss.

Say a house is listed for $1 million, and there are three bidders. Buyer A offers $950,000. Buyer B offers $975,000 with an escalation clause that could go up to $1 million in $5,000 increments. Buyer C offers $980,000. In this scenario, the seller would get $985,000 from Buyer B after the initial offer escalates over Buyer C’s offer. But, had the seller not relied on the escalation clause and instead asked the bidders for their best and final offer, he might have sold the house for $1 million. “We know that the buyer was willing and able to go up that high,” Mr. Reiss says. “Thus, the seller is likely getting $15,000 less in the escalation-clause scenario.”

Empire State Bidding War?

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I was quoted in a Law360 Story on the ongoing Empire State Building saga, Empire State Bids Soar Over Approaching REIT Deal (behind a paywall).  It reads in part:

the bidders that have come out of the woodwork since Schron’s left-field offer may be banking on the assumption that Malkin and its shareholders could be willing to part with the iconic skyscraper in an all-cash deal that would avoid some of the drama associated with the REIT proposal.

“The owners … may lose the prestige by losing control of the Empire State Building, but they may end up making more money,” said David Reiss, a professor of real estate law at Brooklyn Law School, on Friday. “They may be more than happy to sell to the highest bidder if they’re going to get more than what the REIT would get them for it.”

The bidders appeared to think the unhappy shareholders would find value in their offers as well.

In connection with his bid, Schron agreed to enter into a contract with Malkin with a $50 million nonrefundable deposit immediately and to close the all-cash deal in 90 days. As part of the deal, investors would be able to choose to remain invested in the building and receive a membership interest in Schron’s Cammeby’s International Group in lieu of cash, according to an offer letter revealed last week.

The offers that followed — one from Thor Equities that was “north of $2.1 billion,” one from a group of investors including Phil Pilevsky and Joseph Tabak, and another from an unnamed bidder — reportedly offered similar assurances.

In addition to the chance to own one of the most famous buildings in the world, experts say those who have thrown their hats into the sudden bidding war for the skyscraper are also keen to take advantage of its retail potential.

“I think there’s a belief that this is a valuable property, and that particularly the retail portion of it — and to some extent the office portion too — is undervalued,” Israel said. “I think they feel they could do a major upgrade.”

Those who may have been previously interested in the building also now have the assurance, after a May court ruling in one of the lawsuits over the proposed deal, that verified the legality of a controversial $100-per-share buyout provision, according to Reiss.

Potential buyers now know “that the buyout provision is valid and … that a good bid can get the requisite votes,” he said.

An appeal of the ruling on the buyout provision remains pending.