How to Handle Real Estate Bidding Wars & Escalation Clauses

In real estate markets where properties are hot, particularly in places like Houston and Dallas where my companies operate, competition among homebuyers can become pretty steep. In markets like Los Angeles, San Fransisco, New York City, Miami, Chicago, and so many other hot areas around the country, buyers are dealing with the negative side effects of trying to buy in a hot real estate market. We’re all aware that home buyers often lament the presence of all-cash investors in the market, as they usually win out over other bids. Truth be told, real estate investors have to deal with some of the same issues.

The combination of a tight inventory, low-interest rates, and a seller’s market have led to a cutthroat real estate market. Rents are escalating, threats of rising interest rates in the future are very real, and the Millennial generation is quickly adapting to the idea of home-ownership right now. With all of these factors, homebuyers often find themselves losing out on their dream home when dozens of higher bids pop up on the property.

In super competitive markets, those without the capital to make higher offers may find themselves struggling to even get noticed by the real estate agents who represent them. This doesn’t just go for homeowners, but for investors, too. It’s not easy to snag a property when you’re not the only bidder in the game.

And Then There Were Real Estate Bidding Wars

There’s something about bidding that fills people with excitement. Whether it’s investors vying after a good property or a Regular Joe winning an eBay auction, there’s a thrill about it all. It can be exciting, nerve-wracking, and very, very rewarding.

Getting caught up in a real estate bidding war, however, can be very, very dangerous. The high of the competition can get the better of us, which can lead to overspending and unwise investment decisions. I wrote an article and recorded a video for the BiggerPockets blog about a year ago that discussed 5 irrational behaviors that real estate investors exhibit. When you get involved in a bidding war for a piece of real estate, especially an investment property, those irrational behaviors can kick in and kick you right in the backside!

Just as you shouldn’t buy something just because it’s on sale, there’s a profound danger in going after something just to win it and one-up someone else.

When you find yourself bidding on a property with other offers and things get heated, remember:

1. There are more properties out there.

This one isn’t the single deciding factor in the success of your real estate investments. It’s not a perfect property. Others will come along if you miss out on this one. Do not allow yourself to develop a “scarcity mentality.” Always operate from the standpoint that there are plenty of opportunities. They may not all fall in your lap, but they are there. They may take a little more work and you may have to put in more effort, but they are there.

2. A rejected offer is not your fault.

There are always things investors can do to increase their chances in the midst of a bidding war. Pre-approval, having all the paperwork in order, removing contingencies, and even all-cash offers can sway the decision in your favor. If you’re doing all you can to provide the best offer you can make professionally and efficiently, don’t lament the loss as if it’s a flaw in your character or strategy. Ruminating on it won’t help your investments.

3. One-upping someone else is rarely worth it.

The elated emotions we feel in the middle of competition, especially when we claim victory, are short-lived. It’s easy to loosen our purse strings in the name of winning. We may find ourselves with a new investment property, but we also may have increased risk by over-spending. Don’t let your emotions rule financial decisions. If you have done your homework and performed your proper due diligence, then the basics of real estate investing are not going to change as you up your offer. The performance of that investment, however, may.

4. It’s okay to step away.

You aren’t a failure if you back down when bidding gets too heated. Some people don’t thrive on competition. While you shouldn’t allow it to prevent you from making the best investment decision you can make, take comfort in knowing that there’s no shame in stepping away from a bidding war.

Many, many intelligent real estate investors will tell you that the best deal they have ever done is the one they didn’t buy!

Navigating Escalation Clauses

In an already competitive market, escalation clauses can further complicate things. These “escalators,” as most of us know, edge out competition by agreeing on an automatic increase in your bid should a higher offer come along. It increases the chance that an offer will be selected and ensures that your bid doesn’t get buried.

Escalation clauses are handy in situations in which there are multiple bidders—but they aren’t without peril. If you want to fully protect yourself when using an escalation clause, ensure that they include the following:

1. An Escalation Cap

This is most important. After reviewing your finances and running all the numbers, decide what your maximum bid is. At what point will it not be worth it? Make sure you know and detail your cap in the escalation clause to avoid overpaying.

2. Proof of Offer Legitimacy

While it’s rare, there are stories of sellers fabricating bids or buyers bluffing offers to drive up prices. Even legitimate offers can’t always be considered on face value alone. Demand there be proof that the offer is valid before your escalation clause kicks in.

3. A Right to Back Out with Appraisal and Home Inspection

It’s always a huge mistake to neglect home inspections. Ensure that, should the appraisal be unsatisfactory or the property turn out to have too many problems, you can back out of the contract.

Remember that an escalation clause isn’t a guaranteed win. Typically, a lower cash offer will win over a highly financed offer. The seller will work with who they want to work with, end of story, and a higher price point isn’t always going to win.

In many markets around the country, real estate remains a hot topic and a hot commodity. Prices are fluid, and there is a lot of pressure on pricing. Rents are rising, values are rising and the stress of not wanting to miss out before the market changes are driving factors. Make sure you are smart and use a well-thought-out approach when you find yourself in the unique situation of competing for a property.

How do you best prepare yourself to win the bidding in a competitive market?

Share your tips with readers in the comments.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.