How Bidding on a Home in Toronto Just Got Worse
If there is one part of the home buying process that all of Toronto hates – it’s when you have to compete for a home against other buyers.
That’s because in Ontario, buyers compete against each other in what is effectively a blind auction. Buyers only know the number of other buyers they’re competing against, not the details of the other offers. And it’s this lack of transparency that makes the process more stressful - and ripe for unethical behaviour.
Seller (listing) agents often ask buyers to improve their offer, claiming that two offers are “very close”. This leaves buyers wondering if there really is another offer that is close to theirs, or even another offer at all, a problem known as “phantom offers”, and whether the seller agent is dishonestly trying to get buyers to compete against themselves.
To guard against this, the Real Estate Council of Ontario (RECO) – the self-governing body that regulates Ontario’s real estate industry (8 out of 11 board members are real estate agents and/or brokers) started requiring seller agents to retain offer summary documents which have the buyers name and how long the offer is valid for (but not the price of that offer) as of July 2015.
But for every step RECO appears to take forward, they take a suspicious step or two backward - as in the astonishing case of the ‘escalation clause’ which has just made the bidding process even less transparent and worse.
A few weeks ago, one of my agents asked me about a discussion that agents on Facebook were having about using a clause that to date hasn’t been much used in Toronto and GTA - an escalation clause.
Here’s how an escalation clause works. Suppose you’re a buyer and you offer $800,000 for a home, but you really love the house and don’t want to lose it under any circumstances. Your agent might suggest you include an escalation clause which effectively says if there is another offer better than yours, you’re willing to pay $5,000 more than the top offer - without even knowing what the top offer is. Escalation clauses can have a cap on them limiting how much a buyer would pay but agents do make them with no limit on price.
There are a number of problems with escalation clauses. Firstly, seller agents who agree to entertain these types of clauses from a buyer would in effect be violating the RECO obligation to keep all the details of the other buyer offers including price private.
Consider this scenario. Suppose you make an offer on a home for $600,000 and are competing against one other buyer. The seller agent is not allowed to show the second buyer your $600,000 offer and ask them if they’re willing to beat it because the terms of your offer are supposed to be confidential. But suppose the second buyer offered $550K but included an escalation clause that states they’ll beat any other offer by $2,000. When the second buyer is told they won the house at $602,000, they have effectively been told the price you offered - without the seller agent actually telling them. The escalation clause is a work around the privacy rule.
This is why I confidently told my agent that she could not even entertain using (or accepting) such a clause. I had to eat crow two days ago on May 31 2017 when RECO’s newly released educational bulletin walked agents through on how to use an escalation clause.
And this is why I have become more convinced that self-regulating real estate is a bad idea.
Leaving aside the issue of privacy, let’s explore the bigger problem with escalation clauses which is that they make the risks of the blind auction, which already features perverse incentives that may tempt an unethical agent to cheat, even stronger - to phantom offers, RECO has just added the heightened risk of phantom prices.
In a best case scenario, the escalation clause is a work around the privacy rule, as we have seen. But in a worst case scenario, when the seller's agent is less than honest, escalation clauses act like a blank cheque that the seller and their agent can fill in as they please.
Even if buyer Jane includes a cap or maximum price in her escalation clause, the seller agent can push Jane to her maximum price because Jane has to take their word for it - there is no obligation for the seller's agent to retain a copy of the competing offer (and recall that the “Offer Summary Document” does not require the recording of offer price information).
These clauses help sellers and real estate agents by pushing up home prices higher than is necessary, but at the expense of all home buyers.
And RECO’s direction to agents, which does not outlaw the use of these clauses, but tries to regulate them (i.e., make them marginally less bad), continues to demonstrate that it is an organization run by realtors designed to protect and promote the rights and interests of real estate agents – not consumers.
As the Ontario Liberal government deliberates changes to the Real Estate and Business Broker’s Act to further protect consumers – the number one item on their agenda should be to end the real estate industry’s right to regulate themselves because it comes at the expense of the rights of consumers.