What Is Real Estate Bidding War and Is It Legal?

Some people consider multiple offers and bidding wars as the same. That is not entirely accurate because it is much more like a progression of one to the other. At any rate, differentiating the two and having a better understanding of the bidding process helps you in more ways than one. At best, you can avoid getting into a bidding war. If you were to find yourself in such a situation, your chances of owning that dream home are better. More importantly, you can avoid spending much more than intended.

Multiple Offers vs. Bidding Wars

When two or more buyers submit a written offer to buy a property, a “multiple offer” situation arises. On the other hand, a bidding war typically involves oral negotiations between the seller and each of the buyers’ agents. Its purpose is to make buyers outbid each other incrementally.

Listing agents, acting in their clients’ best interest (the sellers), may try to shop for the best offer. For example, they may try contacting other buyer agents after receiving their first and only offer, inviting them to make a better offer. Or, they may tell prospective buyers that the seller is reviewing offers on only one particular day. It is a marketing strategy that gives the impression of a multiple offers situation to encourage buyers to submit their best offers.

Bidding wars in Ontario occur because of supply and demand and the “desirability” of properties. However, some may also be the result of manipulation on the part of real estate agents. Attempting to command a higher price, of course, is nothing new as some sellers or agents have tried to counter the initial offer of a buyer in the past. At any rate, the competition for ownership can push the final selling price far higher than the original listing price.

Bidding War Legal and Ethical Considerations

A bidding war benefits home sellers, especially when properties sell above the prevailing real estate market value. It also helps listing agents because commissions are based on the selling price. For buyers, the thought of competition trying to snatch away a coveted property makes them vulnerable and susceptible to making rash decisions.

Losing out a few times is also the experience of many Toronto homebuyers, making house hunting challenging. It is not only them who are affected. Their agents, too, lose because they do not receive compensation for time used and effort.

Over the years, there were concerns raised over this practice. Bidding wars happen because of market conditions. It can also be abused. For example, a dishonest real estate agent may mislead buyers into thinking there are competing offers. These phantom bids are to make buyers raise their bids or rush into closing the deal.

Depending on who and which side, bidding wars can be beneficial or detrimental, a welcome practice or unethical.

Legality

The duty of real estate listing agents is to the seller, not to any other parties. Hence, they will always have to act in the best interest of their clients. If it is the wish of or should the property owner agree to instigate multiple offers, that is what they will do. Even if it were to escalate to bidding wars, no law states it is illegal.

In the course of doing so, there is also no legal obligation prohibiting listing agents from shopping properties, contacting buyer agents – one after another. Furthermore, if they were to reveal the details of competing offers to get other buyers to come up with better offers, no law prohibits that, too.

Although no law explicitly prohibits multiple offers and bidding wars, some states may have restrictions on the processes involved. In Ontario, for example, The Real Estate Council of Ontario (RECO) may amend the Real Estate and Business Brokers Act. Thus far, listing agents cannot reveal the details of competing offers, except the number of offers.

In the interest of transparency, the Ontario government considers making changes that allow homebuyers in the province to know the details – such as prices –  of competing offers in bidding wars.

A few years earlier, RECO already targeted unscrupulous agents who engage in phantom bids by prohibiting agents from implying there are other offers on a property unless they have written and signed offers.

Ethical Standards

To protect consumers’ interests, including homebuyers, many real estate brokerage companies conform to the National Association of Realtors (NAR) Code of Ethics.

There are no ethical obligations on the matter of shopping offers or instigating multiple offers and bidding wars. Even if there might be local regulations restricting the disclosure of details of competing offers to buyers, it is not deemed an unethical practice.

In reality, most multiple offer situations do not result in a bidding war, even if there are practically no ethical constraints. One reason is that nearly every real estate agent has represented both sellers and buyers. Not only do they understand professional ethics, but also moral ethics.

Perhaps the most plausible reason, however, is that they have experienced failed bidding wars. An example would be turning away potential buyers because of the ruthless nature of such negotiations.

Escalation Clause: The Dark Side of Bidding Wars

Even if buyers try to avoid a bidding war, it seems that prime properties almost always lead to one. When that happens, many sellers have sold their properties at 110% of their original listing price. It could even be much higher, as is the case of a property listed at $749,000 and sold at $901,000 some years ago.

Why do people compete hard in bidding wars?

Having financial capability is the obvious answer. But then again, people of wealth also often have acute business sense and likely to walk away from an overpriced property – unless its value is expected to increase in the next few years. Another explanation would be the tendency of people to make emotional decisions.

Bidding wars rely on at least two persuasive marketing tactics:

Mob mentality. The more people wanting the same property makes you want it too.

Sense of urgency. Having competitors to a property that you desire makes you want to close the deal as soon as possible, even if it means paying more money.

A survey in Ontario commissioned by RECO showed:

• 47% would pay up to 10% over their budget
• 31% would offer 10-20% more than their competition to win a bidding war

The competition in Greater Toronto Area (GTA) is much stiffer:

• 57% would pay up to 10% over their budget
• 38% would pay 10-20% over their budget

These numbers are not surprising because half of the Ontarians who bought homes admitted to being influenced by emotions.

Escalation Clause

In principle, this is how a bidding war works. Assume that two people are trying to outbid each other on a property listed at $600,000. One party offers to buy, and the other counters by offering $10,000 more. It goes on and on until one concedes. In a real bidding war, though, you are more likely to compete with ten or more participants. Hence, some agents may offer to implement an escalation clause or sharp bids in their bidding contract to make matters simple for buyers.

It is essentially like giving an agent the authority to automatically increase the bid by a certain amount until reaching a maximum amount – the most the buyer is willing to pay.

The Problem with Escalation Clauses

Sellers can likely see the stipulations in bidding contracts. It presents problems for buyers as the sellers can see their maximum bid price. For example, you are willing to pay up to $400,000 for a property listed at $350,000. What happens if, after you offered $370,000, everyone else dropped out? Knowing that you were willing to pay more, wouldn’t the seller and the listing agent try to get you to spend more?

The Ontario Real Estate and Business Brokers Act does offer buyers a degree of protection. Registrants are not allowed to reveal details of a bid. The position of RECO on this matter is that they do not support escalation clauses and warn brokerages, agents, sellers, and buyers of potential legal implications by following this course of action.

Should You Participate in a Bidding War?

A few things come to mind concerning this matter. It is easy to say that you can, if you particularly like a property – so long as you stick to your budget. On this basis alone, a piece of advice given to buyers is to find homes listed below their intended buying price range. This way, they can offer higher bids if it comes to that. More importantly, it helps prevent paying more than what is dictated by the real estate market conditions.

There are, however, other considerations. You and the agent will spend a considerable time doing due diligence by visiting properties until you win a bidding war. Moreover, you would also have to consider the time it takes to reach the end of a bidding war, which could take a couple of weeks or more. It would be great if you won, so you do not have to go back to square one again. One more thing, after a few losses, you might become more susceptible to going over your budget if it means you can end the ordeal.

Unfortunately, you cannot avoid a bidding war if the property is very much coveted, especially in the GTA. You should compete if there are not many alternatives available for you. Otherwise, you may consider another acceptable property with less or no competition if there is one in the housing market. Most of all, work with a reputable brokerage that can help find you the best deals and navigate the complexities of negotiations.

Conclusion

As a buyer, engaging in bidding way can result in higher real estate prices, but it may be the only way to acquire the home you’re evaluating. On the seller’s front, having multiple buyers bidding for your property can greatly increase your profits, but you need to work with an agent that creates a transparent environment and keeps you updated with all pertinent offers.

It’s impossible to avoid or fully prevent bidding ways. Moreover, it’s actually pretty common to find yourself in one if you’re looking to purchase a popular piece of property. Nevertheless, bidding wars are actually not all that common, so there’s a strong chance you’ll simply have to follow conventional negotiation tactics during your next home purchase.

To find out more about getting the best real estate in Canada, get in touch with Justo. Our team of local agents will be glad to help!