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In This Article
- What is an Escalation Clause?
- Advantages of an Escalation Clause
- Disadvantages of an Escalation Clause
- How an Escalation Clause in Real Estate Works
- When to Use an Escalation Clause in Real Estate
- Escalation Clause: Considerations for the Seller
- Escalation Clause: Considerations for the Buyer
- Tips For Success With Using Escalation Clauses
- The Bottom Line: Escalation Clause in Real Estate
Submitting an offer for a property can be stressful for real estate investors and homeowners alike.
“Was the offer good enough?”
“Are we going to get the property?”
There is one strategy you can use to improve your chances of securing the contract in a bidding war.
It’s called an escalation clause.
In this article, we’ll explain the nuances of an escalation clause in real estate to see if it’s right for you to use whether you're buying your next home or bidding on your next investment property. Plus, we will explain when you shouldn't use an escalation clause in your real estate offer.
What is an Escalation Clause?
An escalation clause tells the seller you are willing to pay more if they receive a higher offer.
An escalation clause in a real estate contract tells the seller you are willing to pay X, but if they get a higher offer, you will increase your offer.
A real estate escalation clause can strengthen your offer and make your contract more attractive to sellers.
When you include an escalation clause in a real estate offer you are telling the seller two things.
First, you are conveying the message that your offer is serious.
Second, you are telling the seller that you are willing to increase your offer.
You remain competitive even after the seller receives a higher offer.
While a real estate escalation clause is relatively simple, in practice there are many details to consider.
It is important to get professional advice when crafting the language to give you the best chance to land the deal and protect your best interests.
Advantages of an Escalation Clause
There are several advantages to including an escalation clause with your offer.
An escalation clause can reduce stress for the buyer.
When you fall in love with a property you want to make sure you get it.
But in situations where multiple offers are made, there’s always the element of the unknown.
Did you bid high enough?
Will you get outbid?
An escalation clause removes much of this worry because you know that your offer will increase if someone comes in higher.
Negotiations are streamlined with an escalation clause.
Many buyers (and sellers) hate the negotiation aspect of buying a house.
The back-and-forth process can be stressful, especially if multiple buyers have placed offers.
With an escalation clause, you can speed the negotiation process because your offer will automatically increase up to your cap as new offers come in.
With an escalation clause, your offer stays competitive, without overpaying.
When buying a home, it’s important to stay within your budget.
You want to make sure you put forth the strongest offer you can, while still getting the best price possible.
By including an escalation clause in your offer, you can make an initial offer that you’re comfortable with, but also know you’ll stay competitive against other offers.
Include a maximum amount in the clause so that you won’t end up paying more than you can afford.
Disadvantages of an Escalation Clause
An escalation clause may not be for every buyer.
There are some disadvantages to be aware of before including one with your next offer.
You lose the advantage in negotiations.
With an escalation clause, the seller knows the buyer’s maximum amount right away.
Even if a buyer ends up being the top offer, if they haven’t reached their maximum amount, the seller may negotiate higher.
With all your cards on the table, you could end up paying more.
Agents may not be familiar with an escalation clause.
In today’s increasingly competitive real estate market, escalation clauses are becoming more common.
But that doesn’t mean every agent knows how to handle them properly.
Especially in situations with multiple offers — and if each contain escalation clauses — things can get complicated quickly.
With each buyer’s maximum amount known, the agent may simply default to asking for best and final offers to simplify matters.
Poor wording in an escalation clause can be an expensive mistake.
Be sure you have a well-written clause in your offer. Even a slight miswording can cost you.
If the clause neglects to include a cap, you may find yourself with a house far beyond what you can afford.
Or your clause may be too vague on what is included or considered such as commissions or fees.
Comparing your offer to others might be like comparing apples to oranges.
Consult with an attorney to make sure you have the best wording possible.
How an Escalation Clause in Real Estate Works
Real estate escalation clauses can vary, but they all include several basic components, such as:
- the original purchase price offer
- how much you will escalate the offer above a competitive bid
- the maximum amount you are willing to spend on the property
Escalation Clause Real Estate Example
You may submit an offer of $200,000 for a property with an escalation clause of $2,000 and a cap of $240,000.
If the seller receives an offer of $210,00, your offer will jump to $212,000, $2,000 more than the intervening offer.
Your offer will automatically increase until you reach the cap limit of $240,000.
When to Use an Escalation Clause in Real Estate
There are times when an escalation clause is advantageous — and sometimes it's best to not use one.
An escalation clause is most useful when:
- you are reasonably sure the property will receive multiple offers
- if you are offering a low price
- if you have the funds and/or financing to purchase the property at a higher price
If there is not a lot of competition for the property, it does not make sense to reveal the highest amount you are willing to pay.
An escalation clause can also work to your advantage if the property is a great deal that you do not want to pass up.
It is not a good idea to use an escalation clause if you are close to your budget limit with your first offer.
Also, some sellers will not entertain a contract that contains an elevator because they prefer to have buyers submit the exact price they are willing to pay.
Escalation Clause: Considerations for the Seller
When sellers accept your offer that contains an escalation clause, they give up the right to negotiate with the highest bidder.
They cannot give counter offers to other parties who are interested in the property.
This situation puts them in a position where they may stand to lose a substantial amount of money on the sale.
That being said, if you fixed a property and are now focused on flipping and selling it for a profit, you might not want to allow escalation clauses.
Escalation Clause: Considerations for the Buyer
An escalation clause in your real estate offer can keep you in the running if the seller receives a higher offer.
However, it also tells the seller exactly how high you are willing to go to buy the property.
As an investor, you might have a better outcome if you negotiate with the seller.
Also take into consideration that you may be able to get the home at a good price using other avenues, such as submitting an all cash offer.
Tips For Success With Using Escalation Clauses
If you’re thinking about including an escalation clause in your next real estate offer, keep these tips in mind.
Verify that competing offers are legitimate.
Be sure to include wording in your clause that the seller must show proof of a bona fide offer, rather than just taking their word for it.
In addition, consider adding wording that offers must be from an unrelated competing buyer.
This prevents the seller from getting a relative to submit an offer just to drive up the price.
Choose a reasonable maximum amount.
Cap your escalation clause at an amount you can afford.
Don’t get caught up in the excitement of purchasing a new home and offer an amount far beyond your budget.
Even if you get outbid, you’ll know the house you eventually end up buying won’t send you into bankruptcy.
Be aware of a possible appraisal gap.
An escalation clause can cause the purchase price of the house to go over the appraisal amount.
Mortgage lenders often won’t lend more money than what the home appraises for.
This can mean you might not have enough money to pay what you offered.
Be sure you have the cash to make up any difference between the appraisal and your offer.
The Bottom Line: Escalation Clause in Real Estate
Including an escalation clause in your real estate offer can be an incredibly useful tool for real estate investors looking to invest in their real estate niche.
You may be willing to pay a little more to get a great deal, especially if you expect the property to attract multiple offers.
However, it’s important to seek the advice of an experienced real estate attorney to find out if an escalation clause is in your best interest — and to enhance your real estate knowledge. The language of the clause matters, so make sure to consult with a professional if you decide to include it.