Buyers in competitive markets must do everything possible to make their deals stand out from the crowd. It may also be necessary to include an escalation clause in some cases. Continue reading if you’ve been wondering if an escalation clause will help you purchase a house or in your real estate investments. You’ll learn what an escalation clause is, how it functions, some examples and what impact it may have on your bid in the sections below.
What is a Real Estate Contract Escalation Clause?
In real estate purchase agreements, an escalation clause is often part of the agreement. This is particularly when there is a lot of interest in the land. As the name implies, an escalation clause is a provision that allows buyers to escalate, or boost, their bid on the home to beat out the competition.
This stipulation, also known as an escalator clause, is triggered when the seller receives a higher bid than the one initially received by the buyers in question. It notes that the buyers are willing and capable of outbidding the higher offer up to a certain extent.
If the higher bid is less than the maximum amount specified in the escalation clause, the buyers in question will be able to purchase the home at the increased price.
When bidding on a house, why would you use an Escalation Clause?
Simply put, any time you make an offer on a house, you’re taking a risk. If your offer piques the sellers’ attention, they can be open to negotiating with you. If the sellers believe your bid is too low or otherwise impractical, they will choose not to answer at all. In other words, there is no guarantee that you will be able to negotiate with the sellers. This is particularly if you are competing against multiple offers.
In this regard, using an escalation clause provides a bit of a safety net. It gives the sellers extra confidence that they will accept your offer. It shows you’re serious about buying the home. It’s so serious, in reality, that you’re willing to outbid the competition for the chance to be the winning buyer.
With that in mind, escalation clauses are better reserved for circumstances in which you know there is a lot of interest in the property and you are dead set on your bid being accepted. In reality, submitting an offer with an escalation clause involves a bit more uncertainty. This is because you don’t know how much you’ll ultimately be expected to pay when you send in the offer. You must really wish to buy the house, even if that means paying the maximum sum specified in the clause.
What is the Role of an Escalation Clause?
Any escalation clause in a real estate contract usually consists of three distinct sections. Examine them carefully to ensure that your real estate agent has included all of them in your purchase agreement:
#1. Proof of a genuine offer:
You can be assured that sellers would not use an escalation clause to force you to pay a higher sale price. When the contract requests “proof of a bona fide offer,” it means that the listing agent must be able to demonstrate that another offer with a purchase price higher than your original suggestion came in. The listing agent will send over a copy of the page from the other buyer’s purchase agreement showing the higher price. Any identifying details for the other customer, on the other hand, will be redacted.
#2. An Escalation number:
Provide in the escalation clause an amount by which you would like to outbid any higher offers. For example, if the sellers’ highest bid is $300,000 and your escalation sum is $5,000, the escalation clause would automatically raise your offer to a total of $305,000.
#3. A price limit:
A price cap reflects the most you’re willing to pay for the land. It also shows how far you’re willing to let your bid go. If an offer is made that is greater than this number, your offer will be removed from consideration.
An escalation clause works by excluding the middleman from price negotiations. In most real estate transactions, if the sellers receive two equally competitive offers, the selling agent will contact all parties and request that they send their highest and best bid. The sellers will then discuss how to proceed after both buyers have responded.
You’ve removed the need for all of the back-and-forth by using an escalation clause. In this situation, your stance is written down, including how far you’re willing to let your bid go. You’re more likely to hear whether or not your bid was accepted rather than being asked whether you’re willing to discuss the purchase price.
Three Examples of using an Escalation Clause
If you’re still having trouble with how an escalation clause works, it may help to look at some examples. The following are three different examples of how an escalation clause might be used.
Let’s assume there are several deals on the table in each case. You’ve submitted the following bid, which includes an escalation clause:
- The asking price for the property is $350,000.00.
- The initial bid was for $350,000.
- The escalation number is $3,000.00.
- The price limit is $360,000.
Scenario #1: You make the highest bid.
In this scenario, even if you submitted an offer with an escalation clause, it doesn’t have to be implemented. If the sellers are primarily concerned with netting the highest possible dollar sum for their asset, you can win the bidding war. You just have to pay the amount you originally offered, which is $350,000.
Scenario #2: A slightly higher bid is made.
Assume another bid of $355,000 comes in. Normally, since the buyers are concentrating on having a high selling price, your $350,000 bid will be ignored. However, in this case, your escalation clause will take effect. The clause would immediately raise your bid to a purchase price of $357,000, allowing you to purchase the house.
However, for you to be legally obliged to pay the full sum of $357,000, the listing agent must supply evidence that the sellers did indeed accept a $355,000 bid.
Scenario #3: Another bid is significantly higher.
Finally, suppose an offer came in that was significantly higher than yours, at $365,000. Even if the escalation clause is present in this example, it will not be enough to help you win the house. Since you set a price limit of $360,000, your bid would only rise to that level, implying that the other offer is still worth $5,000 more than yours.
Benefits of using an Escalation Clause in a Real Estate Contract
In fact, there are many reasons why you would want to include an escalation clause in a real estate contract. This clause, when used correctly, can be a powerful tool for helping you stand out from the crowd. It’ll eventually, help you land the home of your dreams.
To that end, we’ve mentioned a few of its most significant benefits below. Take a closer look to get a better idea of how adding this clause to your real estate contract could help you.
#1. It aids in keeping you relevant.
When a seller has many deals, they usually go through them one by one. However, when they do so, they have a tendency to rapidly narrow down the field until they’ve zeroed in on the top one or two deals that best suit their needs. When using this approach, it becomes very simple for them to pass up an offer that does not catch their attention.
An escalation clause would almost certainly serve as eye-catching information. If your initial selling price is insufficient on its own, the escalation clause will assist in keeping the bid under consideration.
#2. It demonstrates your strong desire for the property.
Selling a home can be both an emotional and a financial experience. Typically, sellers have built memories in their homes over the years. So it can be difficult to break from them when it comes time to sell. As a result, when it comes time to determine who will live in the home next, many sellers want their property to go to someone who will cherish it as much as they do.
Including an escalation clause in your offer shows the sellers that you’re serious about purchasing the house. It demonstrates that you are prepared to go above and beyond what is needed to become the home’s new owner. For sellers who have an emotional attachment to their home, going the extra mile to demonstrate that your heart is invested in the property may be enough to place your bid ahead of the competition.
#3. It reduces the need for bargaining.
Some consumers relish the prospect of bargaining; others despise it. If you are in the above category, including an escalation clause in your offer might be a good idea. Since it gives the seller a clear picture of your location from the start. Hence, it reduces the amount of back-and-forth between you and the sellers.
Read Also: Buy and Sell Agreement: How It Works, Key Elements, and Importance
Disadvantages of a Real Estate Contract Escalation Clause
That being said, this clause, like everything else in existence, isn’t flawless. It does have some drawbacks, which you should carefully consider before including one in your bid. Here are a few possible pitfalls to be aware of.
#1. It just takes into account the selling price.
While this clause will help you ensure that you’re the one offering the most money to the buyers, keep in mind that the selling price is just one aspect of a deal. Furthermore, in some cases, money might not be the sellers’ top priority.
Some sellers, for example, may have school-age children and prefer a settlement date that allows them to move before the start of the new school year. Some sellers do not feel up to the challenge of making repairs to the property. So they may seek an offer that waives inspections.
#2. It “tips your cap” to the sellers.
Another disadvantage of this provision is that it effectively allows you to put all of your cards on the table. By including a price limit in your escalation clause, you’re basically asking the sellers how much you’re willing to pay for the house. So, there’s nothing stopping them from simply counteroffering at that price.
If you use this tactic, keep in mind that you are giving up some of your bargaining power in return for a greater chance of being the winning bid.
Should you have an Escalation Clause in your Offer?
Now that you’ve learned more about escalation clauses and seen the examples, the next move is to determine whether to include one in your offer. Finally, only you know which decision is best for you. If you’re still unsure, consider the following questions to help you decide whether having this clause in your offer makes sense:
- Are you certain there are several offers on the table?
- How badly do you want the house? Is it bad enough that you’re willing to pay more for it?
- Will you be disappointed if you realized you didn’t get the house because your selling price was too low?
If you replied “yes” to all three queries, chances are you’re ready to use an escalation clause to increase your chances of submitting the winning offer. If not, think twice before including it in your contract.
Tips on Writing an Important Escalation Clause
All of that being said, if you ever intend to include an escalation clause in your bid, there are a few things you can do to make it as successful as possible:
- Let your escalation number count.
In reality, the escalation amount is what tells the sellers how badly you want the home. It shows how far you’re willing to go to beat out the competition. With that in mind, make it count. Be sure to select an escalation number that is big enough to make the sellers feel like they would really profit from accepting your bid.
- Do the math on your limit.
The last thing you want is to be dissatisfied with your new home because you paid too much for it. Do the math before deciding on a price limit for your escalation clause. Ask your agent to calculate your monthly payment and closing costs based on the selling price. Make sure you’re comfortable paying that amount. It’s fine to change your price limit if you think it’s too high for you.
- Make it clear to your lawyer that you are able to discuss other things as well.
Finally, though it will not be included in the written contract, make it clear to your agent that you are willing and able to negotiate on other aspects of the contract in addition to the sale price. This will help cover your bases if the sale price is secondary to the sellers. Hence, it’ll put you in a better light because it shows that you’re willing to accommodate the sellers’ needs.
Advantages Of Escalation Clause
- The escalation clause helps buyers to stay within their budget. Keeping buyers within their budget limits means that buyers are not overpaying for the property.It make both the buyer’s and seller’s offer presentable and attractive
Disadvantages Of Escalation Clause
- It also does not make provisions for property appraisal
What is a Rental Escalation Clause?
A Rental Escalation Clause is a type of Escalation Clause that adjusts the rent amount for a lease based on changes in a specific economic index or formula, such as the Consumer Price Index (CPI).
What is a Consumer Price Index (CPI)?
The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
What is a Producer Price Index (PPI)?
The Producer Price Index (PPI) is a measure of the average change over time in prices received by domestic producers for their output.
Can Escalation Clauses be challenged or disputed?
Yes, Escalation Clauses can be challenged or disputed if they are deemed to be unfair or not in accordance with the terms of the contract.
How are Escalation Clauses enforced?
Escalation Clauses are enforced through the legal process, including mediation, arbitration, or court action.
What happens if an Escalation Clause is not included in a contract?
If an Escalation Clause is not included in a contract, the parties may have to renegotiate the terms of the contract or reach a new agreement in the event of cost increases or inflation.
What is a Cap Escalation Clause?
A Cap Escalation Clause is a type of Escalation Clause that limits the amount of increase in the price of a product or service.
The Bottom line
In the end, whether or not to include an escalation clause in an offer is a personal choice. When putting together an offer, you must be comfortable with all of the terms outlined in the contract. So the escalation clause is no exception. You will be better prepared to decide whether using one is the right choice for you if you learn more about how this clause works as well as some of the benefits and drawbacks associated with it.
Escalation Clause FAQS
Is an escalation clause legal?
Is an escalation clause legal? Writing an escalation clause on the initial offer in a multistage situation could put the buyer in a weak position during the second round. It’s perfectly legal for a seller’s Realtor, with the seller’s permission, to reveal to all potential buyers what the top initial offer is and to ask everyone to beat it
How do you beat an escalation clause?
- Understand the three major components of an escalation clause. …
- Weigh the overall strength of the offer — and the buyer’s commitment. …
- Keep the appraisal top of mind. …
- Request buyers bring their highest and best. …
- Ensure final offer terms are clear — and in writing.
Can you back out of an escalation clause?
Whether you’re able to back out of an escalation clause really depends on the extenuating circumstances and the details of your contract. For instance, if certain contingencies in your contract weren’t met, you may have a case for backing out of the agreement.
Why would a seller not want escalation clauses?
Not To Use – That being said, escalation clauses do have strategic drawbacks buyers should consider. One, including an escalation clause may cause the buyer to pay more. After all, by using an escalation clause, a buyer is telling a seller how high the buyer is willing to go.
- Holdover Tenant: How to Calculate Hold Over Rent Without Stress (+Detailed Guide)
- Buy and Sell Agreement: How It Works, Key Elements, and Importance
- HOUSE POOR: Best Easy Guide to Buying a House Poor Credit (+ Free Tips)
- Proof of Claim: How to file proof of Claim in Bankruptcy
- FORECLOSURE ATTORNEY: Overview and Fees (Updated!)
