ESCALATOR CLAUSE: What It Is & How It Works in Real Estate

escalator clause
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Whether it’s insurance, property tax, buying a property, or even leasing an apartment, there is an escalator clause added to most of the contract agreements available in the State. But why is the escalator clause common in contracts, is it within the context of your lease agreement or buying a house agreement, and how can you deal with it? This guide provides answers to everything you need to know about the escalator clause in real estate.

Escalator Clause

Generally, a clause in any contract is a provision for adjustment. In real estate, there are two common ways this provision is utilized. In a contract offer to a buyer and a lease agreement between a landlord and a tenant. Even when used in different instances, the escalator clause serves the same purpose.

What is Escalator Clause?

The escalator clause is a provision in a contract that permits the parties to increase the value of the initial price or offer made to a landlord or a home seller. This provision is also known as the escalation clause. They are added in the underwriting of offers, suggesting that the buyer is willing and able to enhance their original offer if greater offers are presented in the future. Aside from a buyer’s offer to a seller, the escalator clause is also added to a lease agreement or even an insurance cover. The escalator clause in a lease, however, differs from the purpose of an offer made to a seller. 

How Does It Work?

How this works largely depends on the contract. For instance, when the escalator clause is added to insurance, it serves the same purpose as in a real state or lease but functions differently. However, it is certain that under some conditions, there will be an increase in the price original offer.

Escalation Clause Real Estate

The real estate escalation clause is a provision in a contract that permits a buyer to increase the price at which he intends to purchase a property if other buyers offer a higher price up to a certain amount. It is a strategy used to convince a seller about the buyers intent to buy a house up for sale.

For instance, Williams offered to buy Adam’s property for $470,000. However, there are chances that someone else will offer to pay a higher price for the property. Williams is simply going to add a provision stating that he is willing to increase the price by $2000 up to $10,000. This simply means if another buyer opts to buy the house for $475,000, the seller will still consider Adam’s offer till he gets an offer above $480,000.

How Does Real Estate Escalation Work?

The buyer who writes and presents an offer to a seller must have seen the house up for sale. The offer must contain three key components. These are

  • The initial offer
  • The price at which the offer will rise
  • The maximum offer is a cap on the offer price. 

Using the example above, Williams’s initial offer is $470,000. The price at which the offer increases is by $2000 and the maximum offer is $480,000 which is the highest price at which the buyer is willing to purchase the house. More elaborately, Clinton is another buyer who has an interest in Adam’s property. He offers to pay $450,0000 for it. This is below William’s offer so the seller has no interest in his bid. George offers to pay $475,000 which is above Williams’s initial offer, this simply means he will increase his offer by $2000 and the new offer will be $476,000.

When Should a Buyer Include the Escalation Clause in an Offer?

A buyer wouldn’t want to miss out on any great deal. Especially if the house is still intact, and requires little or no renovation located in a good environment with great chances of increasing in value.  Buyers, therefore, include the escalator clause when;

#1. The House Is a Hot Chase. 

This is basically when there are several buyers showing interest in the house and trying to outbid the others. 

#2. When You Want Your Offer to Stand Out

When you want your offer to stand out When there are numerous potential buyers, including an escalation clause in your offer shows the seller that you are serious about buying the home, which might help your offer stand out.

#3. Speed up the Bidding Process

You can also include this in your offer when you want to want to make the bidding process more efficient and fast. Indicating the highest price you would buy the house, other buyers will likely back out in time. 

Escalator Clause In a Lease

Most lease agreements include the escalation clause. Although, there are times when a tenant can sign the tenancy contract without properly understanding the content. This usually results in a brawl when the rent is reviewed. That is why it is important to properly go through your lease agreement, you also contact an attorney to highlight every clause in your lease agreement.

When a lease agreement is renewed after its term, the escalator clause in the contract permits the landlord to increase the base rent. Most often, the rise is usually a percentage of the rent, and both parties agree to it. The escalator clause in a lease contract allows the lender to increase rent. However, the rent increase will only take place if certain conditions are met. The condition is mostly a rise in tax,  cost of living, inflation, or operational expenses. This simply means the clause has always been part of your contract but becomes effective under some conditions such as an increase in the cost of living or even inflation.

When a lease agreement is renewed after its term, the escalation clause in the lease agreement permits the lessor (landlord) to increase the base rate. The amount of escalation is usually a percentage of the rent, and both parties agree on it.

Why Do Landlords Include Escalation Clause in Contract Agreement?

Landlords usually add an escalator clause in their lease agreement to take advantage of market conditions. This is particularly when the house is located in areas where the rent increases rapidly. So the landlord wouldn’t want to accept any long-term agreement. He will lose out if there is a general increase in rent or a rise in tax. Therefore, landlords require tenants to agree to an escalation clause in their lease contract. 

Tenants’ Response to Escalation Clause

Depending on the type of escalation a landlord adds to your lease agreement, you can negotiate the terms especially if it is a percentage increase escalator clause.

You can also take out time to calculate your new rent. It will help identify your errors and demand your landlord to reveal the calculations that were made.

Types Of Escalator Clause

The following are some of the escalator clauses in a lease agreement.

#1. Indexed Escalator Clause

The indexed escalation is mostly unpredictably high and this results in rent. With the indexed escalation clause,  the rent increase is linked to the Consumer Price Index published by the Bureau of Labor Statistics in the United States. If your lease includes a CPI escalation provision, your rent will rise in lockstep with a predetermined measure of inflation.

#2. Regular Step Increase Escalation Escalation

A stepwise rise means that the amount of your lease will grow by a predetermined amount at regular intervals. It means if your rent will increase by a certain amount periodically, let’s say $3 per square foot. If you paid $10 initially, your rent increase by $3per square footage. This type of escalation gives tenants a clear understanding of their rent ahead of time. And with that knowledge, they get ready for their financial responsibility to the landlord before time.

 #3. Percentage Increase Escalation Clause

In the percentage increase escalation clause, the rent rises by a specific percentage. For example, a landlord can include an escalation that says the rent will increase by 1% of the current rent. You can also negotiate your lease with your landlord, to agree on a percentage increase in your rent throughout your lease.

#4. Direct Operating Cost Pass-Through Escalation

The operating cost pass through escalator clause added to your clause simply means your rent will increase whenever the cost of operating bills such as heating, electricity, maintenance, and security rises. If this clause is being added to your clause, you must ensure your landlord clearly define what he means by operating cost in writings. 

#5. Tax Pass-Through Escalator Clause

When the tax pass-through rent escalator clause is included in your rent, your current rent will only rise if your landlord’s property taxes rise during the period of your lease. This means you will normally be accountable for paying a proportion of the increase based on the units of space you occupy.

How Often Does Rent Escalate?

When it comes to increasing rent prices, it usually occurs at any of these times;

  1. Every year. When your lease commenced
  2. After some time. This can be every three years or 5 years depending on your agreement with your landlord.
  3. Once it is time to renew your rent

Tax Escalator Clause

In real estate, the tax escalator clause occurs in a lease agreement. The provision for a tax escalator clause in a lease agreement implies that rent rises every time the real estate property taxes increase. It simply means the increase in commercial rentals should be commensurate to increases in real estate taxes.

Escalator Clause Insurance

The escalator clause is also added to insurance policies. In the insurance industry, the escalator clause is also known as the inflation-guard endorsement. Insurance protects against losses or damages. Why this is true of every insurance coverage, the escalator clause factor in inflation. Inflation can greatly influence your claim such that it seems like you were underinsured. This is traced to the hike in the cost of things. 

Why Is It Necessary to Add an Escalator Clause to Insurance?

Inflation can greatly influence your claim such that it seems like you were underinsured. This is the result of the rise in the cost of things.  Adding an escalator clause to insurance allows the insurer to increase insurance coverage depending on the current cost of raw materials, labor, and other factors. Well just before you disagree with your insurance provider or argue about the escalator clause added to your policy, do remember the incessant rise in the cost of things. If you will ever make a claim, you will end up digging deep into your pocket to cover the cost of things.

Conclusion

While a seller will be super excited there is a possibility of selling his property at a higher cost, the buyer stands a chance of paying more than the house is worth. The tenant also gets to deal with the incessant rise in his rent agreement with little or nothing to do about it. Because they are merely promoting their interest.

FAQs On Escalator Clause

Can you back out of an escalation clause?

The mitigating circumstances allowed in a contract will determine whether you can back out of an escalation provision.

What is escalation and de escalation clause?

A de-escalation clause is a provision in a contract term that allows for price reduction after the contract has been signed

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