ESCALATION CLAUSE REAL ESTATE: Why And When You Should Use It

esescalation clause real estate

When someone wants to sell a property, interested buyers present their offers. The offer proposal entails how much the buyer is willing to pay for the property. However, depending on the estimated worth of the property, its location, and the tendency for it to increase in value, several buyers compete for the property. In such a situation, a buyer may decide to bid the escalation clause to ensure that he remains the highest bidder on the property. Let’s take a quick tour of the real estate escalation clause, its sample, example, how to beat it, when as well as when and why to use it.

Escalation Clause Real Estate

In real estate, the escalation clause is a mechanism buyers try to ensure they buy a property available for sale.

Generally, adding it to a proposal increases your chances of having the highest offer, thus getting the property. There are usually three elements to it. These are the proof of offer, the escalation amount, and the price cap.

There Must Be a Proof of Offer

There are usually three elements to it. These are the proof of offer, the escalation amount, and the price cap. There must be a greater offer than the bidder’s before sellers can employ the escalation clause. 

The Escalation Amount

The offer must indicate the exact amount he intends to use in outbidding other interested buyers. 

The Maximum Price Cap

The price cap is the highest amount the buyer can pay for the property. 

What Is An Escalation Clause In Real Estate?

The real estate escalation clause is a contract condition that allows a buyer to increase the price he intends to buy a property if other buyers offer to buy the property at a higher price than he bedded. This simply means, that if Mr. Smith promises to buy a real estate property for $750,000, the escalator clause allows him to increase his bidding if another person offers to buy the house above $755,000.

The above example of the escalation clause in real estate expresses Mr. Smith’s willingness to purchase the property. The escalation clause indicates that a buyer is willing to raise the initial offer if successive higher offers are presented in real estate. They are typically found in the underwriting of deals. Generally, it exists to provide a safety net for potential buyers in the event of an outbid. However, there are limits to a bidder’s offer.

How Does An Escalation Clause Work?

Escalation clauses in real estate contracts can take many forms, but the core elements they give are always the same. The real estate escalation clause will address the following;

  1. Original purchase offer
  2. The exact price the intending buyer is willing to pay above other buyers
  3. Maximum purchase price in case there are many offers

There’s nothing complicated about escalation clauses; they simply allow buyers to increase their first offer slightly to compete with other offers. It’s possible to include a provision in an offer that specifies that the investor is willing to beat all additional offers by a set amount, up to the maximum amount they are willing to pay. Let’s take the following real estate escalation clause example. Frank is an investor who wants to buy Mrs. Porah’s inherited property. He offered to buy it for $350,000. However, he can employ an escalation clause to beat other rival offers by a specified amount. So if someone offers to purchase the same building for $352,000, the real estate escalation clause allows you to beat the offer. However, Frank needs to be clear on the amount of money other investors are willing to pay to beat out other proposals, up to a certain price range. 

Does Every Home Seller Accept Escalator Clause?

In real estate, not every seller accepts an offer with an escalation clause. Some would prefer that all buyers enter the precise amount they are willing to spend for the property or home. Others may find it appealing because it encourages investors to outbid themselves. 

Must There Be Multiple Offers On A Property?

Not in every situation. However, buyers should only utilize escalation clauses if they are certain that there will be multiple offers or if they will be able to pay a higher price.

When Should Investors Use The Real Estate Escalation Clause?

Any property buyer who intends to use the real estate escalation clause to beat other buyers must first ensure that there are multiple offers. Moreover, buyers that include an escalation clause in their offer are revealing all of their cards upfront. So the general rule is this, ” only use the escalator clause when you are sure a property is going to get a lot of interest from potential buyers.

When an investor has the cash on hand to buy a new asset, even at a higher price point, than they initially intended to provide, an escalation clause might give them an advantage over their competition without putting them in danger of paying more than they are willing to spend. Investors that wish to keep their offer on the table could take advantage of an escalation clause. With this in mind, it only makes sense to include this condition in your offer if you are convinced that the property will be able to cover any additional costs that may arise from it.

Escalation Clause Real Estate Example 

We already include the real estate escalation clause example above, however, let’s consider another one. 

Let’s assume Will is moving to Washington from Georgia and wants to sell his house. Alfred is a property investor who wants to buy the property from Will. So Will offered to pay $250,000 for the property. However, he instructs his Realtor to include a clause if there are higher offers for the building. Will’s Realtor then will prepare the real estate escalation clause stating Will’s desire to beat other potential buyers.

So the contract indicates Will’s willingness to purchase the property and the maximum price she will be paying for it. For instance, the clause will state Will is willing to pay an additional $1500 with a cap limit of $15,000. This means if someone else offers to purchase the property for $265,000, The clause raises Will’s offer till it gets to $265,000. 

Note: The above example and sample of a real estate escalation clause is only an illustration. Your contract must not be in the above format.

Ethics of The Real Estate Escalator’s Clause

Are there ethics and rules that guide the real estate escalator’s clause? Let’s find out. 

When a client invokes the escalation clause, real estate brokers are bound by a code of ethics and other rules. Some Of these include;

  1. The realtor must understand that his primary responsibility is to protect and promote his client’s interest.
  2. The broker must also gather all the relevant information and make them known to his client.
  3. The buyer’s realtor protects the buyer while the seller’s agent acts on behalf of the seller.

Arguments Against The Real Estate Escalator’s Clause

There are several arguments against the real estate escalation clause. Some argue it leads to certain complexities while others think it is simply unethical. Reasons for arguments are seen below.

  1. Buyers do not see the bids they are competing with. They simply rely on the seller’s agent’s words which is not logical. This is because they can easily manipulate the offers. 
  2. The seller can revoke a buyer’s escalation clause contact
  3. The number of bids is known to the buyer and his realtor but not the exact offer.
  4. There are no criteria to confirm the said counteroffer

In Dealing With Escalator Clause, Seller’s Ensures;

  1. A buyer may drop his proposal with a clause but it is the seller who decides whether to accept it or not.
  2. Keep an eye on the offer price, especially the top end.
  3. It is also possible for sellers to set a fixed price for their property and drop the escalation option.
  4. Make sure the exact price is documented on the agreement before signing because accepting an offer with an escalation clause forms a contract of purchase and sale.

Advantages Of The Escalator Clauses

Investors enjoy several benefits with the escalator clause. We will explore some of them below

Better Chance Of Purchasing Properties

Prospective purchasers who include an escalation clause will not be easily removed from the deal. Most often, they are taken more seriously by sellers. This in turn offers such buyers the advantage over those who are not willing to include it.

It Handles the Fear of Losing Property

The buyer’s peace of mind is one benefit of incorporating an escalation clause in real estate. Making an offer on a piece of real estate can be nerve-wracking, especially if it’s a property you’ve fallen in love with. With an escalation clause, you have a better chance of succeeding while also avoiding overpaying.

It Seal Deals Faster

The clause should raise the offer just enough to seal the transaction without going too much over if the language is equal to the task.

Possible Higher Offer

The seller who already has access to how much you are willing to pay for his property uses it as an opportunity to hike the price. The provision is also beneficial to the seller because they expect better offers if certain conditions are met.

Disadvantages Of The Real Estate Escalator’s Clause

There are disadvantages of including the clauses in your proposals and these are as follows;

  1. The primary disadvantage for the buyer is that the seller already knows your financial position over their property. Being aware that you will likely increase your offer in the face of competition, They may design a counteroffer. Just to get more money from you.
  2. The seller may still give the property to another person particularly when they do not understand the escalation clause functions to beat other offers in real estate. 
  3. Depending on the property in question, sometimes the use of an escalation clause in a real estate contract leads to a bidding war.
  4. It’s possible to overpay for a property if you’re not vigilant enough.
  5. The real estate escalation clause might have an impact on bank appraisal in several cases.

Sample Escalation Clause Real Estate 

In examing the real estate sample, we will look at another critical factor, the Language style. 

Real Estate Escalation Clause Language

Technical language must be employed in drawing the provision for Real Estate Escalation Clause. Using technical language makes it an official contract and doing this correctly makes all the difference. Therefore you’ll want to be as very explicit and overly meticulous with your choice of words. We will look at the sample of the real estate escalation clause language.

The buyer Mr.Hilbert in a particular agreement is willing to pay an additional $__________ for the property in question, on the condition that the seller receives a legitimate offer that exceeds the initial offer. The buyer is willing to raise his buying price to $___________ above other offer up to $___________

Now we will examine the real estate escalation clause sample in a more practical sense.

Mr.Bruce offers to buy a property for $480,000. However, he wants to add an escalator clause to it. The sample of his real estate escalator clause will be similar to something like this.

The buyer Mr.Bruce is willing to pay an additional $2000 for the property in question, on the condition that the seller receives a legitimate offer that exceeds the initial offer. The buyer is willing to raise his buying price to $2000 above other offers up to $490,000.

The sample of the real estate escalation clause shows Mr.Bruce is willing to beat other buyers by $2000 and his maximum cap is $10,000.

How To Beat Escalation Clause

We will look at how to beat the escalation clause from two angles, the buyer’s and the seller’s perspectives.

How Can a Buyer Beat The Escalation Clause?

  • First, understand the three components of the escalation clause
  • Estimate the exact value of the property to avoid overpaying
  • If the property is worth the additional money you want to spend on it, find out if it has multiple offers
  • Get the help of a lawyer or a real estate broker to draw up your escalation contract

How Can a Seller Beat The Escalation Clause?

  • To beat the escalation clause, the seller must first decide whether they want to accept it or not. If you do not want to accept it, you can simply ask interested buyers to submit their best offer.
  • If you choose to accept the offer, then you must weigh the overall strength of the offer and the buyer’s commitment to buying your property. This is pertinent because some buyers will likely back out when it gets to the cap price.
  • Invite buyers to place their offer
  • Make sure the final negotiation terms are clear.

Conclusion

The purpose of the real estate escalation clause in a contract is to keep prices on the table. This does not in any way make you the owner of the property but it does give you a competitive edge over other buyers. 

FAQs On Escalation Clause Real Estate

Can I outbid an accepted offer?

It is possible particularly when your bid is subject to bank approval.  A bidder may overbid you to get your offer if your offer is subject to the bank’s approval. 

What happens if there are two offers with escalation clauses?

When a property is up for sale, interested parties will do everything possible to get the property. That is why buyers use the escalation clause in their contract proposal. When more than one buyer presents a clause, it is up to the seller to choose the highest bidder or sell to whomever he pleases.

Can I keep my house on the market after accepting an offer?

Although the seller may have accepted your offer, the agreement between you and the seller is not legally binding until contracts are exchanged. However, you can ask the seller to take the property off of the market, but it is ultimately the seller’s decision.

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