What is an escalation clause?

What is an escalation clause?                      

In today’s hot, Washington DC area real estate market we have seen the return of multiple offer situations due to the low inventory, great interest rates and high buyer demand resulting in the frequent use of the “Escalation Clause” (search Washington DC properties). An escalation clause is a two-page addendum that will negotiate for a buyer when s/he is up against other offers. The clause states the maximum price the buyer is willing to pay (the cap) in a specified increment (escalating factor, i.e., $1,000) above the other offer(s). In order for a seller to activate a buyer’s escalation clause addendum, they must show proof of a bona fide offer (with documentation) to justify the sales price increase. The escalation increase procedure paragraph explains how the increase will be accounted for - with an increase in the down payment, an increase in the loan amount, or paid by cash.

How does an escalation clause work?

Below is an example:

- Nicole offers $500,000

- Jason offers $490,000 with an escalation clause up to $508,000 with increments of $1,000

- You offer $500,000 with an escalation clause up to $515,000 with increments of $1,000

Your offer would escalate $1,000 above the next highest offer. In this case, $509,000, which is $1,000 above Jason’s maximum offer of $508,000. Keep in mind, just because you are willing to pay a certain amount doesn’t necessarily mean the home will appraise for that price so be careful about going too high. This is where the appraisal contingency comes into play to protect the buyer if a house doesn’t appraise for the contract price. In very competitive circumstances, some buyers may wish to forego the appraisal contingency to make their offer even stronger. By doing that, the buyer is agreeing to pay the difference if the appraised value comes in less than the contract price. 

Price is not the only deciding factor for a seller although it is usually a high priority. Other factors a seller may consider are closing date, contingencies (home inspection, appraisal, mold inspection, radon inspection), financing vs. cash, and pre or post-occupancy needs. Also, in some multiple offer situtions a seller may simply ask all buyers for their "best and highest" offer instead of allowing escalation clauses; this often happens with foreclosures, REO properties and estate sales.

If you do find yourself in a multiple offer situation using an escalation clause, don’t get carried away; determine the maximum price you are willing to pay for the home and stick with it.