How Does an Escalation Clause Work?
Are you wondering what an escalation clause is and how they work? An escalation clause is perhaps one of the most advantageous contract clauses which any buyer can use to their advantage, whether they’re looking for their next property to flip or they’re finally seeking a forever home.
When added to a contract, it can make any buyer more attractive to a home seller looking to sell their property, allowing you to separate yourself from the competition very easily. Escalation clauses are typically used in strong seller's real estate markets where there are often bidding wars on a home.
But, what exactly is an escalation clause? And should you use one the next time you find some real estate you like?
Let’s answer these questions right here, right now…
Typically used when a buyer and their agent believe that a home will receive multiple offers, an escalation clause states that the buyer will need to pay a certain amount of money above any offer a seller has received.
Though this generally comes with a cap as a way for the buyer to protect themselves from paying way too much on a piece of real estate.
Essentially, an escalation clause improves the home buyers’ odds of getting a property, as they’re attempting to submit the highest offer.
Some of the things typically outlined within an escalation clause:
WHEN IT CAN BE USED: Sellers can only activate an escalation clause if a higher offer comes in. Essentially it can be used to increase the home sale price.
THE AMOUNT: Each contract is unique, but every one of them will state just how much the buyer is willing to pay above the highest bidder. The amount above the next highest offer is known as the "escalator."
THE CAP: Along with the amount the buyer is willing to pay, there will also be a cap of which they are willing to pay to ensure the buyer will not be out of pocket when buying the property.
The Mechanics Behind an Escalation Clause
Now that you know exactly what an escalation clause is, as well as how it benefits home buyers and sellers in at least some detail, we want to go over the mechanics behind this type of contract clause.
For example, a seller is selling their property in a great location with all the things a buyer could ever ask for in a piece of real estate from a property, and it’s on the market for $300,000.
The original listing agent has let all of the buyers know that their offers will be presented with the seller on a specific day, all at once, indicating that the seller and their agent expect multiple offers to come through for the property.
The seller receives many offers, and the highest one is currently $310,000.
A buyer comes in with an offer with an escalation clause, stating that they will pay $2,000 more than any other buyer, up to a maximum of $320,000.
In our example, the buyer will be paying $312,000 for the property in question should their offer be selected by the owner.
There Are More Terms in an Offer Besides Price
You need to remember that there are other essential terms in an offer to purchase besides just the price. You could use an escalation clause, be the highest bidder, and still not have your offer be selected. There could be any number of reasons why the seller chooses another offer. Here are a few of them:
- Another offer had a cash buyer.
- A different offer had a seller's preferred close date.
- Another offer had a better financially qualified buyer.
- A different buyer was putting down more money to be held in escrow.
- One of the other buyers was putting more money down, mortgaging less, and had a sterling credit history.
- In a different offer, the buyer waived their rights to a home inspection.
- The buyer waives an appraisal as a condition of sale.
- A combination of many of these things.
Real Estate agents and their respective buyers need to understand that while an escalation clause can be an excellent tool to become the winning bidder, never underestimate other terms' importance to a seller.
An excellent buyer's agent will probe the listing agent to determine what terms a seller is looking for in an offer. By doing this, you stand a much better chance of crafting a contract that will be acceptable to a seller. In other words, the buyer who comes out on top!
Should You Be Using an Escalation Clause?
Now that you know what this type of clause is and how an escalation clause works, it’s time to understand whether or not you should be using them.
Since every situation is unique, we can’t flat out recommend if you should be using this type of clause in your own real estate purchases, though we will go over the pros and cons to decide for yourself in the future.
Pro’s of Using an Escalation Clause
- Escalation clauses provide buyers peace of mind to increase the odds they will be in the running for a piece of property.
- Buyers who provide an escalation clause won’t be left out of negotiations or overlooked by the seller.
- Buyers with escalation clauses can be looked at much more seriously than other buyers.
- When done correctly, an escalation clause can be a great way for a buyer not to overpay for the real estate.
- Escalation clauses are great for sellers, too, as they’re almost always guaranteed a high offer on their property - assuming it’s worthy of enough buyer attention in the first place.
Cons of an Escalation Clause
- Using this type of clause means you lose one of the biggest advantages when it comes to investing in property; negotiations. Since you’re already stating just how much you’re willing to pay upfront.
- Many people, even real estate agents, have no idea what this type of clause is. The inclusion of one might be a cause for confusion and long delays. An unfortunate part of an escalation clause is dealing with an uneducated agent who puts a negative spin on it with their seller clients.
- Some sellers don’t want to deal with this type of clause, so you might be flat out ignored. Usually, they don't want to deal with it because of their agent's reluctance.
Final Thoughts on Escalation Clauses
When used properly, escalation clauses can be an excellent addition to an offer to purchase. Real Estate agents that understand these clauses can put their clients in a better position to land their dream home. When you have made offers on numerous homes and continue to be the losing bidder, an escalation clause can help put you over the top.
Hopefully, you have found this guide to using escalation clauses to be useful.