What is an Escalation Clause?

Escalation clauses are provisions that are included in real estate contracts to protect buyers from losing out on a property due to other offers. Essentially, an escalation clause is a clause that allows a buyer to increase their offer on a property in order to outbid any other offers. This can be particularly useful in a competitive real estate market where properties are selling quickly and for above the asking price.

In this article, we will explore the basics of escalation clauses in real estate, including how they work, the pros and cons of using them, and some tips for including them in your real estate contracts.

An escalation clause in short, is a way to outbid the competition without running the risk of overpaying for a property. Unless there is another viable, written offer, an escalation clause would be a non-factor.

How do Escalation Clauses Work?

Escalation clauses work by allowing a buyer to outbid any other offers that may come in on a property. When a seller receives multiple offers on a property, they will typically review each offer and select the one that is the most attractive to them. This could be the offer that is the highest in price, the offer with the fewest contingencies, or the offer with the shortest closing timeline, among other factors.

If a buyer includes an escalation clause in their offer, they are essentially saying that they are willing to pay more than their original offer in order to outbid any other offers. If another offer comes in higher than the buyer’s original offer, the escalation clause will kick in and increase the buyer’s offer by a predetermined amount, up to a maximum amount specified in the clause. This tactic is commonly used in real estate auctions held online and can be used in traditional deals as well.

For example, let’s say that a buyer submits an offer of $400,000 on a property with an escalation clause that increases their offer by $5,000 over any other offer, up to a maximum purchase price of $425,000. If buyer 1 submits an offer of $405,000, the escalation clause will kick in and increase the first buyer’s offer to $410,000. If buyer 2 submits an offer of $415,000, then buyer 1’s offer will increase to $420,000. If buyer 3 submits an offer of $430,000, buyer 1’s offer will not increase any further, as it exceeds their maximum purchase price of $425,000.

Pros and Cons of Using an Escalation Clause

Pros:

1. Competitive Advantage: In a competitive real estate market, including an escalation clause in your offer can give you a competitive advantage over other buyers.

2. Saves Time: An escalation clause can save time by eliminating the need to renegotiate the terms of the contract if another offer comes in higher and prevents you from losing a deal without having a counter offer or a chance to increase your offer.

3. Increases the Chances of Winning: By allowing you to outbid other offers, an escalation clause increases your chances of winning the bidding war for a property.

4. Avoid Offering too much: You avoid over-paying as there must be a competing, viable offer for your escalation clause to take affect.

Cons:

1. Not Widely Used: Inexperienced agents or agents not as familiar with purchasing investment properties will have a hard time advising you on how to be competitive when offer on a property using an escalation clause.

2. Seller’s Choice: The seller has a choice to ignore this part of the agreement and not honor an escalation clause or to counter your offer.

3. Show your Cards: If you offer with an escalation and you are the only offer, you run the risk of telling the seller the max price you are willing to pay. Even without a competing offer the seller can accept, reject or counter your offer.

As always, discuss this option with your real estate agent. Their job is to get you the deal without you overpaying. I employ this strategy when I see a Highest & Best call on an property. A Highest & Best call is simply when a seller has multiple offers and gives all potential buyers a deadline to present their best offer. Since these can be competitive deals, I like to use an escalation clause in my offer/agreement of sale. It makes my client’s offer stand out and it has worked countless times.

Let me know in the comments if you have ever had any success with Escalation Clause or if you’re interested in learning more. As always, you can schedule time with me to discuss this or any other investing questions you may have by clicking on my calendar.