What Is An Escalation Clause And When Is The Time To Use One?
It’s not uncommon for sellers to receive more than one offer in a soaring real estate market. Therefore, depending on the type of real estate market you’re buying a property in, an escalation clause in real estate may be necessary for winning a bidding war.
What Is An Escalation Clause In Real Estate?
An escalation clause, or “escalator,” is a section in an offer that states that a buyer is willing to raise their offer on a property should the seller receive a higher offer. The clause will state how much more the buyer is willing to pay than the highest offer and the highest price the buyer is willing to pay.
In most cases, an escalation clause will have a cap of how much the buyer is willing to spend to beat the other offers (up to a specific limit).
For example, suppose a buyer submits an offer of $200,000; they could include an escalation clause with their offer that precisely states the amount they are willing to offer above other buyers, up to the maximum they’re willing to spend. If there is a $205,000 offer submitted after their initial offer, an escalation clause makes it conceivable to beat the competing offer by a preset amount, say $210,000. The clause can specify that a buyer will willing to pay X amount above the next higher offer, say $1000.
Pros And Cons Of An Escalation Clause
Pros–Some of the advantages of using an escalation clause in a contract can include:
Buyers can have better peace of mind about their offer. Buying property is stressful enough, let alone putting an offer on a property you really want and then constantly worrying if another buyer has made a stronger counteroffer. Using an escalation clause can give you more confidence when buying a home and ensure you stick within the budget you set in advance.
The buyer doesn’t overpay for a home. As a buyer, you don’t want to pay more than you need to for a home. An escalation clause can protect you from paying more than is necessary to get your offer accepted. This is because your offer only increases when another buyer makes a higher offer.
Cons-–While escalation clauses have their advantages, they also have some drawbacks, which can include:
Buyers and sellers lose their chances of negotiating once an escalation clause is accepted. Since a clause reveals the maximum amount a buyer is willing to pay, the seller will know their highest offer right away. This eliminates the opportunity to negotiate. The “cap” may remove the bargaining power for the buyer. Instead, a seller could reject the escalation clause and ask for the highest offer.
Sellers who accept escalation clauses can no longer issue counteroffers to other buyers. Because buyers might not be putting in their highest offer with an escalation clause, sellers may reject it right away.
Escalation clauses can cause issues with appraisals if their offer exceeds the home’s appraisal value. Lenders are very particular about how much they will lend for a home. Lenders require an appraisal to determine the home’s market value and won’t lend above this amount. Therefore, an escalation clause can lead to a situation in which the price offered goes too high and exceeds the home price it was appraised at. A buyer may win the bidding war to discover later the lender won’t give them enough funds to pay for the home.
