Escalation Clause

What is an Escalation Clause in a Contract?

An escalation clause is a rider written into a purchase offer to assist an individual in beating out competing offers in real estate. This clause allows the potential buyer to ensure that they have the highest offer by not only making a bid or offer but also offering a set amount over competing offers.

In an escalation clause, the potential buyer, or escalator, sets a maximum price they are willing to pay for a piece of real estate and allows for their offer to be increased by a set amount over other offers that are made until it reaches that maximum price. This offer would be put into the real estate contract.

The escalation clause consists of three distinct parts:

1. Proof of bona fide offer. The seller must prove that they received a competing offer higher than the one made by the potential buyer.
2. Escalation amount. Documentation of the amount by which the offer will increase over the competing offer.
3. Price cap. The maximum amount to which the offer will increase.

Here is an article about escalation clauses in a contract.

How Escalation Clauses in Real Estate Work

In real estate, the escalation clause allows a potential buyer a better chance at achieving success in their purchase of a property. The clause allows the buyer to set the offer that they want to make in regards to the real estate and create a purchase and sale agreement that gives them an edge.

The clause itself then allows them to set an amount that they would like to beat all competing offers by and then sets a maximum amount that they are willing to pay for the real estate. This allows the offeror a better chance to be the highest bid.

For example, an offer is made for a house at $250,000. The potential buyer wants to ensure that they get the property and so they add an escalation clause to their offer that will beat any competing offer by $5,000 with a maximum offer of $350,000.

If there is a competing offer of $260,000 for the property, the potential buyers offer would automatically increase to $265,000. If other competing offers come in higher than this the offer would automatically increase again until it reached the threshold of $350,000.

If a competing offer were to come in at $350,000 the original offer would also be $350,000 as this is the maximum amount that the potential buyer agreed to in the clause.

Here is an article about how escalation clauses work in real estate.

Examples of When to Use an Escalation Clause

The use of an escalation clause is entirely up to the potential buyer. Not all purchase offers will include one and they are not necessary in all cases. However, there are a few important situations where this clause may be important:

• You want the seller to know you are serious
• You want to skip over the process of bidding
• You are in a highly competitive market where competing offers are likely
• You are not interested in negotiating with the seller

In some cases, however, an escalation clause may not be the best idea as it can take away some of your ability to negotiate with a seller on anything related to the purchase of the property. In making a purchase offer, there are often other areas where a buyer and seller may negotiate, however this may be removed when using an escalation clause.

This clause could be used for a standard purchase agreement, a real estate lease agreement, or a commercial lease. Working with real estate lawyers will give you the best chance at successfully creating this type of clause.

Here is an article about when to use an escalation clause.

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Pros and Cons of an Escalation Clause

If you are considering using an escalation clause it is important to look at the pros and cons before you do so. This will allow you to make an informed decision related to what you put into your purchase agreement.

Pros of Escalation Clause

• Pro 1. Better chance of beating out competing offers
• Pro 2. Skip the bidding process between competing offers
• Pro 3. Let the seller know you are serious about wanting the home
• Pro 4. Counter a sellers’ market

For some potential buyers these pros allow them to feel more confident in their offer. The escalation clause may be enough to win the bid for them as it does give them an automatic competing bid to any that are lower than their maximum price.

Cons of Escalation Clause

• Con 1 : Reveals your maximum price upfront reducing your bargaining ability
• Con 2. Offer may not be enforceable until a set price is listed
• Con 3. Some sellers will create false offers to trigger the escalation clause for a higher price
• Con 4. An attorney is required in order to draft an escalation clause increasing the cost of the bidding process
• Con 5. Escalation clauses from multiple offers can create a bidding war
• Con 6. May encourage a seller to look for other offers to trigger the escalation clause
• Con 7. Could discourage other buyers who would prefer a traditional bidding process
• Con 8. May still not win the bid

For some potential buyers these cons can outweigh any potential benefit of adding an escalation clause to their contract. Also, some potential buyers may steer away from making an offer on a property that already has an offer with an escalation clause for these reasons.

Here is an article about the pros and cons of escalation clauses.

Is an Escalation Clause a Good Idea?

Deciding whether or not an escalation clause is a good idea is a relatively personal decision. There are many pros and cons associated with this type of addition to your purchase offer and that means it’s important to weigh out the options.

An escalation clause can give you an edge in a sellers’ market by making your offer more competitive and helping to let the seller know how serious you are about buying the property.

On the other hand, this type of clause can tip your hand early, encourage sellers to seek out higher offers to trigger the clause, or take away some of your negotiating power.

In many cases it seems that an escalation clause could be a poor decision. For those who want the best opportunity to win the bid and do not want to spend their time on offers and counteroffers it may be the best option, however. It allows the potential buyer to put in a single offer rather than going back and forth with their agent or the seller.

Here is an article about whether an escalation clause is really a good idea.

Does an Escalation Clause Invite Problems?

Some people have trouble with escalation clauses because they can remove some of the buyers’ power. Because the seller sees the offer and the escalation clause at the beginning there is no real bargaining power. The seller knows what the buyer is willing to spend.

This can also encourage a less than scrupulous seller to create fake offers or get boosted offers that will not be fulfilled in order to trigger the escalation clause and get the larger payment from the buyer.

Here is an article about problems with escalation clauses.