What is an Escalation Clause and How Do You Write One?

By PropertyClub Team
Jun 29th 2020
In today's competitive real estate market writing an escalation clause into a purchase contract is a great way for a buyer to try to gain a competitive edge. Here's what you should know about how to use one and if it's a good idea.

Picture this: you’ve been hunting for your ideal home for months, and you finally find the property of your dreams. You put in an offer, feeling confident that it’s the right one to secure you the home, only to find out that another buyer put in a higher offer and snagged it from you. It’s a disappointing situation that no one wants to find themselves in, particularly if you are looking at highly coveted properties or have been searching for something specific for quite a while. Thankfully, an escalation clause is a measure that can be taken to provide potential buyers with a safety net when it comes to purchasing a home.

hash-markWhat is an escalation clause?

In the world of real estate, an escalation clause (also known as an escalator clause) is precisely what it sounds like: a provision contained within a contract that allows prospective buyers to escalate an existing offer. They are usually written into the underwriting offers, and they allow a potential buyer to increase their original offer upon submission of a higher offer by a different buyer.

Escalation clauses indicate the seriousness of an offer, usually stating how much a buyer is willing to bid in order to purchase the property. They essentially allow you to offer slightly more than any other submission after your initial offer. 

hash-markReal estate escalation clause example

So, for example, say you find your ideal home and put an offer in for $300,000; an escalation clause that was written into the contract allows you to beat any subsequent offer larger than yours in increments of $5000, up to $320,000. If no other offers are submitted on the home, your original offer stands at $300,000. However, in this scenario, Buyer John then puts an offer in for $305,000. Thankfully, because of your escalation clause, you can now beat his offer according to the terms of your contract, bringing your new bid to $310,000. In this case, if the bidding stops there, you would have the best offer on the home.

Let’s now escalate the circumstances. If Bill puts in an offer for $325,000, you’re unfortunately out of luck, as your escalation clause only determines you can bid up to your specified maximum amount of $320,000. So here, since your escalation clause has been exceeded, Bill would have the top offer, and you would lose the bid on the house. 

hash-markWhen to use a real estate escalation clause

Escalation clauses are typically used when a home or property is of great interest to an individual buyer or highly sought after in the market. If there are a lot of different people vying to purchase the same property, it might be a good idea to include an escalation clause in your contract to increase your chances of procuring the sale. As a buyer, it can also be extremely valuable to indicate how committed you are to a deal. 

But while it may seem like a good idea to always include escalation clauses “just in case,” there are times when it can be a disadvantage. It’s only advisable to include an escalation clause if the buyer or their real estate agent is confident that there will be multiple competitive offers on a house because its inclusion downplays the power of any negotiations. This makes perfect sense, as an escalation clause indicates to the seller just how much the property is desired, and how much a buyer is willing to pay for it. If no additional offers are made on a home, but an escalation clause has been included in the contract, the original offer still stands. However, the seller may counter-offer, as the escalation clause has made them aware that the buyer is in a position where they are willing to pay a higher amount to purchase the home.

Sellers who submit escalation clauses are making an unequivocal statement as to the maximum they are willing to offer on a home. Say your initial bid is $410,000, but you put in an escalation clause that allows you to counter-bid up to $430,000. If no other bids are put in on the home, of course, your initial offer stands. However, you have made it clear through the clause to the seller that you have the means and are willing to pay $20,000 more than your offer to buy the home. This leaves the door open for the seller to counter-offer, knowing that you are capable of paying a higher price. Consequently, if you then choose not to accept the counter-offer, it could cause you to lose the home, as the seller may then decide to leave the house on the market in the hopes of obtaining a new, better bid. This is the main reason why it’s not a good idea to automatically include an escalation clause in your offer unless you are sure it will be necessary. 

hash-markEscalator Clause, Additional Info

It should also be noted that it is entirely up to the seller whether or not they will accept an escalator clause. In some cases, sellers prefer that buyers simply put in original offers for what they’re willing to pay for the property. Sellers may also not want to deal with the confusion and increased time that it takes to process multiple offers. But generally speaking, under the right circumstances, escalation clauses work highly in a seller’s favor, as they almost always guarantee they will secure the highest possible purchase price for their home.

If you’re interested in purchasing a highly desired property, an escalator clause can be a great way to provide yourself with some security. However, buyer beware. Don’t push the escalation higher than you’re willing to pay. It can be tempting to become trapped in a bidding war to win a property, especially where escalation clauses are involved. Still, it’s of the utmost importance that buyers don’t set the upper limit of their clause higher than they can afford to go.