Escalation clauses are fairly straightforward. One of the most significant elements to understand about escalation clauses is that they only go into effect when there are competing offers.
What is an escalation clause?
Well, in real estate, an escalation clause or “escalator” refers to written language in a contract that states that a buyer is willing to raise their offer on a property by a certain amount should the seller receive a higher competing bid. Essentially, once an escalation clause is triggered by a competing offer, it will continue to increase your offer amount on the property until your designated price limit has been reached.
In general, a typical escalation clause has three essential parts.
- Proof of a bona fide offer. For an escalation clause to be enacted, a seller must provide proof that they received an additional offer higher than your initial offer.
- Escalation amount. After proof of a bona fide offer, the escalation clause goes into effect. The escalation clause will then follow the escalation amount you offered, increasing until you have the highest bid or meet the price cap.
- Price cap. Of course, the third essential part of an escalation clause is the price cap. This is the maximum amount you’re willing to pay for the home or property.
Escalation clause case study
Here’s how typical escalation clauses actually work. Imagine a seller has a property on the market for $300,000. You place an offer on this home for $275,000 with an escalation amount of $5,000 and a price cap of $350,000. After placing your initial offer, another buyer offers $325,000. This second offer would enact your escalation clause, creating a new offer of $330,000 for the property.
If the other buyer made an additional offer of $340,000, your escalation clause would automatically create a new offer of $345,000. If the other buyer made an additional offer of $355,000, you would lose, as you previously set your price cap or maximum offer at $350,000.
The bottom line
In a nutshell, escalation clauses are tools used in real estate that allow buyers to streamline the bidding and counteroffer process by writing out their position and price cap with their initial offer. While escalation clauses are beneficial in some circumstances, you’re essentially giving up your chance to negotiate since the seller already knows your highest offer.
Another important note is that not all sellers accept offers with escalation clauses, and you may have to change your offer plan accordingly. While there are some drawbacks to utilizing escalation clauses, they help you stand out as a buyer and streamline the bidding process.