In real estate, an escalation clause is an addendum to the offer to purchase that guarantees the buyer will pay a certain amount above any competing offer up to a specific max price. They are most often used in multiple-offer situations in an attempt to keep the offered purchase price of one buyer always higher than the others.
For example, a buyer offers $250,000 with an increase of $5,000 up to $280,000. If another buyer offers $254,000 and a third buyer offers $256,000, the buyer with the escalation clause will pay $261,000. If no other offers are received, the buyer will only pay $250,000.
For this to work, the seller is required to provide proof of the competing offers once they officially accept the offer of the buyer with the escalation clause.
Escalations Clauses are Not a Guaranteed Win
The highest priced offer is not always the one that is chosen. Sometimes, other terms are more important to the seller, like the closing date and due diligence fee. The best way to win a contract is to identify the needs of the seller and meet them. Do they need to stay in the property until they find a home of their own to purchase? Offer occupancy after closing. Do they need a quick sale? Offer a closing date that will happen as soon as possible. Have the sellers been burned by past buyers? Offer a high due diligence fee to show you’re serious about purchasing their home.
When the purchase price goes well above the perceived value of the home, it becomes a riskier transaction for the sellers. If the buyer doesn’t have the money to cover the difference between the loan and appraisal price, the contract will fall apart, and the sellers will miss out on valuable market time for their home. This could lead to a much lower sale price. So, escalation clauses don’t always present the best terms for the seller.
When Should You Not Use an Escalation Clause?
Like other tools in your negotiating arsenal, escalation clauses have their time and place. Here are some situations where you shouldn’t use one.
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You don’t have the money to cover the difference between the offer price and the appraisal.
Just because you are willing to commit to a higher loan amount doesn’t mean the bank is willing to lend that amount. If the home isn’t valued as high as the appraisal, it becomes a risk to the bank, because, if something should happen to your finances, they will not be able to recoup their investment by selling the home. That doesn’t mean they aren’t willing to lend the actual value of the property. You’ll just have to pay the difference.
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You have the money, but if the max price is reached, your finances will be stretched thin.
Putting a high number on the escalation clause is not going to guarantee you win the contract. Maxing out your finances could lead to an unhappy lifestyle that lasts for years.
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There are no other offers coming.
After seeing home after home and being consistently outbid by other buyers, you may be feeling desperate. Sellers can choose whether or not to reveal they have received multiple offers. If they won’t share that information or reveal there are no competing offers, the escalation clause can put you at a disadvantage by revealing how high you’re willing to go. If the sellers counter, they could counter at the max offer listed on your escalation clause.
Keep in mind, not all sellers will accept escalation clauses. Some will just call for highest and best offers by a certain day and time. Also, there are some places that have created legislation against the use of escalation clauses. Have a discussion with your local real estate agent about the appropriate course of action for your needs and aspirations. They will have the best insight.
