What Is A Real Estate Escalation Clause?

Real estate escalation clauses have proven, time and time again, that their inclusion in an offer letter can greatly tip the scale in favor of buyers. Escalation clauses are, after all, a relatively simple way to stack the deck in favor of savvy investors. That said, anything less than a meticulously-calculated escalation clause can do more harm than good. Investors must be certain that the real estate escalation clause example language contained in their offer is well-crafted, deliberate, and efficient. It is how the real estate escalation clause is conveyed which will determine its efficacy. The better the real estate escalation clause language, the better the chances are of landing the deal, which begs the question: What is an escalation clause in a contract, and how does it work? The answer to this question, and many more, is outlined below.

HOW DOES AN ESCALATION CLAUSE WORK?

As their names suggest, escalation clauses award prospective buyers the ability to escalate their offers in the event a subsequent, higher offer is submitted in the interim. Otherwise known as escalator clauses, escalation clauses are essentially offered contract addenda indicating that a buyer is willing and able to increase their original offer if necessary. In their simplest form, however, escalation clauses are nothing more than a safety net; a last-ditch effort on behalf of buyers to remain relevant in the eyes of a seller.

Often included in a buyer’s offer, real estate escalation clause language is specifically designed to convey a simple message: that a buyer is willing to offer more in the event someone else beats their initial offer. It is worth noting, however, that real estate escalation clause language is typically very specific. Not only will a good escalation clause identify a buyer’s willingness to pay more, but it will also clarify exactly how much they are willing to beat the subsequent offer by, up to a predetermined amount—as not to exceed the buyer’s maximum allowable offer.

Real Estate Escalation Clause Example

What is an escalation clause when buying a house? It is a simple question, but far too many people are unfamiliar with the concept of an escalator clause. In its simplest form, it’s a contractual tool to help buyers secure a deal for a fair value. For a more comprehensive explanation, however, perhaps it’s best to provide an example:

Buyer A submits a $100,000 offer on a home with an escalation clause of $2,000 and a cap of $120,000. Soon after Buyer A submits their offer, Buyer B submits a slightly higher offer — let’s say $105,000. Since Buyer A’s offer is lower than the second offer, the escalation clause in the first offer will immediately go into effect. And since Buyer A’s escalation clause specifically stated they are willing to beat out any additional offers by $2,000, Buyer A’s new offer is automatically increased to $107,000 (the competitor’s offer plus an additional $2,000). This escalation, of course, will continue until the offer amount reaches the escalation clause cap set by the buyer enacting it. That way, the escalation clause will incrementally beat out any subsequent offers.

Of course, all of this is contingent on the seller accepting the escalation clause in the first place. If for nothing else, a seller doesn’t have to accept the inclusion of an escalation offer.

PROS AND CONS OF AN ESCALATION CLAUSE

An escalation clause may serve as an invaluable tool in conjunction with a competitive offer. However, these clauses are meant to be used sparingly and are very situational. Used correctly, the proper escalation clause verbiage can tilt the scales in an investor’s favor. Consequently, a poorly executed escalation clause can cut into profit margins. That said, investors must know what they are doing before they use one of these clauses themselves. More specifically, it’s a good idea to become familiar with both the pros and cons of using an escalation clause in real estate offers.

Pros Of An Escalation Clause

The most common reason anyone would include an escalation clause in an offer is to provide themselves with some semblance of reassurance—that their offer won’t simply lose out to the competition for being too low. A well-worded real estate escalation clause form (or the addition of a good escalation clause) should see to it that an offer remains at the forefront of a seller’s mind (without overpaying). It is worth noting, however, that escalation clause language doesn’t only keep a buyer’s offer on the top of the pile, but it also lets the seller know how serious they are, which is valuable in and of itself. When all is said and done, a good escalation clause example is one thing, and one thing only: peace of mind for both the buyer and seller. Adding this clause to an offer suggests the buyer is serious, and nobody appreciates that more than a seller.

Here’s a quick overview of all the reasons someone may want to include an escalation clause in their next offer:

• Escalation clauses serve as a safety net for buyers and sellers.
• Buyers don’t have to worry about their initial offer being ignored because it was too low.
• Sellers may benefits from competition and escalating prices.
• While it may sound counter intuitive, escalation clauses can actually prevent buyers from overpaying.
• A properly worded escalation clause can make a buyer’s offer look more serious in the eyes of a seller.
• It is easy to obtain an escalation clause example to use in your own offer, but work with a lawyer to be sure the verbiage conveys exactly what you want to say.

Cons Of An Escalation Clause

While escalation clauses have proven to be invaluable to many buyers, they are not without their drawbacks, most notably of which is ignorance. For one reason or another, not everyone is familiar with the concept, including many listing agents. Their inability to understand an offer with an escalation clause can be an obstacle—an obstacle that’s easy to overcome, but an obstacle. Not only that, but escalation clauses can get confusing if not left in the hands of an experienced individual. Therefore, the escalation clause verbiage must be not only clear but also says exactly what each party intends.

The most significant drawback to using an escalation clause, however, has nothing to do with comprehension. Instead, it has more to do with giving away a buyer’s position. Oftentimes, leverage at the negotiation table is the result of what a buyer is willing to offer. In the event an escalation clause is included, the buyer’s position is made clear the minute the offer is submitted. If that’s the case, the seller already knows the buyer is willing to pay more, which could result in spending more money than the buyer wants to.

Here’s a quick overview of all the reasons someone may not want to include an escalation clause in their next offer:

• Even the best escalation clause examples can tip the buyer’s hand and hurt any attempts at negotiations.
• Disclosing the exact amount a buyer is willing to pay could prevent them from securing a better deal.
• While powerful tools, escalation clauses aren’t common knowledge to everyone in the industry. The inclusion of an escalation clause could confuse some sellers, and perhaps even delay potential transactions.
• Some sellers may not appreciate the buyer’s intent to lowball their first offer when the escalation clause clearly states they are willing to pay more.
• While not common, an escalation clause can actually serve as an obstacle to bank appraisals and loan underwriting.
• Most sellers will appreciate the inclusion of an escalation clause, but some may prefer not to deal with them at all.

ESCALATION CLAUSE LANGUAGE TO INCLUDE IN YOUR OFFER LETTER

The language of the escalation clause is just as important as the addendum itself, if not more so. If for nothing else, a poorly worded escalation clause can do more harm than good. Prospective buyers will need to be certain that their escalation clauses get a specific and deliberate point across. To do so, you must include some key components, or verbiage — if you will. Remember, how you say it is just as important as what you say.

The escalation clause language to include in your offer letter is nothing if not specific. That said, it’s in your best interest to rid your escalation clause of any ambiguity. It should answer more questions than it asks; quite honestly, it shouldn’t leave sellers with any questions at all.

For starters, the language of your escalation clause should state that it will only go into effect in the event a legitimate subsequent offer is made. That is to say, your willingness to beat out an additional offer is predicated only on the fact that a bona fide offer threatens to beat out your previous one. That’s an important distinction to make, as buyers won’t want to see their offers increase in the face of illegitimate contenders.

Moreover, proper real estate escalation clause language needs to specify the amount a buyer is willing to beat out subsequent offers by, and how much they are willing to cap out at — this can’t be underestimated. The language in a respective escalation clause must clarify specific amounts.

While adding an escalation clause to your offer may seem like a simple step, be sure to consult an attorney that specializes in real estate contracts. They will see to it that your escalation clause contains all the language necessary to complete the perfect offer.

WHEN SHOULD YOU USE AN ESCALATION CLAUSE?

To be clear, escalation clauses aren’t always necessary. When used at the wrong time, they can hurt your chances of landing your next deal. Therefore, knowing when to use an escalation clause is just as important as knowing how to use one, if not more so. A properly-worded escalation clause used under the right circumstances can aid in your attempts to secure a deal. That said, buyers will need to determine for themselves when an escalation clause is needed.

Escalation clauses are most useful when buyers are confident the subject property is going to receive multiple offers. If for nothing else, multiple offers mean more competition, which is exactly what escalation clauses were created for. When a home receives multiple offers, an escalation clause will ensure your offer isn’t overshadowed by all of the competition. The clause will suggest you are willing to beat comparables offers by a certain amount, which automatically keeps you in the running. The same can’t be said for homes receiving very few offers, however. In the event a home isn’t expecting much competition, an escalation clause can work against the buyer by disclosing the true amount they are willing to pay.

In addition to excessive competition, the use of an escalation clause should also be reserved for truly great opportunities. Say, for example, a subject property isn’t expected to have a lot of competition, but the deal is simply too good to pass up. The inclusion of an escalation clause may help the buyer secure the deal. Of course, the inclusion of the clause could result in a higher price tag, but some deals are too good to pass up for a small increase in the purchase price. In other words, investors should use one when it’s worth paying a little more to buy a great deal.

When To Avoid Using A Real Estate Escalation Clause

I want to make it abundantly clear: there are times when an escalation clause makes sense, and there are times when an escalation clause doesn’t make sense. Again, if you are confident the home will receive multiple offers, there’s a good chance you’ll want to include an escalation clause in your offer. That said, there are times when you may want to omit such an amendment, not the least of which include the following:

• You Don’t Expect A Lot Of Competition: Real estate escalation clauses are best left for properties you would expect to generate a lot of attention. If for nothing else, these clauses were born out of a competitive market place. Not every home is going to have several buyers competing over it. If you find yourself looking at a property that doesn’t have a lot of competition, it may be in your best interest to avoid using an escalation clause. That way, you won’t have to identify the highest amount you are willing to spend, and therefore negotiate a better deal. In neglecting to use an escalator clause, you are more likely to have leverage in the negotiation game.
• There Isn’t A Lot Of Wiggle Room: Investing in real estate is contingent on the idea of buying a property at a discount; so that you may sell it for more of a profit on the backend of a deal. The cheaper you can acquire a deal for, the better your bottom line. However, some homes can’t even be purchased at a discount, especially in today’s competitive environment. That said, you’ll want to avoid using an escalation clause if the profit margins are too slim to begin with. If you aren’t careful, an escalation clause could have you spending a lot more on a property than you should have.
• The Buyer Isn’t Interested: the home you are looking to buy may be owned by someone that isn’t interested in entertaining an escalation clause. While some sellers would live the inclusion of an escalation clause, others would rather have buyers submit exactly what they want to pay; they like the idea of buyers trying to outbid each other on the first try. If that’s the cause, it’s in your best interest to avoid using one altogether.

SUMMARY

Investors must fully understand the pros and cons of escalation clauses. When used correctly, and at the right time, their viability magnifies exponentially. When used incorrectly, an escalation clause can cause more harm than good. As a result, the real estate escalation clause language you choose to include in your next offer and the situation you choose to use it in could dictate the outcome of your next deal. It is worth noting, however, that the more specific you are, the better. A vague clause could hurt your chances, so be sure to mind due diligence. Above all, consult a real estate attorney to ensure that your escalation clause spells out exactly what you want to happen.

Key Takeaways

• Think of an escalation clause as an amendment to an offer; it’s a slight change that could potentially move your offer into contention.
• Knowing when to use an escalation clause is just as important as knowing how to use one.
• The real estate escalation clause language you choose to include in your next offer could mean the difference between landing the deal of your dreams or walking away empty handed.

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