In a competitive sellers’ market, it’s not uncommon to see a variety of tactics being used to make a buyer’s offer more attractive.
Some make their bid more enticing by offering more than the asking price. In fact, Marketwatch reports that 39 % of the homes in the US were sold above the listing price. Others may cut contingencies, like the need for inspection or appraisal, to make their bid more favorable.
One tactic, however, that has become more popular in real estate transactions is the use of an escalation clause. So, what’s an escalation clause, and how does it work? More importantly, when should you use one? Let’s figure it out!
What’s An Escalation Clause?
An escalation clause is a clause or addendum to a real estate contract that states that the buyer is willing to raise their offer should the seller receive a higher competing offer.
Also known as an escalator, an escalation clause allows buyers to strategically increase their offer price to win in a bidding war. In other words, it offers prospective buyers a safety net should another party outbid them.
How Does An Escalation Clause Work?
An escalation clause consists of three key components:
- The escalation amount – The increment at which the price will be raised to beat a competing bid
- Escalation trigger – The escalation is triggered if a higher bid is offered
- Maximum purchase price – The highest amount (price cap) the buyer is willing to offer in the event of multiple bids
Generally, escalation clauses and offers are communicated between the buyer’s real estate agent and the seller’s listing agent. An escalation is triggered when the seller receives a bona fide offer from another buyer. Note that escalation clauses are prohibited in some states.
An Example Of An Escalation Clause In Action
Timothy offers $400,000 for a home in Florida. His agent adds an escalator that, in the event of a higher competing offer, he will increase Timothy’s offer in increments of $4,000 above the highest offer.
His escalation amount has a price cap of $450,000. If no competing offers are submitted, Timothy’s bid remains at $400,000.
Suppose Jane, a prospective buyer, offers $410,000 for the house. In this case, Timothy’s offer would automatically escalate to $414,000. If another buyer, Maxwell, offers $460,000 for the property, then Timothy’s $450,000 offer would be exceeded, and Maxwell wins the bid.
When To Use An Escalation Clause
Escalation clauses are very common in a hot sellers’ market.
If you’re confident that the house will attract multiple buyers and could trigger a bidding war, an escalation clause can come in handy. An escalator can help a buyer in many different ways.
- If no multiple offers are received, and the buyer’s offer is accepted, the home remains at its original sales price (listing price). In this case, the seller cannot counteroffer the list price with a higher price.
- If multiple offers are submitted, including cash offers, an escalator can help a buyer outbid and get the home of their dream.
- An escalator provides proof to the seller that the buyer is serious about the property.
While an escalation clause provides a safety net for buyers to secure their dream home, it’s not without its downsides.
For example, by including an escalator, buyers are laying all their cards on the table. Meaning the seller knows exactly how far the buyer is willing to go to secure the home. This can give the seller an advantage in negotiations.
Additionally, an escalation clause can lead to overbidding.
If the buyer sets the maximum price too high, they may end up overbidding for the property, which could lead to financial difficulties in the future.
When To Avoid Using It
While there are situations where an escalator can help get your offer accepted, there are other cases where you should avoid using it. For example;
- Where state laws forbid the use of escalation clauses in real estate transactions, adding it will be of no help. An experienced real estate agent should inform you of this beforehand.
- Where an escalation clause will stretch your budget beyond what you’re able to reach financially.
- When you’re certain, there won’t be other offers.
Wrapping Up
An escalation can be an excellent tool for helping you secure a home in a competitive seller’s market. However, it’s not a silver bullet. Use it to your advantage, and don’t stretch your budget beyond what you can afford.
