The Guide To Escalation Clauses In Real Estate
Making an offer on a house is exciting, but when you know you're competing with other buyers, it's hard to know if your offer will appeal most to the home seller.
Buyers can make a more enticing bid by offering more than the asking price, writing a letter to the sellers that appeals to their sentimental value of the property or cutting out contingencies like the need for an appraisal or inspection. One feature that's becoming more prevalent as many parts of the U.S. sustain competitive seller's markets – when there are more buyers than available properties and multiple bids are common – is to include an escalation clause, speeding up the process of a bidding war so the seller knows exactly how high the buyer can go.
Here's everything you need to know about escalation clauses, how they work and when you should (or shouldn't) use them.
What Is an Escalation Clause?
In real estate, an escalation clause is a clause or addendum to a real estate contract that notes the buyer is willing to raise his or her offer price if the seller receives a higher competing offer.
With the offer price established in the contract, the buyer typically identifies a specific amount above a competing offer that the buyer is willing to go, up to a stated maximum.
Escalation clauses have long been a part of real estate contracts in seller's markets, but they have gained particular popularity since the onset of the COVID-19 pandemic, when pent-up demand has made the housing market even more competitive. "When you're up against 15, 20, 40 other offers on a property, you're going to do anything you can to win," says Emily Olson, a Realtor with national brokerage Redfin in Minneapolis.
Will an Escalation Clause Help You Buy a House?
The National Association of Realtors reported the median existing-home sale price in February was $313,000, 15.8% higher than the median in February 2020. At the same time, housing inventory was down 29.5% compared to the year prior, a record low. The primary cause of these rising home prices is the fact that buyers are competing to purchase an ever smaller number of properties.
When the house you're interested in has other would-be buyers flocking to see it, stepping up your offer may be necessary, and an escalation clause is one option.
An escalation clause isn't a guarantee that your bid will be the winning one, though. In an analysis of thousands of offers written by Redfin agents between July 2020 and February 2021, Redfin found that an escalation clause had no significant impact in improving an offer's chance of success. Comparatively, an all-cash offer improves a buyer's likelihood of success by 290%, and waiving a financing contingency increased a bid's chance of success by 66%.
Of course, providing an escalation addendum may be an additional strengthening factor to an offer that appeals to the seller in other forms. "You're going to want to be competitive in almost every facet (of your offer)," says Nobu Hata, CEO of the Denver Metro Association of Realtors.
What Does an Escalation Clause Look Like?
An escalation clause can look different depending on the home, your offer, the real estate agent you're working with and even the city and state you live in. Here are details commonly established in an escalation clause:
- Escalating factor. Establishes the monetary increments the offer price can be raised in the event that other offers are above the initial offer price. The competing offer is typically referred to as a "bona fide offer" to note that the competing offers can be real and provable. The increment can be anything, but is often a rounded number, like $1,000 or $5,000.
- Cap. The escalation clause establishes the highest possible price that the buyer is willing or able to go, also referred to as the cap.
- Documentation. To ensure all sides operate fairly and honestly, if the seller or listing agent claims to have received other offers, leading to use of the escalation clause to determine a new price, the buyer can request documentation to prove the other competing offers exist. This is commonly phrased as asking for "proof of a bona fide offer" in the clause.
- Number of escalations. The clause may allow only a single escalation to the stated cap, or it may allow for multiple escalations in smaller increments, with the cap price as the maximum possible amount.
When Should You Include an Escalation Clause in an Offer on a Home?
Not every situation calls for an escalation clause to be included in your offer on a home. Here are a few situations when an escalation clause could benefit you most.
- You'll be competing with a lot of other buyers. As is the case in many housing markets throughout the country, steep competition with other buyers invites greater use of escalation clauses to lessen the possibility of losing out on a home simply because another seller offered slightly more than your initial price.
- You want your offer to stand out. An escalation clause on an already appealing offer can show your dedication to buying the home. "A lot of people think that it's a magic bullet because it's gained notoriety (over the last few years)," Hata says. "What it does is it amplifies an already strong offer."
- You have plenty of cash in case of an appraisal gap. When a home has multiple offers, you can expect the final sale price to be above the original asking amount. In this case, it's possible the home will appraise for a lower value than the agreed-upon sale price. "An escalation clause is only as strong as the guarantee that the buyer is going to cover the appraisal gap, if there is one," Olson says.
When Should You Avoid Using an Escalation Clause?
While there are situations where an escalation clause can help your offer be accepted by the seller, there are other cases where an escalation clause is best left out of the contract. Here are a few to consider.
- The seller declines escalation clauses. Before including an escalation clause in your offer, your real estate agent should discuss with the listing agent whether it's a good idea. "You have to know the seller is open to entertaining this type of clause," Olson says. Some sellers prefer to read every offer as the buyer's best and final price and conditions.
- Escalation would take you beyond your budget. Never include any promise that goes beyond what you're able to carry out, and that includes an escalation clause. "The biggest drawback is that you're paying too much for that house, or more than you thought when you submitted it, and now you're stuck with it," Hata says.
- There won't be other offers. Whether you're house hunting in an area that isn't seeing overwhelming demand or you have an eye on a house that's flying under the radar, an escalation clause isn't necessary if the seller will only be entertaining one offer. "Until there is a surefire multiple-offer situation, you won't be using an escalation clause, because it won't benefit you as a buyer," Hata says.
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