What to Know About Escalation Clauses in Real Estate
When real estate markets heavily favor sellers, it can be disconcerting to many potential home buyers. They are often up against many other buyers for a home they love.
Over the last few years, anyone looking for a house has experienced this phenomenon. Buyers' frustration boils over when they have made numerous offers and continue to lose out.
An escalation clause is one of the tactics many buyers have turned to in this strong seller's market. When buyers hear about them, they often ask their real estate agent what an escalation clause is and how they work.
From experience working as a real estate agent for the past thirty-seven years, I know an escalation clause can be highly beneficial to a buyer.
We will examine an escalation clause in detail by covering the pros and cons of using one. Let's dig in.
What is an Escalation Clause in Real Estate?
An escalation clause states that you will outbid other home offers by a certain amount, up to a ceiling price. The ceiling is also called a “cap price” or the most you are willing to pay.
It means, “I am willing to pay more than any other offer but no more than my cap price.”
When you have an escalation clause in your offer, the seller will be informed you're willing to increase your bid if necessary.
Your offer will then be automatically adjusted to the highest amount of the other offers up to your cap price. This process is automated and done quickly.
An escalation clause allows you to compete more effectively in a seller’s market. It puts you in a stronger position to win the bidding war while protecting your budget. The clause can be especially helpful when you are up against an all-cash buyer or an offer with no common contingencies.
However, it is vital to understand the risks of using an escalation clause. You may pay more than the home's market value if the other offers are too high.
Don't Make Your Escalator Too Low
When using an escalation clause, it is essential that your "escalator" is not too low. For example, with a bid of $500,000 for a home, you will also add a dollar amount by which you will go over the next highest offer.
Many agents will put $1000 as their escalator. Doing so is a mistake because $1000 doesn't motivate a seller to accept an offer when other terms in a different offer could be more appealing.
Your escalator should be enough to make a seller think twice about not accepting the offer. From experience, it makes sense that the escalator is at least $5000.
What Are The Pros and Cons of An Escalation Clause For Buyers
Let's look more closely at the advantages and disadvantages of escalation clauses.
Pros of Escalation Clauses
Make Your Best Offer
The main pro of using an escalation clause is that it puts your best foot forward. It allows you to make a competitive offer in the current market conditions. This increases your odds of being the winning bidder.
You Only Pay What You Need to
Another pro is that you only pay as much as necessary to get the house. The clause caps the amount you are willing to pay so you don't overpay. This can be especially helpful when bidding against an all-cash buyer.
Increase Your Odds of Landing The House
Finally, an escalation clause can increase your odds of being the winning bidder. This clause allows you to outbid other offers without making multiple offers and risking losing the house.
Cons of Escalation Clauses
You May Overpay
One of the main cons of using an escalation clause is that you may end up paying more than the house is worth. This is especially true if the other offers are too high.
If this happens, you must be prepared to increase your down payment if the real estate appraisal is lower than the purchase price.
You Give Away Your Position
Perhaps one of the more significant drawbacks of an escalation clause is you give away any bargaining power. You're putting all your cards on the table immediately.
The argument against this would be you want the house, so you're doing what it takes to get it.
The Listing Agent Doesn't Understand Them or is Negative Towards Them
Unfortunately, in the real estate industry, many agents aren't the brightest bulbs in the world. If they don't understand something, rather than learn it, they will tell their clients it's not a good thing.
Escalation clauses are the perfect example of this. Some agents won't even accept them and have already talked their sellers out of looking at one.
You can add that to the list of home-selling mistakes.
Multiple Escalation Clauses Confuse Agents
Some agents panic when there is more than one offer with an escalation clause. It boggles my mind that this happens, but it does.
The clause should be treated no differently than any other contract term.
The purchase offer with the highest ceiling cap is in the top spot, at least regarding price. Realizing the winning bid doesn’t necessarily mean the highest offer price is crucial.
You Fill Out More Paperwork
Another con is that it requires extra paperwork. The initial offer must include an escalation clause, usually a separate addendum.
You're in The Dark on The Final Contract Price
Finally, you may not know how much you will pay until the bidding process concludes. You will be on pins and needles, but it's no different than if you didn't have an escalation clause.
Final Thoughts on Escalation Clauses
In conclusion, an escalation clause in real estate can be useful for buyers in a seller’s market. But it also has several drawbacks, so weighing the pros and cons before using one is important.
Find out from your real estate agent if they are used frequently in the local market. It could be the ticket to scoring a house!
