Understanding Escalation Clauses

Real Estate

Understanding Escalation Clauses

Buyers in today’s real estate market know all too well just how stiff the competition has become. As a result, they are always looking for ways to stand out from other prospective buyers, and one tool that has become increasingly popular is adding an escalation clause to an offer. If you’re unfamiliar with this term, I wanted to take the opportunity to explain escalation clauses in more detail.

In short, an escalation clause is a provision that is added to an offer (or counteroffer) where the buyer offers to outbid any other buyers on a property without them knowing. These are also called “relative bids” or “sharp bids” sometimes. 

As an example, let’s say you have fallen in love with a particular home. You know you want it, but you are worried other potential buyers may feel the same and outbid you. In this instance, you might write into your offer that, “The purchase price shall be $5,000 higher than any other offer.” This is the escalation clause, and they are binding.

If you think about it, this could lead to potential issues for you as the buyer because what happens if another interested buyer puts in an insanely high offer? You are bound to pay whatever the predetermined amount was in your escalation clause over the (now) current offer. 

One way to help mitigate risk if you are interested in using an escalation clause is by including a provision that allows you to verify the next highest competing offer. Since your offer will be dependent on what other buyers offer, you will certainly want to make sure that any additional offers that come in are valid. Again, your attorney or legal team will assist you in writing up the correct language to address this situation.

While an escalation clause might make your offer more attractive to a seller, it also shows them exactly how much you’re willing to pay. This can limit your ability to negotiate with a seller, where you might have come out with a better overall deal from being flexible with things like inspection time frames and so on.

Be prepared for your real estate agent to caution you against using an escalation clause. While they can be effective, there are also pitfalls to be aware of, as discussed above. As a local real estate agent with years of experience assisting buyers, I always advise my clients to speak with their own financial and legal experts before proceeding with such an offer. Generally, escalation clauses would only make sense in a situation where you couldn’t stand the idea of losing the home to someone else. 

Melody Smith & Associates is a longtime leading broker associate in South Orange County, known for super service, and is in the top 1% of 1% of agents in the country. Please contact us for all of your real estate needs.

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