What is an escalation clause in real estate?

Picture this: After weeks of searching for the perfect home, you’ve finally found it. You put in a competitive offer but, unfortunately, you get word that someone has outbid you. Although the bid is higher than your original offer, it’s a number you’re willing to pay. This is where an escalation clause might help. An escalation clause is an addendum added to an offer, stating the buyer’s willingness to increase their bid should the seller receive a higher offer from another bidder.

Adding an addendum to your offer

An addendum provides additional context for a document or an agreement, such as a specific clause or contingency. In the case of an escalation clause, an addendum would be added to the original offer, detailing additional terms depending on how the sale unfolds and what other offers the seller receives.

As a buyer, you may want to connect with a real estate attorney to draft your offer letter and include an addendum you feel comfortable with. More specifically, an escalation clause addendum will spell out how much you’re willing to increase your offer, and ultimately, how much money you’re willing to spend. Crafting an addendum that states these terms clearly may help to both increase your chances of winning the negotiations and avoid overspending on a home.

How do escalation clauses work?

As we’ve learned, the escalation clause states a buyer’s willingness to increase their bid, should the seller receive a higher offer from another bidder. The escalation clause is typically included in the first offer. It will include a “maximum” bid and how much the buyer would increase their offer with each competing offer.

Let’s take a look at a hypothetical example. Suppose you find and put in an offer on a home for $500,000 but have a budget that could go up to $550,000 if needed. In this case, you might include an escalation clause that you’d be willing to outbid any competing offers, possibly by a set amount like $10,000 and up to your maximum amount of $550,000.

Let’s now suppose a competing offer comes in at $510,000. Your escalation clause automatically ups your bid from $500,000 to $520,000 (beating the other offer by $10,000).

It may be helpful to consult a real estate professional to ensure your clause is written effectively. The clause typically has a section requiring the seller to provide proof of a competing offer before your offer increases, which helps protect you against any potentially false offers used to drive up your bid.

From a process perspective, the buyer will:

• Make an offer to the seller that includes the escalation clause addendum, spelling out the original offer, with the escalation document attached.
• The seller will provide evidence of potential competing offers.
• The buyer will receive the courtesy call and may increase their offer using the escalation clause.
• The seller will either accept the new offer or return to the other bidder.
• If the other bidder raises the offer, the two parties continue the bidding war until the original buyer reaches their maximum purchase price.
• The seller, ideally, accepts the original bidder’s price at or before the maximum bid.
• The sale closes.

Is an escalation clause a good idea?

Whether or not using an escalation clause is a good idea for you depends on your personal preferences and circumstances. It may be helpful to review some of the pros and cons of escalation clauses before deciding:

Pros

• Using an escalation clause may be helpful if you’re sure about a home and have some wiggle room in your offer.
• The addendum may help the seller understand how serious you are about the home and could potentially help you avoid being outbid from the get-go.
• The escalation clause may minimize some of the back-and-forth that comes with a bidding war.

Cons

• Including an escalation clause may put you at risk for paying more than what the property was appraised for. Just because someone else is making a higher offer doesn’t necessarily mean the home is worth that amount.
• This discrepancy in value may additionally affect your financing, as lenders understandably prefer to be precise about these kinds of things.
• Since escalation clauses typically allow sellers to know your maximum bid right away, it may take away some of your negotiating power.

In summary

An escalation clause is an addendum to an offer on a property, stating a buyer’s willingness to increase their bid if the seller receives a competing offer. Ultimately, it’s meant to help keep serious buyers from getting outbid, while remaining cautious about their maximum spend. If an escalation clause might interest you, it’s a good idea to consult a real estate professional before including an escalation clause in an offer.