What is an Escalation Clause in Real Estate?

What Is An Escalation Clause In Real Estate

When making an offer on a home, you want to stay under the maximum amount you’re willing to pay but high enough to outbid other sellers. You might also want a way to track other offers so that you can continuously outbid them to increase your chances of making the deal. This is what an escalation clause does, which is an extremely effective tactic in the right situation.

What is an escalation clause in a contract?

An escalation clause is an addendum submitted in a multiple-offer situation to improve the odds that you will outbid other buyers.

For example, you might make an offer on a property for $325,000, but you can include an escalation clause that states you are willing to pay a maximum of $335,000 if a bidding war begins.

The clause also states that your offer will increase in set intervals to counter other offers up to the max offer, or escalation cap.

The intervals work as the next highest offer you are willing to make to beat out another bid. For example, your original offer of $325,000 might be outbid by an offer of $327,500. There’s no need to automatically offer your max bid of $335,000 to win. By setting intervals of $2,500, your offer will only increase to $330,000 to surpass the other offer. But how do you set a cap and what should that cap be?

How do you manage price escalation?

Managing price escalation is incredibly important because it allows you to effectively outbid other buyers without automatically jumping to your escalation cap.

When setting your intervals, you want to keep in mind that a seller may not be interested in the highest possible offer. They consider all factors of an offer. If another contract has better contingencies and provides less risk to the seller, they may take it even if the cash offer is slightly lower than yours.

Therefore, you must use intervals that make your offer more desirable but not so much that you overpay for no reason.

Yes, escalation clauses do have risks!

For an escalation clause to go into effect, the seller must prove that they received a higher offer than yours. This aspect does work to protect you from the seller falsely claiming an offer has been received to raise yours.

However, nothing stops the seller from rejecting your offer and making a counteroffer for the maximum amount you are willing to pay if no other offers are received.

If you know for a fact that there aren’t any other offers on the table, you should simply consider offering more upfront without giving any details on how much you’re genuinely willing to pay. You may also want to consider offering to absorb some of the seller’s fees as part of the contract to make the deal more appealing to them in place of a higher cash offer.

Now that you understand the basics behind escalation clauses, here are some frequently asked questions and answers.

Real Estate Escalation Clause FAQs:

Is an escalation clause a good idea?

Yes, an escalation clause is a good idea if you really want the home and you are in a market with demand. But remember that an escalation clause may or may not work in your favor, and you should only include one in your contract in a multiple offer situation.

You should only submit one when you know for a fact that there are other offers in place. Otherwise, you run the risk of the seller taking advantage of the situation.

How do you write an escalation clause?

In many states, such as Maryland, you must fill out an escalation clause form to submit with your original offer. The form is relatively straightforward and requires you to fill out necessary information such as details of the property along with your name.

You will also include the value of your original offer, the escalation cap, and the intervals your offer will increase until it reaches the cap.

What is Material Escalation?

Material escalation is the inflation of costs for materials in a specified economy over a set period. Taxation and tariffs can directly impact the price of materials such as steel, wood, fuel, and other materials necessary for construction projects. It is a factor that general contractors must take into consideration when submitting a bid.

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