Escalation Clauses

In real estate, an escalation clause allows home buyers to automatically increase their offers to purchase a property facing a competing bid. Because real estate law varies from state to state and thus gets tricky quickly, it is best to consult a qualified real estate attorney, who can help you draft your escalation clause properly when buying a home.

What Is an Escalation Clause?

Also known as an escalator clause, an escalation addendum to the purchase agreement allows the buyer to set increments (i.e., the escalation amount) by which the buyer’s initial offer is supplemented when the need arises.

Here, a price cap (the maximum price) is also included with the buyer’s original offer, wherein a higher competing offer triggers the escalation clause at fixed increments until the cap is reached. Thus, in a competitive market where potential buyers can outbid one another using a higher offer, a prospective buyer can use an escalation clause to automatically submit a higher competing offer rather than wait for a seller’s counteroffer.

Listing agents ultimately realize that the bottom line is about obtaining the maximum amount of money above the seller’s asking price. While the highest offer a seller receives might be well above what their realtor expects, it is not unusual for a seller’s market to support economic circumstances where the home ends up well above the appraised value or the appraisal contingency amount stipulated by the real estate contract. Because maximizing the sale price is a function of obtaining the highest bid, a buyer’s escalation clause communicates to the seller that the buyer is willing and able to pay a higher price as their final offer.

Example of an Escalation Clause in Action

For example, suppose Buyer 1 has submitted a $500,000 offer to purchase a property. Buyer 2 might outbid Buyer 1 by $10,000 with a competing offer of $510,000. If Buyer 1’s offer included an escalation clause for an incremental amount of $5,000 and a cap of $550,000, Buyer 1 would now have an automatic superseding offer of $515,000 against Buyer 2. Upon subsequent competing offers above the $515,000 escalation, Buyer 1’s offer would continue to increase to a maximum of $550,000 before Buyer 1 would be forced to drop out of the bidding war.

Here, the buyer using the escalation clause is rewarded with a higher chance of scoring their dream home; likewise, the seller benefits from the bidding war because their home will sell well above the original $500,000 asking price.

Many states, including Texas, California, Illinois, and Massachusetts, recognize escalation clauses as a matter of contract law.

Appropriate Times for Using Escalation Clauses

It is not always appropriate or even possible for a buyer to use an escalation offer.

Advantages of Escalation Clauses

Assuming that the seller does not object to the inclusion of an escalation clause, a buyer can use it as a security measure to ensure that they will not be defeated in a bidding war, especially if the property is particularly desirable to the buyer.

A buyer’s escalation offer might also be appealing to a seller in and of itself because it signals that the buyer has a good faith and credible intention of obtaining the property at any cost (subject to the escalation cap).

Disadvantages of Escalation Clauses

But sometimes, a seller might be unwilling to accept the clause in the first place for fear that it might discourage other potential buyers.

Another common disadvantage to using an escalation clause is that the buyer loses leverage during purchase negotiation. This is because the escalation cap has already revealed the highest amount (i.e., the best and final offer) that the buyer is willing to pay for the property so any further price negotiation could become moot. The buyer might end up spending more money to purchase the property due to the fixed nature of the escalation increments.

Finally, a loan underwriter or bank appraiser might also subject a transaction to greater scrutiny if an escalation clause is included as part of the real estate contract.

To ensure that an escalation clause is appropriate to your circumstances, a qualified real estate attorney should draft or at least review the proper vocabulary before the time an offer is made or accepted.