Ever found your dream investment property, only to be outbid by someone else?
Whelp, there’s a clever solution for that… the escalation clause.
It’s an amazing bargaining tool for competitive real estate markets!
That is, if you know how to use it.
In this article, we’ll break down everything you need to know about an escalation clause so that you don’t miss out on your first or next real estate investment.
What is an Escalation Clause?
An escalation clause is basically a built-in, automatic counter-offer system.
This clause, added to your real estate offer, lets the seller know you’re prepared to beat competing bids — but only up to a certain point.
Let’s see how it works:
Proof of an Offer
An escalation clause only activates when the seller has a legitimate higher offer from another buyer.
That means the seller must provide proof of the competing offer in order to trigger your escalation clause.
Escalation Amount
The escalation amount is the specific dollar figure you’re willing to add to your original offer to outbid the competition.
For example, an escalation amount of $2,000 means if a competing offer comes in at $350,000, your offer automatically bumps up to $352,000 to stay competitive.
Price Cap
The price cap is your escalation clause safety net.
It’s the absolute maximum you’re prepared to pay for the property.
Because this number is predetermined as you’re creating your initial offer, this protects you from emotionally overspending in the heat of the moment.
Advantages of an Escalation Clause
- Peace of Mind: An escalation clause signals to the seller that you’re serious about the property. You’re showing them you’re flexible and will work to meet their desired price within reason.
- Competitive Edge: When multiple offers are on the table, an escalation clause helps your offer stand out. It might put you at the top of the pile even if your initial offer wasn’t the absolute highest.
- No Overpaying: With the price cap in place, an escalation clause protects you from going overboard in a wild bidding frenzy. You get the house if it’s within your budget; otherwise, you walk away without blowing your savings.
Disadvantages of an Escalation Clause
- Negotiation Killer: By revealing your max price right out the gate, you can weaken your bargaining power. The seller might simply counter with your cap, skipping any wiggle room in between.
- Appraisal Issues: Things can get hairy if the escalation drives the agreed price above the property’s appraised value. Lenders won’t give you a mortgage for more than the home is worth, which means you might need to come up with extra cash out of pocket.
Escalation Clause Example
To further break down the concept of an escalation clause, let’s take a look at an example.
Let’s say you found a dreamy investment property full of ROI potential in an up and coming neighborhood.
- Your Initial Offer: $400,000
- Escalation Amount: $3,000
- Price Cap: $425,000
A competing offer comes in at $405,000. Your escalation clause automatically adjusts your offer to $408,000 — outbidding the competition by your preset increment. If another offer tops that, your bid escalates again until you either win or hit your $425,000 cap.
It’s that simple!
When To Use An Escalation Clause …
An escalation clause isn’t always the winning move, but sometimes it’s your best bet.
Here’s when to consider it:
- Scorching Hot Real Estate Market: In a strong seller’s market, when properties are flying off the shelves, an escalation clause shows you’re a committed buyer prepared to compete.
- Multiple Offers Anticipated: If you sense the home will get multiple offers, an escalation clause can set you apart.
- You’ve Found “The One”: When you’re set on an investment property, whether it’s your first or next one, an escalation clause may be your only way to seal the deal.
…When NOT to Use an Escalation Clause
There are several scenarios where an escalation clause could harm your chances more than help them:
- Slow Market: In a buyer’s market where you have more negotiating power, using an escalation clause can be unnecessary and could backfire.
- Seller Might Not Accept: Some sellers may not accept an escalation clause in an initial offer.
- Cash Is King: In a strong seller’s market, even escalation clauses can lose to all-cash offers. If you suspect there will be cash buyers in the mix, your clause might not tip the scales.
- Contingencies Included: An escalation clause loses strength if your offer is packed with contingencies. Sellers prefer offers that are clean and likely to close without hiccups.
Escalation Clause FAQs
Next, we’ll take a look at some of the most commonly associated questions with an escalation clause.
Q. How do you beat an escalation clause?
A. Technically, the way to win against an escalation clause is simply to make an offer higher than the other buyer’s cap.
That said, this isn’t always about raw numbers.
A stronger offer with fewer contingencies or even an all-cash deal might win out, even if it’s slightly lower than an escalated offer.
Q. What happens if two offers have escalation clauses?
A. It becomes a matter of who blinks first.
This often prompts the seller to ask for a “best and final” offer from each buyer, removing the escalations from the equation.
Q. Can you pull out of an escalation clause?
A. Generally, yes. While an escalation clause makes your offer legally binding, standard contingencies (like those based on inspections, financing, or appraisal) are often still included.
If one of those contingencies isn’t met, you can back out within the agreed-upon time frame.
Q. How does an appraisal affect an escalation clause?
A. If the escalation drives the final price above the property’s appraised value, you could find yourself on the hook for the difference.
That means more cash out of your pocket to close the deal.
Appraisals add a layer of risk to using an escalation clause.
The Bottom Line: Escalation Clause
An escalation clause can be a valuable weapon in your real estate arsenal, but it’s not foolproof.
Understanding the advantages, drawbacks, and quirks of this tool is crucial to using it effectively.
That’s why real estate investing education is key: it’s the difference between an investment that loses money and your most profitable investment yet.
