As keeping up with your investment properties can get tricky, the escalation clause real estate may be of help.
Table of Contents
- What Is an Escalation Clause in Real Estate
- How an Escalation Clause Works
- When to Use an Escalation Clause
- Benefits and Drawbacks of Escalation Clause in Real Estate Contract
- Is It Possible to Back Out of an Escalation Clause?
- How to Avoid Overpaying for an Investment Property
- Escalation Clause Real Estate Recap
In this article, we will review the escalation clause and how it affects purchasing investment properties. Then, we will look at the benefits and drawbacks of this clause. Continue reading to learn all about the important clauses everyone should know.
What Is an Escalation Clause in Real Estate?
Essentially, the escalation clause real estate is a part of an offer for a property that says the potential buyer is willing to raise their initial offer price if the sellers happen to receive another offer that was bigger. In this case, because of the contract, the buyers with the escalation clause will automatically increase their offer, enough to surpass the other buyers’ offers. This process is also referred to as the escalator clause.
Typically, when there is an escalation clause in real estate as a part of the contract, the buyer will come up with a predetermined price. This both accounts for how much their offer will increase each time, as well as the highest price they are willing to offer overall.
The escalation clause real estate is mostly used in cases where the buyers and sellers are expecting to receive multiple offers on their property. This helps both parties. The sellers are able to get the highest price for their property while the buyers are able to stay in the running to purchase a listing they are very interested in.
Though the escalation clause in real estate sounds simple enough, it can become a bit complicated due to all of the numbers and other issues that will need to be figured out. We will look at these complications a little later in the article.
How an Escalation Clause Works
Overall, the real estate escalation clause works through contract conditions. When a buyer submits an offer on a property, they can include the escalation clause. This is a commitment from the buyer to continue raising their offer if the seller gets another offer for their property. This continues to happen until the highest offer is made by the buyer with the escalation clause. This highest price is predetermined and written in the contract.
This allows the buyer to continue to have the highest offer to purchase until they hit the predetermined price.
Overall, these are the main questions you need to figure out when writing your escalation clause:
- What is the original purchase price of the property?
- What is your first offer for the property?
- How much will you increase your offer each time a higher offer is received by the seller?
- What is the highest purchase price you will pay in total for the property?
Escalation Clause Real Estate Example
Let’s look at a scenario in which the escalation clause is seen in real estate. For example, you are a buyer and you see a property listed for $400,000. You decide to submit that exact offer for the house, but you also decide you really want this property.
You write in your offer that you will use the escalation clause. Every time someone else submits a higher offer for the property, you will increase your offer by $5,000. You decide you will continue to do this until the listing has an offer for $500,000. That is your maximum purchase price for this property, so, once the price hits $500,000, you will no longer be bidding on the listing.
This real estate strategy is a great way for buyers to stay on top of their offers, and continue to have the highest price for their property of interest.
When to Use an Escalation Clause
The main reason people use the escalation clause real estate is to secure the highest price on their desired property, without having to initially bid more money than they want to. In some cases, this strategy is a great way to attempt to save money when buying a property. The seller’s market is tricky. No one wants to pay more than they have to, so you can see how low you are able to purchase the listing for.
Buyers also like to use the escalation clause real estate to show the sellers they are extremely interested in the property. The housing market can be super competitive, and this strategy shows sellers you mean business.
Before using the real estate offer escalation clause, always discuss it with your agent. They will guide you in the right direction if it is an appropriate time to use this strategy.
Benefits and Drawbacks of Escalation Clause in Real Estate Contract
Like any real estate strategy or clause, the escalation clause has its pros and cons. Before utilizing one of these strategies, it is always a good idea to familiarize yourself with all of the ways it can be beneficial or negative to you.
Benefits of the Escalation Clause Real Estate
Below are some of the benefits of the escalation clause:
Creates a Peace of Mind for the Buyers
Purchasing a property can be very stressful. Once buyers have found a listing that fits all of their wants and needs, they want to ensure they are able to purchase the property. Using the escalation clause can help secure a home under contract. There is no need to worry about other offers being sent in on the home, as the escalation clause automatically adds to your offer.
Shows Sellers You Mean Business
As the housing market can be a tricky place, sellers love to know you will follow through with your intentions to purchase their property. The escalation clause is a great way to show the sellers of the listing you are interested in that you are serious about this purchase. Sellers may even consider accepting your offer if they see you have the escalation clause in your contract.
Helps Buyers Not Overpay
Purchasing a property is usually a big financial commitment. Especially if you are a real estate investor, you don’t want to spend more than you need to on your investment property to generate a higher return on investment. The escalation clause helps to ensure you do not overpay for the property. As you will only increase your offer when another offer is put into the property, you can always know you are getting the best price of the listing.
Drawbacks of the Escalation Clause
Below are some of the negatives to keep in mind when using the escalation clause:
No Negotiation Between Buyers and Sellers
Once the escalation clause is put into place, there can be no negotiation between the two parties about the price of the property. This is because the clause includes the highest price that you are willing to pay overall for the property, and it becomes available to the seller. This means the seller will already know the maximum amount that you are willing to pay.
Once the seller knows your highest price, another problem could be created. The sellers could just decline your offer, including the escalation clause, and ask you flat out for your maximum offer.
Sellers Cannot Counteroffer Other Potential Buyers
If a seller decides to accept an offer with an escalation clause, they can no longer submit counteroffers to other buyers who place an offer on the listing. This is due to the fact that the buyer with the escalation clause might not yet have their maximum offer submitted yet. The seller in this situation can only accept or reject other offers.
Lenders in the housing market can be extremely exact in how much they are willing to give for a property, based on the home’s property market value. In times the escalation clause is used, a situation could arise in which you win the bidding war but don’t get approved by the lender as the final price ends up being higher than the appraised value. This means the buyer might not actually be able to pay for the property.
In times the escalation clause is used, always consider the property’s appraisal value when determining your maximum purchase price.
Though this is unlikely to happen, there could be a case in which fraud is involved in an offer with an escalation clause. As the sellers know how much you are willing to pay for the property, they could ask a friend to also submit their offer on the property just to increase the overall selling price. This would theoretically work as they just have to offer a little under your maximum price.
Is It Possible to Back Out of an Escalation Clause?
If you are a buyer and you decide to include an escalation clause on your offer, it can be difficult to back out of if you get cold feet. This is because it is basically a contract. Sellers have likely turned away other offers to accept yours.
The only way you can back out of an escalation clause contract is if you had certain conditions to the house under contract that had to be met for the sale to be final—also known as contingencies. If these factors were not met, then you would have legal grounds to back out of the offer.
In any of these cases, always consult with your real estate agent. They will guide you through the entire process, especially if you decide to include an acceleration clause real estate in your offer.
How to Avoid Overpaying for an Investment Property
Any investor knows how essential it is to save as much money as possible when investing in real estate. To do so, you should always conduct a real estate comps analysis. This will ensure you are not overpaying for any investment property. Below are the steps to follow to complete a real estate comp analysis:
- Figure out important features to your property, such as square feet, property price, and unique features.
- Search for real estate comps similar to your listing.
- Find the average price per square foot of your comps, and compare that price to your property.
The goal of this is to figure out the average pricing in the area, based on similar listings nearby.
For additional help finding reliable real estate data, visit Mashvisor to access a variety of tools and services. We offer tools, such as the Investment Property Calculator, that help you conduct real estate comps analysis in minutes. This tool not only offers pre-calculated data for your specific property but also provides a comparison between how your property will perform as a long-term rental vs as an Airbnb. Mashvisor can help you make the best decisions for your investment property.
Escalation Clause Real Estate Recap
The escalation clause is a strategy in real estate for buyers to continuously have the highest bid on an income property they are interested in. This is a contractual agreement that states your offer will increase a certain amount every time you are outbid. This is a predetermined increase that will occur until your maximum offer is hit. When this happens, you will be outbid and out of the running for the listing.
Like any real estate strategy, there are certain benefits and drawbacks you should be aware of before committing to the process. Especially because the escalation clause is a contractual agreement, there is little wiggle room to forfeit the contract. The only times in which a buyer can back out is when conditions and terms are not met by the sellers.
To get access to our real estate investment tools, click here to sign up for a 7-day free trial of Mashvisor today, followed by 15% off for life.