Real estate investors: have you ever lost out on a great investment property because another investor swooped in at the last moment and outbid your offer?
It’s a pretty frustrating situation. Yet, in order to avoid it completely, you might feel as though you must make a higher offer than you’d like to. Luckily, thanks to a little known trick, you don’t have to. It’s possible to both try to get the best price and protect yourself from losing your grip on a great investment property.
How? With an escalation clause.
What Is an Escalation Clause in Real Estate?
An escalation clause in real estate is essentially a price escalation clause that is added to an official real estate offer. It lets the seller know that you will automatically outbid any other offers they receive, outlining the specific terms of how you will do so.
This gives you a greater level of control over making sure you get the property you want. Otherwise, sellers will often turn to the better offer and leave you out of the running.
Do Escalation Clauses Work?
Does using an escalation clause really work?
Often, the answer is yes. The reason an escalation clause can work in favor of the buyer is that it can be written by a real estate agent or real estate attorney to accommodate the buyer’s exact desires.
See also: When to Hire a Real Estate Attorney
The escalation clause states how much you are willing to outbid competitors when making an offer on a house. It also provides a cap or a maximum purchase price.
So, for example, let’s say you are buying an investment property and you make an offer of $200,000. You include an escalation clause stating that you are willing to beat any competing offer by $5,000, up to a maximum sales price of $250,000. If another buyer offers $230,000, you’re automatically offering the seller $235,000, ensuring you get the house. But if another buyer offers $260,000, you lose the house, because, in your escalation clause, your bidding is maxed out at $250,000.
Can a Seller Lie About Competing Offers?
Something you might be worried about is a seller trying to get you up to your max bid by lying about what other buyers have offered.
You can rest assured that this is not a possibility, as long as your escalation clause is properly written. Make sure your real estate agent is knowledgeable in this area and knows how to write an escalation clause. It should have a section stating that the seller must provide proof of a competing offer in order for your offer to increase.
Pros of Having an Escalation Clause
- Your offer is taken seriously because the seller knows you are willing to outbid other offers.
- You automatically get the chance to outbid other offers, as opposed to being left in the dust.
- It reduces the back and forth communication associated with real estate bidding wars, putting the process on autopilot.
- Your chances of buying the investment property you want increase.
Cons of Having an Escalation Clause
- You are locked into paying a higher price if other real estate investors or homebuyers outbid you, so you need to make sure you’re comfortable paying the maximum price if it comes to it.
- You let the seller know how much you’re willing to pay, which can be detrimental to real estate negotiations.
- The seller’s agent may legally reveal the cap price in the clause to other buyers, meaning they will know how to outbid your highest offer.
When to Use One
At this point, you might be wondering when to use an escalation clause in real estate. When would it be most beneficial or advisable for a real estate investor to consider using this tool?
Typically, real estate investors would only consider using an escalation clause if they were either:
- Completely determined to own a particular property, or
- dealing with a hot seller’s market.
The first reason makes sense because an investor wouldn’t want to lose a great property to a competing bid, especially if they could easily outbid the competition.
This could be a great strategy in a buyer’s market because it could mean the best of both: offering a very low bid, knowing there probably won’t be other offers, but also securing the right to increase your bid on the property in the event that other buyers are interested. However, if you are not dead set on owning a property, it wouldn’t make sense to include an escalation clause.
The other reason for including an escalation clause in real estate is if you’re dealing in a seller’s market because it makes your offer more competitive. Depending on how hot a market is, including an escalation clause might be your only chance for scoring a home you want.
For instance, the way the US housing market 2021 is looking so far, it will be difficult for buyers to stand out from the competition without something like an escalation clause. We are experiencing extremely low inventory, and properties aren’t staying on the market long. There are many ways to get sellers to take your offer more seriously, such as offering cash or being pre-approved, and an escalation clause is one more way to get noticed.
The Takeaway: Is an Escalation Clause a Good Idea?
The answer is, it depends. It can be a good idea if you are willing to go above your initial bid in order to secure a property you really want, especially if you believe others will also be making offers on the investment property for sale.
It can also be detrimental in that, by putting all of your cards on the table (letting the seller know how much you’re willing to pay), you lose some power in negotiating.
In order to determine if an escalation clause in real estate is right for you, ask yourself:
- How much does owning this rental property mean to me?
- How likely is it that other buyers will want it just as badly?
The best tool you can have on your side is knowing the real estate market very well and understanding the real worth of the property. For this, we recommend using Mashvisor as a resource for the latest information on housing markets, demand, inventory, and investment property returns.