What is an Escalation Clause in Real Estate

A Tool for Buyers

In some parts of the United States, the market is shifting in favor of home buyers. This is happening mostly in the sunbelt states like Texas, Arizona, New Mexico, North Carolina and Nevada to name a few.

But in Virginia, Maryland and Washington D.C., there are still situations where several home buyers will write offers for a single property. If you find yourself in a multiple offer situation, the escalation clause can be an effective tool. Here’s a brief explanation of what an escalation clause is, when to use it, and how to use it to your advantage.

What is an Escalation Clause?

An escalation clause is a condition in a real estate contract offer that allows a buyer to increase their offer price if the seller receives a higher competing offer. The escalation clause gives the buyer the chance to offer more for a property (their Cap) but do it incrementally (the factor) to control the spending. 

Here’s how it works:

1. Initial Offer Price: The starting purchase price indicated on the contract as the sales or offer price. 
2. The Factor: The amount by which the buyer is willing to increase their offer above any competing offer.
   
   
3. The Cap or Maximum Price: The highest price the buyer is willing to pay for the property.

How an Escalation Clause Works

To understand how an escalation clause works, consider the following example:

• Buyer A offers $900,000 for a home and includes an escalation clause with a $5000 Factor and $950000 Cap (max they are willing to pay)
  
  
• If Buyer B submits an offer of $910,000, Buyer A’s offer automatically escalates to $915,000.
  
  
• If Buyer C then offers $955,000, Buyer A’s offer does not escalate further because it exceeds their cap of $950,000.
  
  

Once the winning buyer emerges from the competition, the seller must provide written proof of the competing offer that triggered the escalation, justifying the final purchase price.

Advantages of Using an Escalation Clause

1. Increased Competitiveness

Including an escalation clause can make your offer stand out among others.

2. Controlled Risk

Rather than starting with your highest possible offer, you start lower and only increase if necessary. This can save money if the next highest offer is still significantly below your cap.

Risks and Considerations

1. Revealing Your Hand

By including an escalation clause, you are effectively telling the seller the maximum amount you’re willing to pay. We recommend using an escalation addendum only when the listing agent has confirmed there are other buyer offers in consideration. 

2. Some Sellers Don’t Like Escalation Clauses

Escalation clauses can be tricky to calculate especially when there are more than two buyers making offers. If a listing agent isn’t careful, there can be confusion and mistakes. In some cases, a listing agent will ask buyers for their “highest and best” offer. 

3. Use the Correct Addendum

Be sure your buyer agent or exclusive buyer’s agent uses the correct escalation addendum. If you have any questions, contact an attorney. 

How to Use an Escalation Clause Correctly as a Buyer

If you use an escalation clause in your offer, follow these steps to ensure it’s done correctly and effectively:

1. Work with an Experienced Exclusive Buyer Agent or Broker

Exclusive buyer agents specialize in working for home buyers.  Your agent should understand escalation clauses and how to use them in your market. An experienced exclusive buyer’s agent can help you draft a clause that protects your interests and resonates with sellers.

2. Be Specific in the Clause Language

A well-written escalation clause should clearly define:

• The initial offer amount.
  
  
• The factor amount or how much more you will pay above a competing offer
• The maximum cap price.
  
  
• The requirement for written proof of the competing offer. Ask for a copy of the first page of the sales contract and a copy of the escalation addendum of the competing offer. 

Example:

“Buyer agrees to increase their offer by $5,000 above any competing offer, not to exceed a maximum purchase price of $950,000. Seller must provide a copy of the competing offer to validate escalation.”

3. Talk to Your Lender

If you’re including an escalation clause that pushes your offer significantly above your initial offer, make sure your pre-approval or proof of funds supports your maximum cap. This should be discussed with your lender prior to submitting an escalation addendum.

4. Talk to Your Lender About the Appraisal

There are times a buyer is comfortable waiving the appraisal contingency. 

Background: What is an appraisal and appraisal contingency? An appraiser is sent to a property by the lender to do an independent evaluation or appraisal. The appraiser writes an appraisal which becomes the amount the lender will give as a loan. Before waiving an appraisal contingency, talk to your lender! Your finances must be checked to ensure you can pay the difference, out of pocket, if the house appraises for less than your escalated offer. 

When NOT to Use an Escalation Clause

• Some sellers ask for no escalation clauses in the listing or agent instructions. They may use the phrase, highest and best offer.
  
  
• You have not discussed this option with your lender. Remember, the lender evaluates your financial situation and provides valuable advice when creating your offer. An experienced lender is an important member of your team. 

Final Thoughts

An escalation clause can be a powerful strategy for home buyers—especially when it’s been discussed in advance with your lender. This clause allows you to increase your offer in a controlled manner if there’s a competing bid. It only activates when another offer is on the table, ensuring you pay more only in a competitive situation and never beyond your escalation limit or escalation cap.

Carefully consider if the escalation clause is good for you and your financial situation. To recap, the terms should be clear, you should talk with your lender and feel comfortable with the escalation cap price. If you have any further questions, contact a real estate attorney for guidance. 

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How can we help?

The exclusive buyer agents at HomeBuyer Brokerage specialize in serving home buyers. Please reach out with questions at info@homebuyerbrokerage.com.