What is an escalation clause, and how does it work?

In a competitive market with plenty of buyer competition and continued high mortgage rates, it can be challenging to win the bid on a desired home. Thankfully, there’s a tool you can use that may improve your leverage and odds of claiming your dream home. It’s called an escalation clause, and it can enable you to beat competing offers on a coveted property without overpaying beyond your budget, or surpassing your pre-determined maximum offer amount.

That begs several questions: Exactly what is an escalation clause? How do escalation clauses work? When should they be used? How do you put an escalation clause in a real estate contract? And are escalation clauses a good idea if you are trying to avoid getting outbid? Trust in this article to provide helpful answers to these and other queries.

What is an escalation clause?

An escalation clause for real estate is a provision used in a competitive offer that permits a buyer to automatically increase their initial offer price if the seller receives one or more higher competing bids (otherwise known as a bidding war). This clause commonly indicates three things: the starting offer price, the incremental amount by which the offer will escalate, and a maximum offer – also called the “not-to-exceed” price.

“An escalation clause is a strategic tool you can write into your purchase offer that says, ‘Hey seller, I’m willing to beat any competing offer – up to a certain point,’” says Tommy Lee Kirby, a real estate agent with Tommy Lee Homes. “It’s like bidding on eBay, but for homes.”

Because you set a limit on the maximum amount you are willing to pay, an escalation clause protects you from overpaying on a home. It does not guarantee that you will not get outbid, but an escalation clause improves your odds of winning the bid without breaking the bank.

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How do escalation clauses work?

An escalation clause must be written into your offer on a home, which can be worded and handled by your real estate agent or attorney, or by yourself if you do not have representation (although this is not advised).

To include an escalation clause in a contract properly, your offer should specify your starting price, exactly how much you are willing to increase your offer beyond any competing offer, and also the top price you are willing to pay and not escalate beyond. Experts also strongly recommend including a requirement in your offer that the seller furnish written evidence of any competing bids.

Here are the typical steps involved:

— You make an offer to the seller of a property that includes an escalation clause.

— The escalation clause indicates exactly what will happen, such as, “If another purchaser bids higher, I will beat that offer by ($_) up to a maximum of ($_).”

— The seller receives multiple bids.

— Your offer escalates automatically by a particular increment you’ve set ahead of time.

— The seller picks the best offer.

Example of an escalation clause in real estate

Escalation clause real estate examples abound in the real world.

“For instance, say a buyer offers $500,000 for a home but includes an escalation clause stating they will beat any higher offer by $5,000, up to a maximum of $550,000,” explains Neil Cohen, president and managing partner at the law firm Barsh and Cohen, P.C. “If a competing offer of $530,000 is submitted, the escalation clause would raise the original buyer’s offer to $535,000 – assuming proper proof of a competing bid is presented by the seller.”

Attorney A. Kelton Longwell, founding member of Longwell Riess, L.L.C., provides another scenario, one in which an escalation clause is helpful but doesn’t ensure that you’ll outduel rivals.

“Imagine a property is listed at $500,000. You submit an offer for $510,000, but it includes an escalation clause that says you’ll beat any competing offer by $5,000 up to a maximum of $540,000,” she notes. “If another buyer comes in at $520,000, your offer would automatically escalate to $525,000. But if a third buyer offers $550,000, you’re out of the running because you capped your escalation at $540,000.”

When should escalation clauses be used?

Escalation clauses are most useful in seller’s markets where limited inventory and bidding wars are expected. They can also help you stay in the game if you don’t have the time or interest in negotiating back and forth with a seller.

“They allow buyers to remain competitive in hot markets where multiple offers are anticipated, without committing to their highest price upfront,” adds Cohen. “This can be an effective strategy to avoid losing a home over a small price difference.”

According to Realtor and real estate investor Marc Afzal, using an escalation clause is recommended when you and your agent are confident the home is worth stretching for. 

“An escalation clause is also helpful when you want to show you are serious but don’t want to drastically overpay, and when you suspect others will also submit strong offers,” says Afzal.

Are escalation clauses a good idea?

Overall, do the benefits of escalation clauses outweigh the drawbacks? Let’s take a closer look.

Pros of escalation clauses

On the plus side, an escalation clause can give you a leg up because:

— It’s efficient. It does the work on your behalf so you don’t have to keep renegotiating, saving time in the homebuying process.

— It provides a competitive edge, showing that you're willing to buy at a higher price if needed. “An escalation clause demonstrates that you are serious and have the money to back it up without giving away your maximum limit,” points out Dennis Shirshikov, a professor of economics and finance at City University of New York/Queens College.

— It controls costs. An escalation clause prevents emotional overbidding by setting an offer ceiling you will not exceed.

Cons of escalation clauses

Then again, an escalation clause has its downsides, among them:

— It reveals your hand. “Sellers can see your top price, which could weaken your overall negotiating position,” cautions Longwell.

— It increases appraisal risks. If your escalated price goes too high, the home may not appraise for what the lender thinks it’s worth, possibly jeopardizing your financing.

— It limits your control. Remember: You are empowering the seller to increase your offer based on competing offers.

— It can backfire. The seller may desire only clean offers; they could frown on an offer that includes an escalation clause.

— It can lead to overpaying. If comparable sales aren’t yet available, you might pay more than the home’s current market value or what it will appraise for.

Is an escalation clause right for me?

It’s important to weigh these pluses and minuses carefully and determine if you are a worthy prospect before committing to an escalation clause. Escalation clauses work best for purchasers who are in competitive markets, those willing to pay cash, and buyers who are confident the property is a good fit and not worth losing over a few thousand dollars.

“Good candidates for considering an escalation clause are first-time buyers and those with tight budgets who need to be aggressive yet strategic, as well as investors who use escalation clauses to win fixer-uppers where competition is fierce,” advises Afzal.

Shirshikov agrees.

“You should be a well-qualified buyer preapproved for financing who knows how much you can afford to spend and are okay with possible appraisal gaps,” he says.

Better Mortgage helps you compete with confidence in a competitive market—offering fast, 100% online pre-approvals in as little as 3 minutes and competitive rates. With your buying power clear, you can focus on winning your dream home without overpaying.

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Escalation clause FAQs

Why do escalation clauses spark disagreement?

Escalation clauses can be controversial and cause uncertainty, especially if they are confusingly worded. Critics say they make the playing field uneven by giving an advantage to buyers who can write complex provisions in their offer. Some sellers dislike them because they don’t know how to interpret them, they feel less in control, or they want to avoid legal ambiguity. Additionally, attorneys or real estate agents can have disparate views on how to use the clause based on how it is worded or enforced. And there’s also room for manipulation if the listing agent is not transparent about competing offers.

What does an escalation clause mean in a business contract?

Escalation clauses can be used outside of real estate within long-term business contracts, particularly in construction, services, or supply chain scenarios. In a business contract, an escalation clause typically refers to a provision that permits increases in pricing due to changes in external conditions – such as labor costs, inflation, or materials pricing. Case in point: A construction contract can include a clause allowing for cost increases if the price of steel rises significantly during the project timeline.

Can you compete against an escalation clause?

Yes. You, the buyer candidate, can beat an escalation clause by submitting a strong offer without contingencies, offering better terms like a cash deal or quick closing, submitting an offer above the escalation cap, and/or making a personal connection with the seller or writing them a compelling buyer letter.

When is using an escalation clause not recommended?

Avoid using an escalation clause if the property has been sitting for a long time with no offers, the seller has specifically requested “best and final” offers only, there are trust concerns around verifying other offers, the offer process feels uncertain, or you don’t want to reveal your maximum price to the seller.

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