Real estate is not about buying and selling properties, it is a tricky business, and if you want to succeed, you must know about things like the Escalation clause. Many investors, particularly the new ones, have no idea about it. Here we discuss everything about the Escalation Clause, which you may find helpful.
Escalation Clause in Real Estate
In the real estate business, an escalation clause is a part of an offer for a property. According to it, the potential buyer agrees to raise his initial offer price if the seller receives another offer higher than the buyer's initial offer. The buyer's initial offer will be raised to the level that it automatically exceeds the other buyer's offer. This process is called an escalator clause.
This clause is part of the contract, and the buyer comes up with a predetermined price for a property. When a seller expects multiple offers for his property, he can ask the buyer to add this clause. It is beneficial for both parties as the seller can get the highest possible price for his property, and the buyer can buy a property without fear of losing it if someone buys it at a high price. It seems very simple, but it cannot be very easy in some situations.
How does It work?
The escalation Clause depends on the conditions of the contract. When a buyer submits an offer for a property, he can add an escalation clause, depending on the level of interest in this particular property. It is like a commitment on behalf of the buyer that he will also raise his offer if the seller gets multiple offers for the same property. The highest price of the property is predetermined and already mentioned in the contract.
If you want to write an escalation clause in the contract, you must have the answers to the following questions.
What is the original purchase price of the house?
What is the first offer for this house?
How much price will you add to your offer when the seller receives a higher offer?
How much are you ready to pay for his property at the highest purchase price?
When should you use the escalation clause?
People choose to add an escalation clause to the contract as they want to secure their desired property, but at the same time, they don't want to bid a high amount initially. This can be an effective way to save your money when you are in the real estate business. Moreover, buyers also want to show the seller that they are interested in his property. The housing market is very competitive, and this clause reflects that buyer is a serious business person. However, discuss it with your real estate agent before adding this clause to the contract. They are the professionals who are always part of the business; they can guide you if you should add this clause at this particular time or not.
Advantages and disadvantages of the Escalation clause
Like every other strategy, the escalation clause also has advantages and disadvantages. If you have an idea about them, it will be easier to use this clause more effectively.
Advantages of an escalation clause
Peace of mind for buyers: Real estate purchases are very stressful. If you have found a house that fulfills your requirements, you want to buy this property. If you use this clause, you can secure your deal to some extent. You always remain part of the offer, no matter how high and how many offers sellers get for this particular property.
Reflects your professional approach: Some buyers throw the offer when they are not interested in buying a particular house. Adding an escalation clause shows your professional approach, and the seller clearly understands that you are here for business. Sometimes sellers close the deal quickly if they see an escalation clause in the contract.
Reduce the risk of overpricing: Every real estate investor wants to buy good properties, but he doesn't want to overspend. This clause helps the buyer to avoid overpaying. The first buyer's offer will raise only if the seller gets another higher offer. If the seller doesn’t get a higher offer than yours, you can close the deal on the same initial offer.
Disadvantages of the escalation clause
No negotiations: If the escalation clause is part of the contract, the buyer and seller cannot negotiate the property's price. The highest price you are willing to pay for this house is already part of the clause. So the seller already knows what you are willing to pay, and he can decline your offer or ask you to raise your maximum offer.
The seller loses the right to counteroffer: if the seller accepts an offer with an escalation clause, he cannot counteroffer to other buyers interested in the same property. He already has the maximum offer, so he can accept or reject other offers.
Appraisal problems: Lenders have their own rules and regulations for giving money for a property. They consider the market value of the property. If the escalation clause is there, the lender can refuse your application just because the final price is higher than the property's appraised value.
Chances of fraud: this is not common, but an offer with an escalation clause can also be a fraud. If a seller knows that you are interested in his property and ready to pay a good amount, he can ask a friend to submit an offer at a higher price just to increase the selling price of the property. They will offer less than your maximum price, and you will pay a high amount.
Can you back out of an escalation clause?
It is not easy to back out, as it's an offer, and the seller might have been refused various offers just because of your offer. You can back out if you have imposed certain conditions for the finalization of the deal. If the conditions were not met, you have the legal right to back out.