What is an Escalation Clause and How Do They Work

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Have you heard the term “escalation clause” and wondered what it means?

It is not uncommon for a seller to get multiple offers for a home in hot real estate markets, and bidding wars become commonplace in a seller’s market.

As a buyer, the situation can become frustrating as you make offers – only to lose to other buyers who go higher and repeatedly have to find another house to bid on.

Many home buyers find it can be an endless loop where a higher offer in a competitive market beats them.

Over the years, a type of language inserted into an offer known as an escalation clause has become prevalent to address such situations.

Understanding what an escalation clause is and how it works is essential for buyers and sellers today.

In a competitive real estate market, buyers often hear about such contract clauses and ask their agent, “What is an escalation clause?” or “How does an escalation clause work?“

Of course, buyers asking these questions look for any edge to beat out a competing buyer for their dream home.

With sellers and their agents setting up deferred showings to increase the odds of a bidding war, buyers need an edge. An escalator can do just that.

It is a valuable tool in a hot market with abundant real estate transactions containing escalation clauses.

However, it should be abundantly clear that you or your agent better know what they are doing when adding an escalation clause to an offer.

Keep in mind that offers are legal and binding real estate contracts. Consult a real estate attorney if you don’t completely understand what you agree to with an escalation clause.

By the time you are done reading, you’ll have a firm grasp of how escalation clauses work.

How Does An Escalation Clause in Real Estate Work

So, what is an escalation clause? Below is the specific language inserted into a real estate contract, including an escalation clause. Escalation clause phrasing such as this is common in a real estate offer.

“Buyer offers to pay $____ for the home, but if the seller receives a bona fide offer that is higher, buyer will increase the price to $____ above the amount of the other offer.”

Some critical language here is the word “bona fide.” A bona fide offer to purchase is made in good faith and is legitimate and enforceable.

At the buyer’s request, the seller must provide documentation to the buyer that the other contract is, in fact, a bona fide offer. In other words, a seller can’t “make up” an imaginary offer. Escalation clause proof is not out of the ordinary.

An escalation clause states that you are willing to outbid any other offers on the home by a certain amount, up to a ceiling price. The ceiling is also called a “cap price” or the most you are willing to pay.

The maximum amount you are willing to pay becomes the cap in the purchase agreement. The escalator amount and the ceiling cap are essential components of the clause.

Escalation Clause Example

For example, you may offer $400,000 on a home with an escalation clause stating that you will outbid other offers by $5,000 up to $421,000. So, if another buyer offers $405,000, your escalation clause means you will pay $410,000 for the home.

If a prospective buyer offers $425,000, you are out of the bidding according to your escalation clause because the offers have exceeded your $421,000 ceiling or cap. So, your offer price would be capped at $421,000 in this offer situation.

An escalation clause’s usefulness is evident if you buy homes in an area where competing offers are common. You can put in your bid and feel more confident that you will still get the house if no other potential buyers outbid your ceiling.

One of the buyers’ greatest frustrations is not knowing what it will take to get the home they want. Real Estate agents are often asked by their clients what they should offer.

On the one hand, buyers don’t want to overpay, but they don’t want to lose the house. The escalation clause allows buyers to put their best foot forward financially without feeling they overpaid. You are essentially making your best offer without the seller asking.

When a buyer asks me if an escalation clause is a good idea, my answer will be YES most of the time! Let’s dig a little deeper into why that is the case.

When Are They Used?

Escalation clauses in real estate are typically used in hot seller markets. They become popular because of multiple offers and bidding wars.

Rarely are real estate escalation clauses used in buyer’s markets.

Do Escalator Clauses Work?

A real estate escalation clause can be very effective for home buyers. It is often the difference between winning and losing when a seller has multiple offers to consider.

The escalation clause can trump other offers due to the increase in the price of the offer.

What Are The Rules?

An escalation clause in real estate will only go into effect if a competing offer exists. If no other bids are presented to a seller, the escalator clause will not apply.

Sellers will need to prove additional offers exist.

How Can You Beat an Offer With This Clause?

Be the highest bidder to beat a real estate escalation clause. Buyers can also win over other offers with these clauses by offering more attractive terms to the seller.

For example, a buyer could agree to waive all property inspections or make their offer more appealing by letting the seller stay in the property beyond the closing date.

Other terms besides the price could entice a homeowner to accept another offer.

Are They a Good Idea?

In real estate markets that favor home sellers, they are often the difference maker for a buyer being the winning bidder. The clause can be an excellent choice to increase your chances of coming out on top in a bidding war.

How an Escalator Clause Can Backfire

The biggest potential problem with an escalation clause is it can cause a buyer to pay more for a home than was necessary. There are a couple of ways this can happen.

There could be another higher offer that would never be acceptable due to other terms. However, the escalation clause is activated, given this offer exists. For example, the higher offer contains a home sale contingency.

An additional way the clause can backfire is if the seller counteroffers at the cap price in the escalator. Unfortunately, for buyers, these clauses give away the maximum amount of money they are willing to pay.

These reasons are why escalation clauses in real estate are bad in specific circumstances.

Can The Clause Have No Cap?

Yes. The clause does not need a price cap, although most do. Removing the cap from the clause can be very risky for a buyer. You are essentially opening up your wallet and paying unlimited money.

Most buyers want to know how much they will pay for a home.

Pros and Cons

Let’s examine the upsides and downsides of writing an offer with one of these clauses in the contract.

Pros

1. Peace of Mind For The Buyer.

It is stressful to make an offer on a home you want and then go home and constantly worry that someone else will come along and create a more substantial offer.

When you want a particular property, an escalation clause lets you negotiate terms that work for your budget and keep you in the running for the home.

You have a competing bid that goes to a higher price. It’s possible you can knock out the competition by using the language.

2. The Buyer Doesn’t Overpay.

As a home buyer, you want to pay only as much as necessary to get the house.

A real estate escalation clause protects you financially because it prevents you from paying more than you need to.

Your escalation clause only bumps your price when other buyers compete with you.

Once they stop making offers, your final purchase price is the lowest you could have paid to get the home.

3. Increase Your Odds of Getting The House!

As a buyer, the biggest reason you would add an escalation clause to your offer is to increase your chances of being the winning bidder.

A properly written escalator will do just that, giving you a competitive edge over other home buyers.

If there are no other offers, your initial offer could be accepted. However, if there are additional offers from other interested buyers, you have a good chance of winning.

Cons

1. The Listing Agent May Not Understand The Clause.

Sad but true. While they are becoming more common, seller agents still do not always see escalation clauses, especially in less demanding markets. The listing agent may see your escalation clause and not “get it.”

If the agent doesn’t know what it is, then the seller is even less likely to. That means your first offer may be the only one you get to make, as other offers will top yours, and neither the agent nor the seller will realize that you are willing to keep increasing your offer.

Real Estate escalation clauses can be confusing if you have never seen one before. In Massachusetts, where I am located, The Greater Boston Real Estate Board has created a standard form when writing an offer.

Such a form eliminates uncertainty for agents who have never dealt with an escalation clause. Most states now have an escalation clause form that can be included with offers.

Real Estate agents should know how to handle multiple offers to achieve the best possible outcome for the seller. Unfortunately, many agents don’t have a clue.

It would be wise to ask your buyer’s agent to ask the seller’s agent if they know what an escalation clause is and how it works when submitting an offer.

2. You Give Away Your Bargaining Position.

The biggest drawback of an escalation clause to a buyer is you are giving away your hand up front. There is no playing poker with an escalator in your offer.

An escalation clause identifies the maximum a buyer will pay, which is much more revealing than a traditional offer. The seller will know the highest sale price the buyer will pay for the home up-front.

Instead of accepting the offer with an escalation clause, the seller could reject the bid and suggest a counteroffer at or above the escalation clause’s maximum price.

The “cap” information in an escalation provision could jeopardize the buyer’s bargaining position with the owner. A good buyer’s agent should explain this so there is no confusion.

3. The Confusion Created by Multiple Offers.

Sales, where multiple offers come in, are always confusing, but an escalation clause only increases the confusion. The seller and the listing agent may struggle to keep up with the different offers, especially your escalating offers.

Someone will have to do the math and keep track of your escalation clause’s meaning with each new offer, which may or may not happen.

The seller may give up on the calculations and focus on the new, traditional offers. Considering that the other buyers may be adding escalation clauses, it is easy to see how the situation could quickly become hard to deal with.

It’s never been an issue for me, but that is the thinking of some inexperienced agents.

4. You Might Frustrate The Seller.

Sellers want to make as much money as possible from their home sales. That means they want the highest offer you have to give.

When you approach sellers with a real estate escalation clause, you might encounter an individual who is confused and angry that you are trying to short them on the house’s asking price.

If your ceiling is $321,000, why didn’t you start at $321,000? If you want the home, the seller may think you should be willing to put all your cards on the table.

This is not to say that such an attitude is fair – if the situation were reversed, would the seller-turned-buyer want to pay more than necessary to buy the home? Probably not.

But the situation is what it is, so the seller may not be willing to see things your way.

5. Bank Appraisal Issues.

Banks lending money for mortgages are very particular about how much they will lend for a home. They demand an appraisal to determine the home’s market value and not lend buyers more than the appraisal price.

With escalation clauses, the offer’s automatic nature can sometimes lead to a situation where the price is too high – higher than the home will appraise.

You could be told you won the bidding war, only to discover later that the bank will not give you enough money to pay for the home.

Homes with these clauses often see the final price escalated way above what the seller is asking.

Appraisal Gaps Become More Common

Your options are to raise the money another way, convince the seller to sell for less, or walk away from the deal. Not surprisingly, bidding wars increase the odds of fighting a low appraisal.

Often, the appraiser is justified in their opinion of value; other times, they are not. To make the best offer, many buyers are removing the appraisal contingency.

Some buyers are adding an appraisal gap clause, putting in writing they will make up the difference with a higher down payment if the appraisal comes in low.

6. The Seller May Not Consider Your Offer.

Some sellers will not be interested in offers that include escalation clauses, whether because they are annoyed that you aren’t putting in their highest bid, they are confused over the nature of these clauses, or for some other reason.

No matter how badly you want the house or how well you get along with the seller, you will still encounter people who aren’t interested in anything but traditional offers. You may want your agent to feel the listing agent out in advance.

Nine times out of ten, it is in the best interest of a home seller to entertain such a clause.

While it may seem like there are more downsides to an escalation clause, that is NOT the case.

What Happens if There Are Two or More Contracts With These Clauses?

Some real estate agents panic when receiving multiple offers with escalation clauses. It’s no big deal. Multiple escalation clauses are now commonplace.

With hot real estate markets nationwide, competing escalation clauses have become standard for most houses.

You address each offer on its own merits. The purchase offer with the highest ceiling cap is in the top spot, at least regarding price.

It is vital to understand the winning bid doesn’t necessarily mean the highest offer price.

Do The Clauses Escalate Each Other?

Yes, they do. When multiple offers are made on a property, each with an escalation clause, the price offered for a home automatically increases.

The Clauses Only Consider The Price

The other issue buyers need to understand is that an escalation clause only addresses the amount they are willing to pay for a home.

Many other terms in an offer could be equally important to a seller. This is where a great buyer’s agent in your corner comes in handy.

Your agent should be probing the listing agent to determine the terms and conditions that are most desirable to the seller.

For example, maybe the seller desires to have an extended closing date. The home’s sale price is not always the only term that matters in consummating a real estate transaction.

What Other Terms Make a Difference to The Seller?

Other buyers could put a significant amount of money down on the home.

It’s also possible one of the competing bids could be paying cash. These terms might weigh heavily in the seller’s mind, and deservedly so.

A cash offer is tough to beat as it removes many roadblocks in a real estate transaction.

In areas where there are bidding wars on homes, some buyers will even remove their home inspection contingency if they feel it will help them land the property.

By the way, doing so could help if the home is not in perfect condition! Home inspections are often a significant hurdle in a real estate transaction, so we always counsel preparing for them ahead of time.

The seller might need something different than the typical closing time frame.

As a buyer, you can never underestimate what is essential to a seller. You might think everyone only looks at the price, but that is far from the truth.

Buyers should understand that an escalator in their offer does not guarantee them anything. A buyer using an escalation clause could be the highest bidder but lose out due to terms in another offer that was better for the seller.

Understand How to Use An Escalator as a Home Buyer

This is where understanding the “escalator” becomes crucial. Some buyers assume incorrectly that making the escalator tight at $1000 over the highest bidder is wise.

If other terms are just as important to the seller, getting a thousand dollars more will probably not make a difference.

You might need a more significant spread, so the seller should think twice. Something like five thousand dollars would be more likely to persuade them.

When trying to understand how a real estate escalation clause works, it’s important not to discount the importance of either the escalator or the cap price!

Not too long ago, the seller was fortunate to get multiple bids while selling a home in Bellingham, Massachusetts. One of the offers happened to have an escalation clause.

However, the agent who wrote the offer had a tight escalator of $1000. Even though they were the highest bidder, other terms in the second and third-best offers were more appealing.

The better deal was not taking the highest offer. Here is some of the best advice on how to write an escalation clause. Use these tips to increase your odds of being successful.

The Controversial Love Letter

Buyers often write a personal letter to the seller to make an offer more appealing. The letter usually includes a beautiful picture of what the buyer loves about the home and how they envision living there.

Including your picture so the seller knows who you are is a nice touch. It adds a personal element that other offers might not have.

If the seller is an emotional thinker and not necessarily caught up in their bottom line, this could give you an edge. Believe it or not, some sellers value who will live in the home after them.

It will make little difference if you are dealing with an analytical thinker. However, writing a love letter is controversial, and many attorneys recommend not accepting it when representing a seller.

Accepting these letters puts a seller and their agent in a position where they could be accused of not accepting an offer based upon someone’s race or ethnicity. Yes, people can sue you for just about anything, unfortunately.

Home sellers should be asked upfront whether or not they would like to view a buyer's love letter when offers are made.Click To Tweet

Be Weary of Fraud

You like to think everyone you deal with is above board. Ninety-nine percent of the time, you are. However, using an escalation provision in an offer does raise the possibility of fraud.

Nothing prevents a seller from asking a friend to write an offer on the home. The seller could then turn around and present this to the buyer with the escalation clause. The seller will artificially get more money from the buyer by doing so.

Do I think this happens? Rarely, but it is always something to keep in mind. Any good Realtor following the Code of Ethics would never do something like this.

What Happens in Negotiations?

The seller’s agent will review all offers with the owner when they have been made. It is in the seller’s best interest to choose the contract that has the most attractive terms for them.

Whether that is the highest selling price possible, some other term or a combination of multiple terms is for the seller to decide.

A better offer for a home seller doesn’t necessarily have to be the one offering the most money. The winning bid could be something that was appealing to the seller, like no home inspection or a cash offer.

The buyer and seller could have counteroffers back and forth before the final agreement is signed.

Should You Use One?

Escalation clauses can be beneficial, so more buyers are attempting to add them to their offers—especially in hot real estate markets. But they are not foolproof and may not be practical for your situation.

Talk with your realtor to determine whether a real estate escalation clause suits you—whether you should try one as a buyer or accept one as a seller.

Hopefully, your real estate agent understands escalation clauses, which can be a handy tool when bidding with other buyers.

Always remember what you are ultimately willing to spend on a property. Please give it some serious thought. It is often in bidding wars where buyers later feel remorse.

If not, speaking with a real estate attorney who can draft the escalator clause for you might be wise.

Final Thoughts on Escalator Clauses

You will know the answer when someone asks what an escalation clause is. Hopefully, this guide to using escalator clauses has been helpful!

Additional Helpful Home Buying Resources

How to avoid buyer’s remorse is not unusual for a buyer to have some remorse after making a significant purchase. It happens all the time, even for less expensive items. See how you can increase your chances of not feeling down after making an offer.
What is a dual agent in real estate? Dual agency is one of the more essential real estate terms buyers and sellers should be aware of. Consumers should avoid it. See why dual agency benefits a real estate agent and why it is a conflict of interest.
The ins and outs of an escalation clause – see more excellent information on what you should know about an escalation clause.
Understanding agency in real estate – Kevin Vitali explains how agency law works in real estate sales.

Use these additional home-buying resources to make intelligent decisions when purchasing a home.

About the Author: Bill Gassett, a nationally recognized leader in his field, provided the above information on real estate escalation clauses. Bill has expertise in mortgages, financing, moving, home improvement, and general real estate.

Learn more about Bill Gassett and the publications in which he has been featured. Bill can be reached via email at billgassett@remaxexec.com or by phone at 508-625-0191. For the past 38+ years, Bill has helped people move in and out of Metrowest towns.

Are you thinking of selling your home? I am passionate about real estate and love sharing my marketing expertise!

I service Real Estate Sales in the following Metrowest MA towns: Ashland, Bellingham, Douglas, Framingham, Franklin, Grafton, Holliston, Hopkinton, Hopedale, Medway, Mendon, Milford, Millbury, Millville, Natick, Northborough, Northbridge, Shrewsbury, Southborough, Sutton, Wayland, Westborough, Whitinsville, Worcester, Upton, and Uxbridge MA.

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