Escalation Clause

Definition of "Escalation clause"

Written by

Ermelinda McLaughlin

Tristate LM realty group

Generally, the escalation clause, often known as the escalator clause, means a provision in a contract enabling an upsurge in prices, bids, or wages. You must understand that they come into force on a large scale when an extreme economic situation occurs, such as a rise in the cost of living or inflation. 

What does an escalation clause imply in real estate deals?

Escalator clauses in real estate are valuable when, for example, home buyers sign a long-term mortgage. As a result, they don’t have to constantly worry about the instability of future economic conditions of the real estate market. 

In finance, escalator clauses can safeguard that an increase in wages will meet the pace of inflation. In addition, it guarantees that landlords can ask for higher rents due to a boom in general prices. Moreover, the provision also assists buyers in winning higher bidding at real estate auctions.

How can you benefit from an escalation clause when you buy a home?

It’s practical knowledge that you can add an escalation clause to your sales contract before actually buying a property. On a more technical level, the escalation clause states that buyers are willing to boost their initial offer by a specific amount over the next highest candidate. Still, they must establish a maximum bid known as the escalation cap (max purchase price.)

Let’s take a concrete example of an escalation clause. Bill makes an offer of $350,000 for a house. Tom offers $340,000 for the same real estate. However, the bidding winner isn’t always indisputable. Suppose Tom’s local real estate agent has found out that there’s another buyer. Subsequently, the realtor recommends Tom include an escalation clause of $15,000 with $1,000 intervals (the most common amount.) Tom must consider how much he’s willing to pay above the highest competing bid. Bill’s offer triggers Tom’s escalation clause. Yet, Tom doesn’t have to pay the total $15,000 extra; it’s sufficient to reach $351,000. Tom undoubtedly wishes to pay the least but is willing to offer the most, in other words, the escalation cap.

Frequent mistakes buyers make in escalation clauses

Firstly, buyers may be wrong in assessing the escalation interval at a substantial amount. Often, escalating only a smaller amount, such as $1,000, each time won’t cut the deal for the seller. Note that the seller might have received better terms from another buyer, for example, a better closing day. Or, the current property owner may be tempted with a proposal with fewer real estate contingencies. 

Secondly, don’t submit an escalation addendum without knowing with certainty about the existence of another contract! By disclosing how much you’re willing to pay extra without a counteroffer, the seller will reject your initial offer and demand the price they know you can afford. You can lose an additional $5,000 or even more in vain when no other offer exists. To dodge this bullet, we recommend requiring information from your listing agent if a new proposal emerges.

What is an escalation clause in rental agreements?

Landlords are adept at using escalation clauses in their lease agreements. Suppose rents rise swiftly in a given region. In that case, landlords may think twice before signing a long-term lease. They are aware that this could backfire on them by losing revenue, or their property appreciation might go downhill. 

However, they can steepen rent by a specific amount at regular intervals by incorporating an escalation clause into the rental agreement. Therefore, they can take advantage of present market conditions. At the same time, the renter can obtain and protect their welling deal in the long run.

How to write a real estate escalation clause?

Escalation clauses vary by state, city, and even homes. Most typically, however, they include the following elements. The escalating factor or the monetary increments define the amount you’re willing to “raise the stakes” above the initial list price if other offers show up. Secondly, the clause includes the cap, the highest possible bid you, as the purchaser, are willing to pay. Then may come the documentation, essentially proving to the buyer that other offers exist for the same property. Lastly, you can set the number of escalations in an escalation clause to the established cap from only one to multiple increases in smaller amounts.