What is an Escalation Clause in Real Estate? (2024)

What is an Escalation Clause in Real Estate?

You finally found it—the dream home you want to make an offer on. Maybe it was love at first open house. Maybe it was a slow-building certainty with every new detail you learned until you knew in your bones this was the home for you.

Buying your next home can feel incredibly exciting. At the same time, it’s a substantial financial investment. You don’t want to overpay for a new home, no matter how much you love it. At the same time, you don’t want to miss out on a house you love when you could have had it with a slightly higher bid.

The real estate market is a competitive market. Whether buying your first home, your next home, or buying an investment property, closing the deal is the most unpredictable because that’s when the deal could go either way. Luckily, there’s a bidding option to help you achieve that balance. Using an escalation clause, real estate buyers can raise their offer on a home if the seller receives a higher bid from a competitor buyer.

Escalation clauses explained

To understand escalation clauses in real estate, it helps to understand how home buying in general works.

The basic model of home buying

In the simplest version of selling and buying a house, a seller lists an asking price for their house. A prospective buyer then submits a bid on the house.

If the buyer expects a multiple offer situation, they may bid above the asking purchase price to try to beat out other buyers. If, however, the buyer suspects that few other people want the house, they may submit a bid below the seller’s purchase price.

The seller then looks at your competing offer and either accepts it, rejects it, or reaches out to the potential buyer or highest bidder to begin bargaining with them until they both reach an agreeable compromise.

Home buying with an escalation clause

In real life, buying a home can quickly become more complicated than the above model. For example, what if you don’t know how interested other buyers are in this home?

That’s where an escalation clause can help.

An escalation clause lets you submit an initial bid with the caveat that you’re willing to bid more if certain conditions are met.

For example, if you’re submitting a bid of $750,000 on an L.A. home, you might include an escalation clause stating that you’re willing to beat any competing bids by $5,000, up until the bidding reaches $800,000—or whatever the top of your budget is—at which point you automatically stop bidding.

In short, if you’re using an escalation clause in your bid, you’ll have to specify:

• Your initial competing bid

• The amount by which you want to automatically increase your competing bid if another buyer outbids you

• Your final cap, or the point at which you want to stop bidding no matter what

It’s important to have an honest and realistic conversation with yourself when setting your final point at which you want to stop bidding. Otherwise, you could end up paying more than you’re comfortable with when the bidding process has finished.

You might also hear an escalation clause referred to as an elevator clause, or a laddering clause. It’s the same thing—a clause that can help you be more specific about exactly how much you’re willing to bid on a house, and under what conditions.

Escalation clause purpose for real estate

While escalation clauses can prove effective for many buyers, there are a few scenarios where they can make less sense. We’ll walk you through when to consider using an escalation clause, and when you might want to consider other tactics.

Benefits of using an escalation clause include:

• Helping you stand out: An escalation clause can help you signal to the seller that you’re a serious buyer who’s prepared to go above and beyond to make this deal work.

• Surpassing other bids: An escalation clause helps you automatically top other buyer’s bids near your own, helping to make you a more appealing buyer to the sellar.

• Helping you avoid overbidding: By automatically increasing your bid in small increments based on the bids of other buyers, an escalation clause can help you increase your bid past that of other buyers—and no farther. And if there are no higher bids to compete against, your bid won’t escalate above your initial offer.

Here’s why an escalation clause doesn’t always make sense:

• It potentially weakens bargaining power: Because an escalation clause includes how high you’re ultimately willing to bid, some experts feel it weakens your ability to drive a strong bargain with the seller. In less competitive home-buying markets, it might make sense to start by submitting a bid without an escalation clause.

• It can limit negotiation options: Because an escalation clause locks certain price points into effect if specific conditions are met, it can limit both the buyer and seller’s ability to continue negotiating after a deal has been made.

• It can complicate the loan process: If you plan on taking out a mortgage loan, the company loaning you money will typically appraise the value of the home you want to buy, and only loan you funds up to that value point. If your escalation clause extends your bid past the price point the mortgage broker thinks your prospective home is worth, it can cause complications that may interfere with your ability to purchase the home.

When it comes to deciding whether or not an escalation clause makes sense for your specific situation, it’s normally best to have an expert in your corner. That’s one of the many reasons we recommend working with a qualified and respected REALTOR® when purchasing a home.

Preparing for the competitive California market

An escalation clause often makes more sense in particularly competitive housing markets, such as California. Our state has some of the fastest-selling homes in the country—it’s not unusual for homes in certain markets to sell in 35 days.

A REALTOR® can help you know what to expect in your specific market, from how fast homes typically sell, to current sale prices for the type of homes you’re considering, to how you can make your bid as attractive as possible to sellers.

While buying a home can seem daunting, especially in competitive markets, home ownership can offer a range of critical long-term financial benefits, such as:

• Avoidance of the potential instabilities of the rental market, such as rent hikes and changes in landlords or apartment management

• Greater control over your living space, including the ability to renovate and customize your space until it fits your vision

• Tax breaks for homeowners

• An improved credit score

• The opportunity to take out home equity loans down the road

• Owning a home that can become more valuable over time

In addition to financial advantages, home ownership can offer emotional and psychological ones as well. There’s nothing quite like building the life you dreamed about in a home you love.

Here are some other tactics to help your offer stand out in a competitive market like L.A. or San Diego, above and beyond your initial bid:

• Avoid round numbers in your escalation clause – If you’re going to use an escalation clause, a California realtor may recommend avoiding increasing your bid by round numbers. Because many buyers increase their bids by a few thousand, for example 5,000, you may be able to narrowly beat out other buyers by increasing your bid by increments of 5,500.

• Buy in cash if possible – If you can buy in cash without taking out a loan, it can both simplify and speed up the homebuying process because you don’t need to be approved for a mortgage, and a mortgage broker doesn’t need to appraise the value of your the home you’re interested in buying.

• If you can’t use cash, try to use a mortgage broker that closes quickly – While buying in cash has benefits, about 78% percent of homebuyers have to use loans to purchase a new home. If you choose to use a mortgage broker, try to find one who can help you close quickly once you’ve made an offer. People purchasing a home with cash can often close within seven to ten business dates. Closing with the financing can take closer to a full month. So finding a mortgage broker who can help you close more quickly can help keep you competitive against cash buyers.

For additional ways to help make your bid as appealing as possible, try working with an experienced REALTOR® who can leverage their knowledge, reputation, and connections to help you buy your dream home.

Using and choosing the right REALTOR®

Using a respected local REALTOR® can help guide you through the best ways to find—and buy—your perfect home. In addition to walking you through decisions like whether or not to use an escalation clause, REALTOR®s can help you in several other important ways.

Here’s why experts recommend using a REALTOR®:

• Market knowledge: From knowing which homes are available for sale in your preferred market to knowing how much they’ll probably sell for, a REALTOR® can help you find the home you want in a fast-paced and occasionally complicated housing market.

• Smoother buying process: A REALTOR® can help you navigate every step of the home buying process, from understanding legal documents, to filling out necessary forms, to digesting and commissioning reports and disclosures.

• Negotiation expertise: REALTOR®s negotiate on behalf of their clients every year. By comparison, most home buyers don’t purchase more than a few homes in their lifetime. You’re also likely to feel more emotional because it’s more personal for you. A REALTOR® has the professional experience and cool head to help you negotiate the best possible deal.

There’s also something reassuring about having an experienced guide to help you navigate this incredibly exciting—but occasionally challenging—life step. That’s even more true if you’re a first-time home buyer, or haven’t bought a home in the last decade.

When it comes time to choose a real estate agent, we recommend looking for an official REALTOR®. When you see “REALTOR®,” you know you’re dealing with a member of the National Association of REALTORS®.

We adhere to a code of ethics that prioritizes serving our clients and acting with utmost professionalism.

Find your home with Berkshire Hathaway HomeServices California Properties

Why hire a real estate agent? At Berkshire Hathaway HomeServices California, we believe everyone deserves to find their perfect home.

Serving home buyers in San Diego, Los Angeles, Orange County, Santa Barbara, Ventura, and Riverside, we help people all over California find their next home. With nearly 3,000 real estate agents in 60 offices across Southern California, we can help match you with an agent who can help make your home-buying journey efficient, less stressful, and ultimately rewarding.

We’re ready to help you move into your future.

Sources:

Curbed 1, 2, US News

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