What is an “Escalation Clause” and how can real estate investors use them in offers, good/bad idea?

by | Indiana real estate, Indy Anna, Real Estate Investing

What is an escalation clause and what to real estate investors need to know about them?

I got a few questions about “escalation clauses” and what they are and what Indianapolis real estate investors need to know about them.  Today we’ll talk about what escalation clauses are, how they are used and how you can make the most of these situations while avoiding pitfalls.  Just be nice and take care of people and things like this you’ll never need to worry much about.

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Now for today’s class on escalation clauses…

What is an escalation clause?  What do real estate investors need to know about making offers with escalation clauses?  How can you stay safe and protected with escalation clauses?

Indy Anna explains what an escalation clause is and when they are appropriate and a good idea to use- and when they aren’t necessary to use when offering on a property.

There are two basic types of standard offer methods:

Offering a single amount in what a buyer is willing to pay

Or, offering an amount the buyer is willing to pay that can increase in increments up to a set price- the escalation clause method.

An escalation clause is…

An escalation clause is stating, “I, the home buyer, am willing to offer this specific amount for your property now, but IF you get a higher offer, I will increase my offer by this amount – a set denomination dollar amount in increments- up to a final end stopping offer amount.”

I’m going to include a blank sample escalation clause for you to see the verbiage and how it works here in Indy- the link to the DL will be in the description below.
Parts to an escalation clause…

There are a few parts to the escalation clause to consider in terms of money

The original price offered
The increment amount to increase by above original offer price
The cap or maximum offer to be made
The difference payoff, will it be cash or loan term change

Here’s an example from this week where we used an escalation clause
A Class A+ area property with an asking of $279K
The buyer offered $267K, with an escalation clause of $500 increments up to $292.5K, paid in the difference between the pre-approval amount and the maximum amount accepted as noted in the clause by cash.

Will your offer and escalation clause be accepted?
Some agents/brokers and sellers will not accept any offers that have an escalation clause addendum attached. There is more work involved for the agent and laziness is one part of this, while some sellers simply want a solid price offered without the back and forth.
Other times, sellers and agents see the value in accepting offers with escalation clauses as it leaves a window open in bidding war style to get the best offer possible- usually in a seller’s market.

When do you use an escalation clause?
Escalation clauses should only be used in cases where it’s a safe assumption that multiple offers will be made.

Buyers should be aware that it does mean they are maybe losing any leverage in negotiations, especially if a higher offer comes in that does not include an escalation clause.

It also means that the seller and seller’s agents know how much the buyer is willing to pay at most, from the day the offer is submitted.

It makes the most sense to use an escalation clause when you’re pretty certain of multiple offers, you’re not making a low ball offer, it’s a seller’s market, and the maximum amount of your offer still makes sense in your bottom line.

Did the listing agent clearly state a day/date review of offers, or stated no acceptance of escalation clauses?

There are times where the MLS description might state, ‘no escalation clauses accepted’ which means there’s no point in submitting one and it’s time to make your higher and best offer that still makes sense.

More professional agents will update the ‘agent remarks’ and make it known that multiple offers have been received ahead of time, directly to the buyer’s agent in MLS note communications.

Most of the time an MLS description of “highest and best offer by X day/time with response by X day/time” means there are multiple offers. Sometimes however, this is a marketing ploy and it’s not accurate. This is why having someone here in Indy that knows the market well and part of your boots on the ground is vital.

Bid with reason…
It’s never reasonable to make an escalation clause that will simply be rejected in terms of incitement amounts

If you want to do deals here in Indy, we can set up a time to chat and see if we’re a good fit to work together, but for now- go to BigREIA.com, go there and…

You’ll make the Universe SMILE.  = )

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Thanks so much!  = )

Make the Universe Smile.

~ Indy Anna
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