Escalation clause (or escalator clause) is a device that’s gained so much traction, the Boston Globe featured its pros and cons.
What is an escalation clause?
Simply put, an escalation clause says the buyer will pay a certain amount over another, competing offer.
If structured smartly, an escalation clause can work favorably for both buyer and seller: it guarantees the seller the best possible price and terms for the seller while allowing the buyer not to overpay (relative to what other buyers at that given time would pay for the property).
The escalation clause is handy when the buyer just has no idea where competing offers may be headed. This can arise in a location where sale prices are rising suddenly, and there isn’t really a clear precedent for how high buyers might be willing to go for such a property.
A buyer is wise to consider an escalation clause when they’re ready to submit their strongest offer in terms of price. You may choose to use it right out of the gate if you want to come in strong and don’t intend to increase later. Or, you may choose to wait until the seller calls for best and final offers.
How does it work?
So if you’re a buyer aiming in the dark, what do you do? Here’s how an escalation clause can work:
- Choose a price that you and your agent consider solid enough to get or keep you in the running: it’s competitive, but not so high that you think you’re overshooting.
- Next, think about how high you would (reasonably) be willing to go on price, taking into account appraisal concerns and other matters of your financing, if that’s relevant. What’s the highest price you’d pay without remorse (even if it means overpaying somewhat)?
- Then decide how much you’d be willing to spend to beat the highest offer on the table (as long as that highest offer isn’t above your max). Let’s say your numbers look something like this:
- Your solid, attractive base price: $400,000.
- Your ultimate max price: $430,000.
- The amount you’d be willing to spend to top another: $2,000.
- With those numbers determined, you and your agent indicate something like the following to the seller: Price: $400K. Price to increase by $2K above any other offer up to a max of $430,000.
- You and your agent will need to specify that any offer you’re asked to beat would be bona fide and in writing for you to review.
With these features in place, you know you’re not paying an undue amount above what any other buyer was willing to pay. And the seller gets the best possible price, because you’ve topped what any other buyer was willing to pay at that time.
Even with an escalation clause in place, the price you end up at may be well below your ultimate max. For instance, if the next highest offer was $410K, you’d end up paying $412K.
This way, both seller and buyer win handsomely.