A Bit More On Escalation Clauses

The other week I responded to a reader's question about why real estate brokers don't like to use escalation clauses, and this sparked several additional readers to ask questions about escalation clauses, so I figured the best way to answer those questions, in lieu of another mailbag, would be to write an article about them.

To start, an escalation clause in a real estate transaction is a contractual provision used by buyers to outbid competing offers. When included in an offer, it stipulates that the buyer is willing to increase their bid above any other offer by a specified amount, up to a predetermined maximum limit. For example, if a buyer offers $550,000 for a property with a $5,000 escalation clause up to a maximum of $575,000, and another buyer offers $560,000, the escalation clause automatically increases the first buyer's offer to $565,000. This can continue until the maximum limit is reached or surpassed. Escalation clauses are designed to give buyers a competitive advantage in multiple-offer situations while ensuring they don't overpay excessively.

The downside of escalation clauses, briefly touched on a few weeks ago, is that they carry a fair amount of risk and/or liability due to their reliance on external factors and the potential for misunderstanding or manipulation. Firstly, verifying the existence and terms of competing offers can be challenging, leading to disputes and legal issues if not handled transparently. This is a major factor in many listing agents not accepting escalation clauses. There is too much risk, and it's much easier in the case of multiple offers to simply request a "highest and best" offer deadline for those who wrote up offers.

Secondly, escalation clauses expose buyers to the risk of overpaying for a property, especially if the maximum limit is set too high or if market conditions change unexpectedly. Additionally, sellers may exploit escalation clauses to drive up prices without genuine competing offers, again potentially leading to buyer resentment or even legal action. Moreover, the complexity of escalation clauses can introduce ambiguity into the transaction, increasing the likelihood of misinterpretation or disagreement between the parties. These types of situations get convoluted, but a somewhat straightforward example of this would be if a property receives multiple offers, say five, and one of them has an escalation clause, and this clause is needed to beat out one of the offers. However, prior to mutual acceptance, one of the offers is rescinded, and this particular offer was what forced the escalation clause to kick in. Now what? Consequently, while escalation clauses can provide a competitive advantage, their implementation requires careful consideration and clear communication to mitigate associated liabilities and risks. Which is why as I discussed in the "Winter Mailbag, Deux," a lot of agents simply choose to not accept escalation clauses for their listings.

Escalation clauses were more common in the wild days of the "COVID market" where almost every single listing received multiple offers. These days multiple offers are pretty rare, and only homes in the most in-demand areas are likely to receive multiple offers. Therefore, escalation clauses are a bit rarer today, than, say, three years ago. Thanks so much to our readers who have reached out to me with great questions. I really appreciate interacting with all of you! Send me your real estate related questions to [email protected].