Many markets are experiencing limited home supply with increasing buyer demand. These factors lead to higher prices for homes and the potential for multiple offers to be made on a single home. This can be a great opportunity for sellers and a frustrating experience for buyers. This articles describes price escalation clauses and when they should be used.
What is a Price Escalation Clause?
A price escalation clause is a provision in a purchase and sale agreement stating that a buyer is willing to increase the price she offers to a specified amount if the seller receives another offer with a higher price. In other words, a buyer who includes a price escalation clause in an offer agrees to raise (escalate) the original offering price in the hopes of beating out a competing offer.
As an example, if a home is listed at $300,000 in a good market, and a buyer is very eager to buy the home, then the buyer may include an escalation clause in her offer which states that she is willing to beat every other competing offer with a higher price up to $310,000, in $1,000 increments. So if another buyer comes in with a price of $305,000, then the escalation clause will kick in to increase the first buyer’s officer from $300,000 to $306,000, beating the other offer which was made at $305,000.
If no other offer is received by the seller, then the seller may choose to counter the offer at a higher price knowing that the buyer who included the escalation clause is willing to go higher.
When Should a Price Escalation Clause be Used?
Price escalation clauses should be considered when a buyer is concerned about competing with other competitive buyers for the same home, and the buyer wants to ensure an automatic increasing of the purchase price to beat out the other competing offers.
What are Some Problems with Price Escalation Clauses?
The buyer presenting the escalation clause should keep in mind that by doing so, that buyer has disclosed their negotiating position to the seller (since the upper maximum price is disclosed to the seller in the purchase and sale agreement or purchase proposal). As noted earlier, the seller is free to counter the buyer at a higher price, with the knowledge that the buyer was willing to go higher (at least up to the upper amount in the escalation clause).
On occasion, sellers may collect offers from potential buyers and then notify buyers that the seller wants a “final and best” offer. This may put the buyer into a weaker negotiating position, since a seller may use the maximum price of the escalation clause as the new floor for a new round of offers. Using the earlier example, the seller could go back to the buyers and state that the seller wants the “highest and best” offer that beats $310,000 (using the maximum amount that the buyer in the example would go).
Escalation clauses can be helpful in a rising and competitive market. Buyers should be careful to understand the maximum amount that they can afford and work with their mortgage lender before committing to an escalation clause. As always, buyers should consult an experienced real estate lawyer if they have questions about this type of an offer.