A Property Buyer is More Likely to Make the Highest Offer if There is an Escalation Clause; Explore the Benefits and Drawbacks with a Well-Versed Real Estate Attorney

High and Lows of Escalation Clause in NJ Real Estate ContractsPurchasing real estate in a hot seller’s market is not an ideal situation for homebuyers, as it typically means that market values are high and bidding wars are much more likely. When you find your dream home and begin to imagine your life there, it is quite stressful to become involved in a bidding war that could cause you to lose the deal or overpay for the property.

One potential solution to this dilemma is for a buyer to include an escalation clause in their offer to purchase a property. If you are trying to purchase a home in a market where options are limited, property prices are high, and sellers are manifold, you should understand and consider whether an escalation clause may be right for you. As experienced real estate attorneys, we assist buyers with budgets large and small with writing escalation clauses into real estate contracts and executing the details to preserve your peace of mind and your interests throughout the transaction. Here, we will discuss what an escalation clause is, how it works, and the pros and cons of including an escalation clause in your purchase offer.

The Escalation Clause in NJ Real Estate

An escalation clause is a provision within a real estate contract in which the buyer outlines increased counteroffers they are willing to make in the event that a higher offer is made by another potential buyer. Also known as an escalator, an escalation clause sets out increments the buyer is willing to increase their offer to buy to exceed other bids on the property, limited by a cap of the maximum purchase price that the buyer is willing to go to.

Advantages of the Escalation Clause

Buyers who anticipate a potential bidding war in a hot seller’s market may find the inclusion of an escalation clause in their offer to purchase real estate to mitigate their stress and build confidence in their offer. In the event that a higher bid comes along, the first buyer does not risk losing the deal immediately if the bid is not presented to them for an opportunity to make a counteroffer.

Including an escalation clause in a purchase offer also demonstrates to the seller that the buyer is serious about buying the property and is willing to be flexible to secure the property, if necessary. Having an escalation clause in a real estate contract streamlines the process of counteroffers. Once a seller presents the buyer with a bonafide higher offer from another potential buyer, the buyer’s increased offer under the escalation clause will apply without the additional paperwork and negotiation that is normally involved with a counteroffer.

Disadvantages of the Escalation Clause

The immediate potential disadvantage of including an escalation clause in an offer to purchase a real estate property is that the buyer reveals their hand to the seller, causing them to possibly lose a significant amount of bargaining power in the deal before their offer is even accepted.

Including an escalation clause also has the potential to fuel the very scenario a buyer wished to avoid in a bidding war. The seller’s agent is not precluded from sharing with other potential buyers that there is an existing offer on the property, and that offer includes an escalation clause with a certain maximum purchase price. Not only could such a scenario inspire a bidding war in which the buyer who included an escalation clause is essentially a passive player, but it could actually cause other bids to jump immediately to the maximum purchase price under the escalation clause and knock the buyer out of negotiations right away.

Finally, even if an escalation clause aids a buyer in securing the sales contract for a property if the purchase price exceeds the appraisal value of the home, it is unlikely that the buyer will be able to finance the deal through a mortgage lender. That might either cause the deal to fall through completely or require the buyer to pay cash for the difference between the purchase price and the appraisal value of the property.

Escalation Clause Example in Action

When considering how an escalation clause may play out in practice, it is important to contemplate both the best and worst case scenarios. Consider the following example:

Buyer 1 is looking to purchase a home in a hot market where bidding wars are extremely common. Buyer 1 had a friend who lost out on their dream home because another bid came in, and the seller accepted the other bid immediately. That seller did not even give Buyer 1’s friend a chance to make a higher offer. So, when Buyer 1 finds their own dream home, they are determined to avoid that situation by including an escalation clause.

First, let’s consider a situation where an escalation clause plays out in a way that is beneficial to Buyer 1.

Explore the Advantages and Disadvantages of the Escalation Process in Monmouth County, NJBuyer 1 finds a home that is listed for a purchase price of $500,000. They make an initial offer of $500,000 with an escalation clause that will increase this offer buy increments of $3,000 to beat a competing bid. The escalation clause states that the maximum purchase price shall not exceed $515,000. Another bid comes in at $507,000. Buyer 1’s escalation clause is triggered, and Seller accepts Buyer 1’s increased offer of $509,000 (three increments of $3,000) to beat the other bid.

In this situation, Buyer 1 had to pay a bit more, but they secured their dream property with little stress or back and forth.

However, escalation clauses do not always play out so positively for a potential Buyer. Including the same escalation clause described above could have easily resulted in the following situation:

Seller reviews Buyer 1’s offer to purchase the property for $500,000 with an escalation clause up to $515,000. Since Seller has not accepted the offer and knows how high Buyer 1 is willing to come up on the purchase price, Seller counters with an offer of $510,000. Not knowing if there will be any other bids on the property, Buyer can’t be sure whether accepting this counteroffer will ultimately save them $5,000 or the deal itself or if including the escalation clause in the first place was a mistake.

Considering an Escalation Clause in Your Real Estate Contract? The Team of Attorneys at Bronzino Law Fim Can Guide You

An escalation clause is not a standard provision in a real estate contract. Whether an escalation clause is a prudent inclusion in an offer to purchase real estate property depends heavily on the property itself, the market, the appraisal value of the property, the desires of the buyers, and the specific language of the escalation clause.

While a real estate agent may be well-versed in the current climate of the market, an escalation clause must be very carefully considered and worded. If you are considering including an escalation clause in your offer to purchase a real estate property, it is wise to consult with a real estate lawyer before submitting your offer. In the real estate transaction process, attorney review occurs after an offer has been accepted, and by this time, it will be too late for a lawyer to review the language of your escalation clause or counsel you on the pros and cons of including one in the first place.

Our real estate lawyers at the Bronzino Law Firm have helped hundreds of clients with the real estate purchase and sale process in Monmouth County and Ocean County, such as Freehold, Holmdel, Asbury Park, Beachwood, Colts Neck, Lakewood, Brick, Point Pleasant, and Wall. For more information about how we can help you to protect your legal interests while buying or selling your home, contact us at (732) 812-3102 or fill out the online intake form today for a consultation.