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What Is An Escalation Clause?

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Want to invest in real estate market? It’s best to know what escalation clause is and how it works. Have a look at this blog to find out more.

Escalation clause

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Have you missed the home of your dreams? Have you targeted some spectacular properties you want to buy?

If yes, understanding an escalation clause is unavoidable for you. This blog contains everything you must know.

Real estate can fulfil your dreams. It signifies wealth but acts as an asset class to help diversify your portfolio.

It has always been a hot sector in Canada, with increased Canadians willing to buy properties. As per a recent study, investments in building construction have increased to $19.1 billion, exhibiting robust demand and a steady inflow of investment in the real estate sector.

Hence, if you get tempted to invest in the real estate sector, you must know the escalation clause.

What Is “Escalation” In the Real Estate?

In Oxford English, “escalation” refers to an increase or a hike. Its meaning remains the same when used in the real estate sector.

The term “Escalation” refers to an increased offer from the buyer of a particular property. You usually escalate your buying offer when several buyers are in contention for buying a property, and your bid is lower than the other buyer(s).

What Lead to The Development of “Escalation” In the Real Estate?

Issuing revised and escalated price offers or bids usually happens in a bullish or soaring real estate market when there is a widespread notion that property costs are about to rise in the coming future.

It attracts several investors to the real estate sector and creates a robust demand for unique properties. Following the general demand law, the prices of the properties will rise, and a seller tries to cash in this momentum to earn higher profit margins.

Let us further understand this with an example:

Property X is a residential condominium on Tremaine Road, Milton, Ontario. This property is in an excellent location and possesses all the desirable amenities besides being surrounded by green space.

Five different buyers, including you, are interested in buying this property, and a bidding war is going on. The seller’s agent has received $510,000, the highest bid for this property.

Since the property rates are rising fast, you have escalated your offer and revised it, intending to outbid the highest price. You placed a bid of $525,000 and won the property, as all the others were lower than your amount. 

What Is An “Escalation Clause” In the Real Estate?

An escalation clause is a paragraph in the real estate contract stating you will hike your current offer. The seller of the property receives a higher deal.

This clause also precisely states the maximum amount you will increase over and above your current offer.

For example, 

You are engaged in a bidding war for a desirable property and have offered a bid of $600,000.

Now, let us say the property received a bid for $610,000. In such a scenario, you can exercise your escalation clause and revise your offer to $615,000 will be within the limits of the maximum pre-set amount.

Understanding escalation clause
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How Does an Escalation Clause Works in The Real Estate Sector?

The practical working of an escalation clause depends on the following factors:

What is the selling price of the property as set by the seller?

What is the maximum purchase price you will offer if the property receives multiple offers from different interested buyers?

What is the amount of escalation you will offer over and above a competing price offer?

Further, an escalation clause also contains the payment schedule, in which you will make incremental payments to the property seller if your offer is accepted.

When Should You Exercise Your “Escalation Clause”?

The demand and supply market forces control the prices of real estate.

A property buyer should always exercise the escalation clause in a seller’s market to win their dream/ target property and not let it slip by.

Extending an escalation clause with your purchase offer shows you are a committed buyer and will buy the property at competitive rates. It further improves your chances of having a hold over your desired property.

References:
https://www150.statcan.gc.ca/n1/daily-quotidien/220314/dq220314a-eng.htm?indid=19277-1&indgeo=0
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