Listen on: Omny | Spotify | Apple Podcasts | YouTube
Introduction
Most developers obsess over finding the site, nailing the design and securing the finance. But there is one piece of fine print that can quietly eat your profit if you are not careful: the escalation clause.
In episode 262, Bob Andersen and Hilary Saxton unpack escalation clauses from a developer’s point of view. What they are, where you will find them, why builders ask for them, and how to handle the conversation so everyone wins.
What you’ll learn
- What an escalation clause actually is, and why costs almost always creep up over time
- Where developers usually run into them (hint: the building contract)
- Why it is usually the builder asking, not you
- How to isolate an escalation to specific items like steel and concrete
- Why lenders and valuers prefer a lump sum fixed price and time contract
- The feasibility trap: escalate your costs and you must escalate your sale prices too
What is an escalation clause?
An escalation clause is simply a mechanism that lets a cost increase over time. In property development, costs almost always creep up: land, construction, even consultant fees. An escalation clause builds that expected increase into a contract.
Where you will run into them
Most of the time, it is the building contract. And here is the reassuring part: the vast majority of building contracts do not have one. Bob reckons well over 90% of the contracts he has done over the years have no escalation clause at all. They tend to surface when builders feel nervous about where prices are heading, like the post-COVID period in 2022 and 2023 when material shortages sent prices sky high.
It is usually the builder asking, not you
Developers do not generally ask for an escalation clause. Builders do, because they are unsure how material and labour costs will move, especially on a build that might take ten to twelve months. Plenty of builders went broke in the post-COVID years locking in fixed prices they could not hold. So the request is often fair. The trick is knowing how to handle it.
You can isolate it
A lot of people do not realise you do not have to apply an escalation to the whole contract. If a builder is worried about steel and concrete specifically, you can agree to escalate just those items and leave the rest fixed, as long as it is open book and they can prove the increases.
Why lenders love certainty
Financiers and valuers love a lump sum fixed price and time contract, because they know exactly what the project costs and how long it takes. Introduce an escalation clause and the valuer will simply work off the highest possible price. That can affect your construction finance, so it is worth understanding before you sign.
The feasibility trap
Here is the big one. If you escalate your costs in a feasibility, you have to escalate your sale prices too. It is a see-saw. And the maths matters: construction is often around 40% of your end sale price. Escalate 5% on your build and you are only moving 5% of 40%. Escalate 5% on your sale price and you are moving 5% of 100%. People get gloomy about rising costs and completely forget the other side of the ledger.
Bob’s takeaway
Do not be fearful of escalation clauses. You do not have to accept them. A builder might offer you a lump sum fixed price contract you are more comfortable with, even if it is slightly dearer. And as always, get your contract checked by a qualified professional before you sign.
Ready to learn how to run a development from finding a site through to settlement? Join our free masterclass on Saturday 15 August, or come along to our 3-day workshop on 9 to 11 October.
This episode is general education only, and is not financial or legal advice.