Using escalation clauses to protect your bottom line
In a perfect world, the prices of raw building materials like wood would stay low and consistent. But as we’ve seen from the recent plunge in new home starts, high and volatile materials prices make completing homes challenging for builders. In times like these, you may need to include escalation clauses in your contracts. Let’s talk about what they are, how they can protect your bottom line, and some ways to explain them to potential buyers.
What is an escalation clause and who’s using them?
An escalation clause is a provision you can include in your contracts that can help you recover costs when certain circumstances occur. Perhaps the most important aspect of escalation clauses for you is to work with a local attorney to craft them.
If you’re thinking about implementing an escalation clause, you aren’t alone. According to the National Association of Home Builders, 47% of builders have included an escalation clause in their sales or construction contracts to address rising lumber prices.
How can an escalation clause protect your bottom line?
According to the builder magazine Construction Executive, there are several kinds of escalation clauses you can include in your contracts. To combat higher lumber prices, you may want to talk to your attorney about using a percent-change escalation clause to protect your bottom line.
Generally, a percent-change escalation clause may allow you to recover costs when your project goes over budget by a certain percentage. When that happens, your client (most likely the potential buyer) could pay some portion of the higher price (depending on how you and your attorney draw up the language). Including this clause can be helpful in addressing the costs of unpredictable lumber price spikes.
Another aspect to consider is who—other than you—could be responsible for contributing to paying for the higher costs of lumber. For example, you may include this clause for potential buyers, as stated above. However, you might consider including similar clauses in contracts with your suppliers or subcontractors as well.
How can you explain it to a potential buyer?
First, you should carefully consider the pros and cons of including an escalation clause in your contracts. While including this clause can help your bottom line, it may also be a deal breaker for buyers.
Additionally, you should take caution if you want to consider inserting escalation clauses into already-agreed-on contracts. It’s crucial to consult your attorney to discuss options for adding an escalation clause to existing contracts.
When including an escalation clause, it’s important to explain how the clause works. Give potential buyers an easy-to-understand rundown of any escalation clauses you include. That can give them the knowledge they need to make an informed decision and help you build trust.
A structural warranty from 2-10 HBW can protect your bottom line
Lumber price volatility is a problem that’s out of your control. But it’s one you must confront to protect your bottom line. Including escalation clauses in your contracts is one way to protect your bottom line against the uncontrollable.
Another way to protect your bottom line against problems outside of your control is by covering all your homes with a structural warranty from 2-10 Home Buyers Warranty (2-10 HBW).
About 80% of all structural defects are caused by soil movement, which is outside of every builder’s control. And each structural defect can cost between $42,000 and $113,000 on average.
With a structural warranty from 2-10 HBW, you get protection from qualified structural defects, including those caused by soil movement. You also get access to our administration teams, which can help you avoid and mitigate disputes, manage client callbacks, and help you look forward.
Learn how you can protect your business and add valuable selling points to your new builds with a 2-10 HBW structural warranty.