If you’re looking to rent or lease a property but may want to purchase it at a later date if given the option, consider including the right of first refusal (ROFR) in your contract.
Right of first refusal is a popular clause that gives lessees preference to the property in which they occupy.
However, there are some reasons that property owners may not be so fond of them.
Here’s everything you need to know about the right of first refusal if you’re considering it for an upcoming transaction.
1. What is the right of first refusal?
The right of first refusal (ROFR) is a contractual right to enter a transaction with a person or company before anyone else can.
The seller is only free to entertain others if the ROFR party declines to enter the transaction.
Lessees of real estate property favor the right of first refusal clause because it gives them preference to properties that they occupy.
That said, this clause can limit what the owner receives from interested parties competing for the property.
As a result, many owners are hesitant to offer it.
2. How does a right of first refusal work?
A right of first refusal clause is like an options contract.
The holder has the right but not the obligation to enter a transaction that generally involves an asset.
When you hold the ROFR, you can establish a contract or agreement on an asset before others can.
ROFR is often requested by individuals or companies who want a preview of how an asset or an opportunity will turn out.
They don’t want to commit right away, but they want the option to get involved down the road if the venture is successful.
Holding the right of first refusal allows them to do this without having to worry about competition from other bidders.
A ROFR clause can also be customized to create variations of the standard right of first refusal agreements.
Here are some examples of modifications:
How long the right is valid
Allowing a third-party to purchase if they are nominated by the buyer
The period by which the ROFR is bound
3. What are the advantages of a right of first refusal?
A ROFR acts as a type of insurance policy for the person who holds it.
It guarantees that they won’t lose rights to an asset that they want or need.
For example, a commercial tenant may decide to lease a location for their store for now.
Yet, they hold a ROFR because they’d rather buy the property long-term than be evicted if the property was sold to a new owner.
The moment leasing becomes impossible, the current tenant has the first right to purchase.
Here are some other top reasons buyers may consider requesting ROFR:
It creates a first-mover right on real estate
It allows you to consider your options without rushing into anything
It allows you to set a predetermined purchase price
It keeps your options open if you’re waiting for a home or property to come on the market
ROFR can keep everyone happy.
Here are the advantages for sellers:
It can entice interest from current renters/future buyers
It can prevent shoppers on the fence from deciding not to buy
It allows you to agree on a proposed purchase price with the potential buyer
It provides peace of mind while you’re getting the property listed
4. What are the disadvantages of a right of first refusal?
A property owner who has given the right of first refusal to their tenant isn’t able to negotiate with multiple buyers.
Thus, there is no bidding war over this property.
They aren’t able to leverage bids or buyers against one another to ensure they get the best deal possible.
Landlords can also have a difficult time attracting buyers at all if buyers know that the current tenant could always swoop in to buy it.
So, why would a landlord offer the ROFR?
Well, it could attract the right buyer in the present, which is often enough for them to include it in the contract.
Still, if you’re a property owner considering adding a right of first refusal into a contract, make sure you keep these disadvantages in mind.
It doesn’t obligate the buyer to make a purchase which can leave you in a tough spot
It can cause you to lose out on a better offer
It can limit your financial upside if your property value increases during the time of the contract
It can create an added obligate and burden for sellers
Similarly, this scenario isn’t all good for rights holders or buyers either.
It doesn’t guarantee a purchase
It doesn’t mean sellers are obligated to list properties during a particular timeframe
It may be financially disadvantageous if your property value declines
It can cause you to become overly attached to a specific property or deal
5. What is the value of a right of first refusal?
Having a ROFR allows you to hold an essential asset and gives you the option of purchasing the property if you’re going to lose access to it.
The financial value of the ROFR is the difference between the price agreed upon and the market value or the offer price made by a third party.
6. What is the difference between the right of first refusal and the right of first offer?
You may also hear about the right of first offer (ROFO) when discussing the right of first refusal in real estate.
Both clauses in a contract permit the buyer to make the first move.
ROFO, however, requires the seller to negotiate with the rights holder.
In this scenario, the buyer is typically given a specific amount of time to make an offer on the property.
Simultaneously, the seller can market the property to other buyers.
After receiving the ROFO holder’s bid, they can accept or reject it.
A ROFO puts the rights holder in a good position because they can make a strong offer to the seller and attain the property right off the bat.
However, it also puts the seller in a comfortable position.
They don’t need to accept the bid as they do in a right of first refusal.
They can accept or reject the offer after receiving it.
They can also return to the rights holders and renegotiate after they’ve declined their initial bid.
7. Who is eligible to negotiate a right of first refusal?
If you want a ROFR agreement in your contract, then both parties should hire qualified real estate attorneys.
While the process itself is not overly complex, the clause often includes important points like time limit and calculation of future price.
With these factors in mind, it can be in the interest of both parties to have an external representative who has been through the process previously.
8. How can I avoid right of first refusal problems?
Before signing a contract with ROFR, think of all the possible future scenarios.
Here are some questions that can help get you thinking.
What is the period of the right of first refusal? How long will it last?
How much time should a buyer have to exercise their rights or step away from the deal?
What’s a fair method to calculate a future purchase price for the property? Will you determine the purchase price when creating the contract or leave it up to an appraisal down the line?
How will a down payment impact a ROFR?
Additionally, owners should consider if entering into a right of first refusal will create any issues if they’re intending to refinance an existing mortgage.
This is worth thinking about because your current property likely serves as loan collateral.
We recommend meeting with a real estate attorney to get your questions answered and minimize future challenges.
9. Does the right of first refusal expire?
What’s the duration of the right of first refusal? Does it ever expire?
It depends.
Your ROFR could expire after a certain period or after an event occurs, like the expiration of a lease.
If your ROFR expires, then the property owner could enter a transaction without notifying the holder of the right of first refusal.
10. What are variations of ROFR?
There are a handful of common variations associated with the right of first refusal.
Understanding these variations can help you customize your contract to fit your needs.
Exclusions
Your ROFR may include some exclusions stating that the right doesn’t apply in certain situations, like a sale to a family member.
Transactions that trigger the ROFR
The contract must specify when the right of first refusal is triggered.
For instance, does it only arise if the property owner wants to sell the property?
Or is there a specific period that’s in question?
Duration
ROFR isn’t a lifelong agreement.
Often, they expire after a certain amount of time or after an event occurs (like the expiration of a lease).
When this happens, the property owner can enter into a transaction without the obligation of notifying the ROFR holder.
Time to respond
Some right of first refusal clauses may specify a period in which the holder has to decide whether to act on the offer.
If they decide not to allow this time to expire, then the property owner can move forward with a third party.
Alternatives
Another alternative to the ROFR is the right of first negotiation, which is also called the right of first offer.
However, as previously noted, the holder is more limited because they are not given the opportunity to accept the transaction on the same terms.
The holder is merely given the right to make their own offer, and the owner isn’t under any obligation to accept that offer.
The owner can move forward with a different party if they offer a better bid.
11. What is the penalty for violating a ROFR?
A right of first refusal is a contractual right, and as a result, the penalties for violating it are based on contract law.
If the holder of this right isn’t given the right to refuse, they can sue for monetary damages or specific damages.
12. When is the right of first refusal most often used?
You’ll most likely encounter ROFR in real estate.
This clause helps interested parties increase their chances of acquiring a property that they are interested in.
The most common scenarios that trigger a ROFR are when an owner decides to sell or when an offer is received from a third party.
Owner decides to sell
Once an owner decides to sell and lists their property on the real estate market, the ROFR goes into effect.
The seller must notify the ROFR holder before they can bring their listing to the public.
This individual typically has a certain amount of time to put their offer in before their right expires.
Owner receives an offer from a third party
In some cases, interested third parties will put offers on a property that isn’t for sale.
If this happens and the owner is interested in selling, the owner must notify the ROFR holder.
They cannot immediately accept the offer if someone else has the right of first refusal.
They must give the rights holder the option to buy first.
There are also some other areas of the law the right of first refusal plays a role.
For example, ROFR exists in child custody agreements as well.
This commonly means that one parent must first offer the other parent the opportunity to look after their children before contacting a babysitter or another family member to care for the kids.
13. How does the ROFR impact the inheritance of real property?
ROFR can sometimes be used in the inheritance of real property.
If there is a stipulation in a trust to give the home to one child and assets of equal value to other children, then the trustee has to figure out how to divide these.
While it may seem clear cut, the property may be the primary asset in the trust estate.
Thus, to ensure all children get assets of equal worth, the child receiving the property must buy out their other siblings before proceeding.
If you’re in this situation, you can consider adding language to your trust about the right of first refusal.
You can offer the designated child or children the right to purchase the real property in the trust before distributing the estate in equal shares.
This language provides clear direction and intent of the trustor while also helping children avoid resentment about who gets what.
Final Thoughts
If you’re interested in adding the right of first refusal to a contract, make sure you work with an attorney to get it done correctly.
This clause can help protect your interests when it’s properly implemented.
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Disclaimer: we are not lawyers, accountants or financial advisors and the information in this article is for informational purposes only. This article is based on our own research and experience and we do our best to keep it accurate and up-to-date, but it may contain errors. Please be sure to consult a legal or financial professional before making any investment decisions.
Prior to starting Gokce Capital, Erika received a Bachelor of Architecture from the University of Southern California and a graduate degree in Urban Policy from Columbia University. She worked as both an architectural designer and engineer in New York before joining the New York City Department of Housing Preservation and Development.
Erika currently lives in the New York Metropolitan area with her spouse, daughter and cat. She is originally from Chicago and still considers herself a midwesterner at heart.
Erika also loves to read, write and travel (fun fact, she has visited all 50 states and more than 30 countries!). Her new book, Land Investing Mistakes: 11 True Stories You Need To Know Before Buying Land, is now available on Amazon.
1. Does the first right of refusal document need to include language regarding consideration?
2. Does a first right of refusal need all parites to sign the document.
Hello David, these are legal questions, so I would recommend speaking with a real estate attorney local to your area. Thank you for reading!