Right of First Refusal
Right of first refusal (ROFR), also sometimes known as right of refusal, is a contractual right that gives the signer the first chance to purchase a property if it goes up for sale in the future. If he or she ultimately decides to pass on the purchase, the seller can then consider other offers.
Here’s what we’ll discuss:
- What is a right of first refusal in real estate?
- How does a right of first refusal clause work?
- In which situations would you find an ROFR clause?
- What does the ROFR contract look like?
- Pros and cons of signing an ROFR, for tenants
- Pros and cons of signing an ROFR, for property owners
- What happens if the property owner breaks a ROFR contract?
- How can you avoid complications with an ROFR?
- What’s the difference between a ROFR and a ‘Right of First Offer’?
What is a right of first refusal in real estate?
In the world of real estate, the term ‘right of first refusal’ refers to a clause in a lease that gives an interested buyer the right to make the first offer on a property when a seller lists it on the market. It’s often used by tenants who lease a property. If and when the property is listed on the market, the tenant would have the right to put in an offer first.
An ROFR doesn’t mean the potential buyer has to make an offer; they can ultimately decide not to bother, at which point the owner could offer the property to anyone else on the open market.
How does a right of first refusal clause work?
A right of first refusal (ROFR) clause within a rental lease is a contractual provision that grants the tenant to purchase the property before anyone else.
Imagine Nico has been residing in his rental for three years and is particularly fond of the location and layout. He’s also signed a ROFR clause in his lease, with a price (agreed upon at the time) of $300,000.
If the landlord or property owner decides to sell the home or building, Nico would have first dibs on whether or not to purchase it based on those set terms. He could decide not to, at which point the landlord would be free to search for other buyers.
The ROFR is a valuable safeguard for tenants like Nico, ensuring their interests are protected amid potential changes in ownership, and giving them the chance to buy a property they already know and love.
In which situations would you find an ROFR clause?
In the field of real estate, you’ll likely encounter the ROFR in different contexts, such as:
- Private lease–if you’ve signed a ROFR with your landlord, you’ll be first in line to make an offer on your home in case she ever wants to sell it.
- Commercial tenants–let’s say you’ve leased a particular storefront for your flower shop for several years. If your lease includes a ROFR, your store’s property can’t be sold to a different buyer—who might evict you, and your flowers—before being offered to you.
- Real estate firms–in some cases, a real estate firm might want to sign a ROFR on behalf of a particular client who has shown an interest in a property. It’s like seeing an attractive property that’s not yet on the market and saying, “If that’s ever up for sale, I want to be first in line to snap it up.”
What does the right of first refusal contract look like?
Let’s break it down:
- Property’s purchase price: Sometimes, the future sale price can be predetermined in the ROFR contract. If the party with the ROFR later refuses to purchase at the price that was set in the ROFR, the owner is free to offer the property to others at the same or higher price.
- Time limit: Usually, the property owner will set a certain time frame during which the holder of the ROFR has to make up his mind whether to buy or not. If no decision is made, the ROFR agreement expires and the property will be open to other offers.
- Duration of contract: The property owner might specify in the ROFR that it’s only valid until your lease expires.
How might this work? Well, let’s take the flower shop example from earlier.
Suzy of Suzy’s Flowers leases a 2,000 square foot storefront in Brooklyn. She has a 10-year-lease, which expires in 2030, and she has signed an ROFR contract with her landlord.
That ROFR contract might set a future, agreed-upon sale price if the property is to be sold (let’s say, $800,000); a time limit, from when the property goes on sale, for Suzy to make up her mind; and a stipulation that the ROFR contract itself is only valid until Suzy’s lease expires in 2030.
Pros and cons of signing a ROFR, for tenants
Let’s break it down so you can weigh your options.
Pros of signing an ROFR, if you’re a renter
- You might not be 100% sure of whether you want to purchase the property or not. A ROFR will allow you to make up your mind later, without losing an opportunity. (Without a ROFR clause, you should know your rights as a tenant if the landlord decides to sell their property.)
- You won’t have to compete with other interested parties whose offers might drive up the property’s selling price. The moment you’ve signed the ROFR, you can get your finances sorted out and to improve your credit score.
Cons of signing an ROFR, if you’re a renter
- The owner might want to sell their property much sooner than you anticipated.
- In that case, you might feel pressured to make a decision—and buying property is a huge decision you don’t want to rush.
In any case, make sure you understand all of the contract’s conditions. And it’s always a good idea to get yourself some legal advice.
Pros and cons of signing an ROFR, for property owners
At first glance, the ROFR seems less beneficial to the property owner than to the potential buyer. Is that the case?
Pros of signing an ROFR, if you own the property
- It can make it easier to attract great tenants—since an ROFR contract might be seen as a pretty decent perk for the lease signer.
- The process of selling a house or an apartment can be time-consuming and tough. With an ROFR in place, the owner might not have to deal with any of this, as the new buyer (you!) has already been determined.
- There’s a chance that the sale price the owner set in the ROFR contract is higher than the property’s value at the time of the actual sale. That’s great for the seller, and tough luck for the buyer… but he or she still has the option to opt out of the contract altogether, so they’re not actually stuck purchasing the property at an inflated price.
Cons of signing an ROFR, if you own the property
- It might stop the seller from attracting competition over the real estate—forget about a ‘bidding war’ that might bring in extravagant offers in a hot market.
- The ROFR is hard to get out of. Let’s say you’re a property owner, and you’ve signed an ROFR contract with a tenant, but afterwards decide that you want to negotiate a new ROFR with a family member instead. That won’t be easy.
- You might take a hit if the real estate market soar. Let’s say you signed an ROFR contract on a Miami apartment that you own, setting a pre-determined sale price of $550,000. If you suddenly need to sell the property to pay off debts five years later, when the value of that apartment has jumped to $750,000… you still have to give the person who signed the ROFR the opportunity to purchase it for $550,000.
What happens if the property owner violates the right of first refusal?
If your landlord changes his mind and breaks your contract, you have the right to sue in order to enforce the original contract.
How can you avoid complications or problems with an ROFR?
To avoid headache with an ROFR clause in a rental agreement, keep three points in mind:
- Make sure the ROFR clause is clear and unambiguous. Spell out the timeframe for exercising the right, the process of notifying the tenant about a third-party offer, and any other specific requirements.
- Consult a real estate attorney or legal expert familiar with local laws and regulations.
- Document all communication related to the ROFR clause: written notices of the landlord’s intent to sell, third-party offers, and the tenant’s decision to exercise or waive their right. This will come in handy if if any legal snafus arise in the future.
What are the differences between the ‘Right of First Refusal’ and ‘Right of First Offer’?
Once a landlord has signed a right of first refusal, he or she cannot reject the contract holder’s offer—at least not if it’s in accordance with what has been agreed upon in the original contract.
A right of first offer (ROFO) is a little different. In this contract, the tenant has the right to make the first offer on a property when it goes up for sale. However, the owner can decide whether to accept or reject it.