What is the right of first refusal (ROFR) in real estate and how does it work?

What is the right of first refusal (ROFR) – and is it something you should agree to? The right of first refusal is a legal clause that gives an interested party the right to be the first in line to make an offer when an owner decides to sell their property – and it’s an approach worth pondering.

We’ll take a closer look at ROFR, what it means for property owners and prospective home buyers and explore how the right of first refusal works in routine real estate scenarios.

What is the right of first refusal in real estate?

The right of first refusal is a legal clause in a real estate contract or lease. You’ll typically find it used in an agreement for a property a tenant wants to purchase from a landlord. ROFR essentially gives interested buyers a contractual right to be the first party to place an offer on a property when it’s listed for sale by an owner.

If another buyer expresses interest in purchasing the property, the holder of the right of first refusal can either buy the property or decline the opportunity and let the seller pursue other offers.

When is the ROFR used in real estate?

ROFR is a common incentive for lease tenants in buyer’s markets, contingent buyers subjected to kick-out clauses in hot seller’s markets or estate planning scenarios to prevent conflict among family members over an inheritance. The clause obligates a seller to contact the holder of the ROFR, notifying them that they can purchase the property before the seller can entertain or accept another offer.

How does ROFR work?

ROFR is a contractual obligation that binds a prospective real estate buyer – such as someone who wants to buy a townhouse, condo or single-family residence – and a seller. While the clause creates a right you can exercise if you decide to purchase the property, it doesn’t create an obligation to buy.

If you want to buy a property that’s not on the market yet or are uncertain about purchasing, an ROFR can serve as a form of insurance.

As the holder of the ROFR (a right that can only be held by someone other than a property owner or their lender), you get to decide whether or not to purchase the real estate before a seller can entertain other interested buyers. Most ROFR contracts specify a predetermined purchase price before the property comes on the market, allowing you to purchase at that price. If you no longer want to buy the home, you can simply waive your rights and move on.

When is an ROFR negotiated?

A right of first refusal is usually negotiated before a homeowner sells their property. Under its terms and conditions, the home seller must notify the ROFR holder about the sale before other buyers can put in an offer.

Does an ROFR expire?

Yes, an ROFR can expire. An ROFR generally includes a timeline that details how long a buyer has to negotiate with a seller before their window of opportunity to buy and right of first refusal expires. Upon expiration, the home seller is free to sell to another buyer.

Right of first refusal vs. right of first offer

Another real estate term you may hear is “right of first offer” (ROFO). While ROFO and ROFR each allow a buyer to make the first move, ROFO allows the seller to entertain other offers.

Instead, the buyer has a specific amount of time to make an offer on a property. In the meantime, the seller can market the home to other buyers. When the seller receives the ROFO holder’s bid, they can accept or reject it. If the seller doesn’t receive a better offer, they can reopen talks and renegotiate the purchase terms with the rights holder.

What are the advantages and disadvantages of an ROFR for the buyer?

A right of first refusal generally favors buyers. But, as with any real estate investment, the strategy has pros and cons.

ROFR pros for the buyer

The most common advantages buyers can expect from an ROFR include:

• It allows priority access to the property.
• It gives you time to consider your options.
• It lets you set a predetermined purchase price.
• It provides opportunities if you’re waiting for a home to come to market.

ROFR cons for the buyer

The ROFR also has drawbacks buyers should be aware of before adding the clause to a contract, such as:

• It doesn’t guarantee purchase.
• Sellers aren’t obligated to list their property.
• It may be unfavorable if the home value drops.
• It may result in an overattachment to a specific property or deal.

What are the advantages and disadvantages of an ROFR For the seller?

Sellers are generally hampered by a right of first refusal, particularly because there’s no guarantee the holder of the ROFR will buy the property. Still, there are legitimate reasons to pursue this strategy.

ROFR pros for the seller

The main benefits sellers can expect from an ROFR include:

• It may generate interest from renters or future buyers.
• It may help keep buyers on the fence from walking away.
• It sets a proposed purchase price upfront.
• It can provide peace of mind knowing a buyer is lined up before listing the property.

ROFR cons for the seller

On the other hand, several disadvantages may discourage an owner from agreeing to an ROFR, such as:

• It doesn’t obligate the buyer to purchase the property.
• It can tie your hands if a better offer comes up later.
• It may limit your financial upside if the home’s value increases.

Who is eligible to negotiate an ROFR?

If you want to include a right of first refusal in a contract, you and the homeowner should get qualified real estate attorneys involved.

While the process is fairly straightforward, ROFR clauses typically outline important terms, including the time frame that the ROFR applies and how the seller and ROFR holder will calculate the price of the real estate holding. The home sale price can be a flat rate, a percentage above market value or an agreement to match an offer the seller would otherwise accept from a buyer.

Real estate agents looking to make potential sales or landlords hoping to entice renters to transition from tenants to future homeowners are typically eager to draft agreements granting ROFR.

How can I avoid ROFR problems?

Whether you’re the prospective buyer or the seller, you can minimize issues with ROFRs by considering possible future scenarios.

For example, how long should a right of first refusal last? How much time should a buyer have to exercise their right or step away from the deal? What’s a fair method of calculating the property’s purchase price? How will a down payment affect an ROFR?

Home sellers should also consider whether entering into a right of first refusal would create any issues if they want to refinance their mortgage.

If you’re considering an ROFR, consult a real estate agent and attorney to help avoid issues down the line.

Right of first refusal FAQs

For more information about the ROFR, review these frequently asked questions.

What happens if the ROFR is violated?

Under contract law, the ROFR holder can sue for provable damages when the right of first refusal is violated. The damages can be monetary or specific, such as getting the first chance to purchase a property after the initial ROFR was violated. If specific reparations aren’t possible, the holder of the ROFR is typically awarded monetary damages.

Can ROFR apply to a tenant living in a rental property?

Yes, a tenant living in a rental property can use the right of first refusal. It’s usually included in the lease agreement and gives the tenant the right to be first in line to purchase the property when the landlord decides to sell. It’s a win for the tenant and the landlord because it lets the tenant stay in a property they’ve grown used to, and the landlord doesn’t need to find a new tenant.

Can I get out of an ROFR?

Yes, you can get out of an ROFR. Extinguishment is the formal term for canceling a right of first refusal. The ROFR holder can either fail to act within the agreed ROFR time frame or decline to purchase the property.

The bottom line: ROFRs offer peace of mind at a price

Think of the right of first refusal as a future planning tool and a way to enjoy some measure of relative certainty in an unpredictable real estate market.

However, as much as an ROFR can be a helpful incentive that convinces tenants to become property owners, a sale isn’t 100% guaranteed, which can trigger unintended consequences. Get legal advice before you add an ROFR clause to a real estate contract.

To help establish a seamless home buying experience, start the mortgage approval process online today.