What Is The Right Of First Refusal (ROFR) In Real Estate And Should You Agree To It?
Scott Steinberg5-minute read
September 30, 2021
What is the right of first refusal (ROFR) in real estate jargon – and is it something that you should be willing to agree to? Glad you asked: Given that the right of first refusal refers to a legal clause that effectively gives a party the right to be the first in line when an owner decides to sell a property, it’s a question worth pondering.
Here, we’ll take a closer look at what ROFR means in practical terms for property owners and prospective home buyers alike. Likewise, we’ll also look at an example or two of how the right of first refusal works in common real estate scenarios.
What Is The Right Of First Refusal In Real Estate?
A right of first refusal is a fairly common clause in some business contracts that essentially gives a party the first crack at making an offer on a particular transaction. In real estate terms, the phrase “right of first refusal” operates similarly.
Put simply, it’s a type of legal clause that you may find in a contract or lease, especially on a property that a rental tenant may be looking to acquire from a landlord. ROFR essentially gives interested buyers a contractual right to be the first party to have an opportunity to place an offer on a property when it’s listed on the market for sale by its owner. Should someone else express an interest in purchasing the property instead, the current holder of the right of first refusal has the option to first elect to purchase the property themselves. Alternately, they can decline the opportunity and let the seller pursue other offers.
An ROFR is most commonly used as an incentive for lease tenants in buyer’s markets, contingent buyers subjected to kick-out clauses in a hot seller’s market, or as a tool in estate planning to prevent conflict among heirs over an inheritance. Basically, a ROFR clause obligates a seller to contact the rights holder with an option to purchase the property before they can accept an alternate offer from another party on the piece of real estate.
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Why Is ROFR Important?
ROFR is a contractual obligation that binds both a prospective real estate buyer – for example, a potential homeowner looking for an apartment, condo, or single-family residence – and real estate seller. But even more importantly, while it creates a right that you can exercise if you wish to buy property, it does not create an obligation to do so.
In essence, if you find a piece of property that you’d like to buy that may not be on the market yet, or that you are uncertain about purchasing, it can serve as a form of insurance of sorts. As a rights holder under an ROFR clause (and this right can only be held by someone other than the property owner or their lender), you gain the option to decide whether or not to make a real estate purchase before others can. (And at a predetermined price, as in most ROFR contracts, the real estate purchase price is set before a property comes on the market.) However, if you do not wish to proceed, you can simply waive your rights and move on.
A right of first refusal is generally negotiated before a homeowner decides to bring their property to market. Under its terms and conditions, prior to members of the general public being allowed to put in an accepted offer on a residence, the home seller must first make a purchase opportunity available to the person who holds the right of first refusal. Of course, for these reasons, an ROFR generally comes with a time limit on it that states how long a buyer has to negotiate with a seller before their window of opportunity and right of first refusal expires. Upon expiration, the home seller is free to engage with any other buyer.
What Are the Advantages And Disadvantages To The ROFR For The Buyer?
A right of first refusal generally favors buyers. But as with any real estate opportunity, it can come with pros and cons attached.
- Creates a first-mover right on a real estate deal
- Gives you time to consider your options
- Allows you to set a predetermined purchase price
- Provides opportunities if you’re waiting for a home to come on the market
- Doesn’t guarantee a purchase
- Sellers aren’t obligated to list their properties by a set timeframe
- May be financially disadvantageous if the home value drops
- May cause you to become over-attached to a specific property or deal
What Are The Advantages And Disadvantages To The ROFR For The Seller?
In many cases, sellers are hampered by a right of first refusal, especially as under its terms, there’s no guarantee that the ROFR holder will buy. Still, there may be reasons to pursue one.
- May serve to entice interest from buyers
- Can keep shoppers on the fence from walking away
- Allows you to agree on a proposed purchase price up-front
- Provides some peace of mind as you work to get a property listed
- Doesn’t obligate the buyer to ultimately make a purchase
- Can tie your hands if a better offer comes up later
- May limit your financial upside if the home value increases
- Creates added obligation and burden for sellers
Who Is Eligible To Negotiate An ROFR?
If you’re looking to execute a right of first refusal agreement, it’s recommended that both sides get qualified real estate attorneys involved.
While generally not complex, it’s common for such clauses to contain important points including a time limit under which the ROFR applies and agreed-upon way to calculate the future price of the real estate holding. By way of example, the home price might ultimately end up being a flat rate, a certain percentage above market value, or simply the matching of an offer that the seller would otherwise accept from a member of the general public.
ROFR clauses often come into play at the behest of real estate agents looking to make potential sales, or landlords hoping to entice renters into upgrading from tenants into future homeowners. Noting this, it’s important to research and consider their terms before entering into any binding agreement.
How Can I Avoid ROFR Problems?
You can minimize issues surrounding ROFRs by taking time to think through possible future scenarios.
For example: How long should a right of first refusal 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? And, of course, for home sellers: Will entering into a right of first refusal create any issues if you’re looking to refinance an existing mortgage (for which your current property typically serves as loan collateral)?
If you’re considering employing an ROFR agreement, be sure to consult with a real estate attorney to help minimize future issues and concerns.
The Bottom Line: ROFRs Give Peace Of Mind, But At A Price
So, what is a right of first refusal in the end? Think of it as a future planning tool … and way to enjoy some measure of relative certainty in what can otherwise often be a highly volatile and/or unpredictable real estate market.
However, as much as a ROFR can prove a helpful incentive for enticing prospective buyers and upgrading rental tenants into property owners, it’s no 100% guarantee that a sale will occur, and can often cause unintended consequences.
Readers considering implementing a ROFR clause should seek legal advice before entering into one, and read more about what it takes overall to win a bidding war in a seller’s market.
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