Put simply, a right of first refusal in real estate is a name for a specific provision in a lease agreement or purchase contract. It gives a prospective buyer the right to purchase the property before the seller negotiates with anyone else. That said, there's more to the right of first refusal than first meets the eye. Keep reading to learn how this clause works, what it means for each party in the transaction, and how to tell if using this clause is right for you.
How does a right of first refusal work?
A right of first refusal (ROFR) is typically written up well before the seller even considers putting their property on the market. In this case, a ROFR agreement can be part of an existing lease or a freestanding agreement on its own. However, in either case, the clause specifies that before the seller can market their home for sale, they must reach out to a named, interested party.
At that point, the interested party can decide whether or not they intend to move forward with buying the property. If they are, they can work with a real estate agent to put together a bona fide offer for negotiation. However, if not, they can decline and the seller would be free to market their home normally.
While technically a ROFR agreement can take place between any seller and potential buyer, most often it will be drawn up between:
- A landlord and their longtime tenant.
- Family members or close friends.
- An HOA or condo board and a unit owner.
How does a right of first refusal affect the seller?
In all honesty, as the seller, a right of first refusal clause can often be limiting. In this scenario, you will have to wait to negotiate with the right holder until you can accept any other offers. If it takes the right holder a while to put together a bona fide offer, there is a chance that you could lose out on the interest of a qualified third party in the meantime.
That said, it's not all negative. In a down market, having a ROFR provision in place can actually work to your advantage. Here, you won't have to market your home in order to find a potential purchaser. As soon as you're ready to sell, all you would need to do is reach out to your potential buyer and wait for the offer to come in.
It's also worth noting that you're not required to accept the offer. For example, if the prospective buyer offers far less than fair market value for the home, you can try to negotiate or decide to walk away from the transaction entirely. All this clause requires of you is that you consider the right holder’s offer before entertaining any others.
How does a right of first refusal affect the buyer?
On the other hand, for prospective buyers, there are some big benefits to being the right holder. As long as you have this agreement in place, you are essentially guaranteed first dibs on the property. This guarantee can give you time to get your finances together if you aren't quite ready to buy a home at the time that the provision is put in place.
The one small downside is that, unless you're close to the seller, you may not have much warning before being asked to put together an offer. While you have the contractual right to choose whether or not to buy the property, the seller has the contractual right to decide when to put the property on the market. To that end, it's possible that the timing may not be ideal for you.
How does a right of first refusal affect a real estate investor?
Lastly, as you might suspect, the effect of a right of first refusal clause on a real estate investor completely depends on what side of the transaction the investor is on. On one hand, if the investor is the right holder, it can be a huge advantage. If, for instance, the seller talks to you before they talk to a real estate agent, there's a chance that you could secure the property for below fair market value.
However, if you're the seller, it may be wise to think carefully before putting this contractual right into writing. In this case, whenever you decide to sell, you'll be tied to the right holder. Unless you're confident that they'll present you with an offer that will generate a profit or you can specify a purchase price within the provision, it may not make sense to offer this option.
Is a right of first refusal right for you?
Ultimately, whether or not a right of first refusal clause is right for you will depend on your goals for the sale. If you have the opportunity to be the option holder, there is really no downside to agreeing to this clause. After all, you always have the option to walk away from the transaction. However, if you're the seller, it makes sense to think twice before agreeing to this clause. In that case, you’ll want to be sure you protect your interests if you do end up putting this provision into a real estate contract.