Right Of First Refusal (ROFR) In Real Estate: Advice From Experts and What You Need To Know
JK
Summary:
A right of first refusal clause in a real estate contract gives the holder the right to purchase a property before it is listed or match an offer made by another party. One can avoid ROFR problems by consulting a real estate attorney and considering future issues that may arise.
So you think you may have found your dream home. Even if it’s not on the market just yet, there are ways for you to up your chances and even guarantee that the home is yours once it’s up for sale.
This is the first right of refusal real estate clause, which guarantees you the right to either match or exceed an offer or pass up on a home when the owner decides to sell. While a great way to guarantee control of a property, there are cases where it can be detrimental. Keep reading to learn more about the right of first refusal clause, how it differs from other real estate clauses, and whether including one in your contract is the best option.
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How the right of first refusal works
A right of first refusal (ROFR) is an agreement to provide the holder first rights to a home before it’s listed and allows the holder to match an offer that is made on a property for sale or lease.
The property owner may only proceed with listing, selling, or leasing the property to another party if the holder of the ROFR does not exercise their right within the determined time window. After all, the ROFR holder only has the contractual right, not the obligation, to purchase the property.
Why would someone want a right of first refusal?
There are several reasons why someone might want a right of first refusal clause:
- Protecting their interests. A right of first refusal allows the holder to protect their interests in a property by ensuring that they have the first opportunity to purchase it if the owner decides to sell or lease it.
- Control over the property or asset. By having an ROFR, a party can maintain control over the property and prevent it from falling into the hands of someone they don’t want to have it.
- Investment opportunities. If a party is interested in a property or asset as an investment opportunity, a right of first refusal can give them the chance to acquire it before other potential buyers or investors.
- Strategic advantages. A right of first refusal can also provide strategic advantages, such as enabling a party to consolidate their holdings in a particular area or preventing a competitor from gaining a foothold in a particular market.
Right of first offer vs. right of first refusal
A right of first offer (ROFO) and a right of first refusal (ROFR) are both legal agreements that give a party the opportunity to purchase or lease a property or asset before it is offered to other potential buyers or lessees. However, there is a key difference between the two agreements.
A right of first offer is a contractual agreement that requires the owner of a property or asset to offer it to a specific party before offering it to anyone else. The party with the ROFO then has the opportunity to accept or reject the offer. If they reject it, the owner can then offer the property or asset to other potential buyers or lessees.
A right of first refusal, on the other hand, is a contractual agreement that gives a specific party (the holder) the right to match any offer that the owner receives from another potential buyer or lessee. If the owner receives an offer from another party, they must first offer the property to the holder, who then has the opportunity to match the offer and purchase or lease the property or asset.
In short, a right of first offer gives the party the opportunity to make the first offer, while a right of first refusal gives the party the opportunity to match an offer made by another party.
How do you draw up a right of first refusal agreement?
When executing a right of first refusal agreement, your first step (no matter what side you’re on) should be to get a lawyer involved. After all, real estate law can get complicated, and it’s best to ensure the contents of an ROFR agreement are clearly laid out.
Of course, the two most important pieces of information to include in this document are the property’s purchase price and the holder’s time limit to act on the ROFR.
Purchase price
The price can be a flat amount or a certain percentage above the current market window. However, the price doesn’t have to be a predetermined amount. In that case, the parties may agree to allow the prospective buyer to match or exceed any offer that the owner receives from a third party.
Alternatively, if the buyer no longer wants the property, they can refuse to purchase it and the seller can accept other offers from potential buyers.
Time limit
In addition to the purchase price, you’ll typically need to outline a specific window of time the ROFR holder can act on their right. This may be a specific timeframe — such as 30 days, 60 days, or 90 days — or it may be that the buyer and seller agree for the ROFR to be conditional. Instead of providing a time limit, the seller would simply provide notice to the buyer of their intention to sell the property.
Regardless of the specific time limit, once this date passes or the buyer refuses, the seller is free to sell to another buyer.
Pros and cons of an ROFR agreement for the buyer
Though rights of first refusal clauses can be great options for buyers, this isn’t the case for every real estate transaction. Before incorporating a right of first refusal clause into a contractual agreement, first consider these pros and cons.
Pros explained
- Avoid competition. No matter what, the seller can’t accept any offers before allowing you an opportunity to view the offers and make a decision on the home. Bidding wars can get competitive and cause stress, so it’s great to do without this part of the process.
- Pre-determined purchase price. Pricing terms are often pre-determined in a contract containing an ROFR clause. If you’re in a hot market (with rising prices), this means you could get the property for less than what you would pay if it was on the open market.
- Provides you time to consider options and save. Entering into a right of first refusal clause means you can still determine whether you want a specific property. If you do, an ROFR gives you time to work on your credit and save up for the purchase price and down payment.
Cons explained
- Limited decision window. Part of a right of first refusal clause is a built-in time limit. Once the seller puts the property on the market, you need to be ready to make a quick decision and be financially able to meet the purchase price.
- Pre-determined purchase price. For the buyer, you could be overpaying if the housing prices go down. However, letting the property exit the clause and go to open market means you risk losing the property entirely.
- No guarantee on a purchase. Sellers aren’t obligated to list their properties, so you could be waiting a really, really long time.
If you know you want the property but need some help meeting the purchase price, take a look at some of the mortgage lenders below.
Pros and cons of an ROFR agreement for the seller
Just as there are pros and cons for the buyer, there are also benefits and drawbacks for a seller to agree on including a right of first refusal clause in a contract.
Pros explained
- No listing required. As a seller entering into a right of first refusal clause, you could potentially sell your property without ever having to list it. This can keep your costs down considerably.
- Could make a great profit. An ROFR clause is proof that at least one buyer wants the house and prefers to avoid competition. This could mean they’ll spend more than the property’s market value to guarantee the transaction happens and keep it away from other prospective buyers.
- Give preference to certain buyers. A right of first refusal clause is a good way to keep chances high that current tenants or family members can consider the property first before it hits the market. This is often helpful to a tenant, who can use this clause to purchase the property that they already occupy.
- Can keep undecided buyers from walking away. A buyer that’s enticed by the property but on the fence may enter into a right of first refusal clause instead of walking away entirely.
Cons explained
- Limited market. Typically, the more buyers that have a chance to participate, the better chance a seller has to gain a higher price. By giving someone the first option, you could unintentionally be lowering your price.
- Pre-determined purchase price. If you have a specific price point laid out in the contract that ends up being lower than the current market value for the property, you could be leaving money on the table.
- Could cause lending issues. Even if you’re not currently looking to sell your property, the existence of an ROFR could create issues if you’re thinking about refinancing an existing mortgage.
Lenders and major mortgage investors generally prohibit you from getting a loan when these types of clauses exist because the property serves as collateral for the loan. If you default for any reason and the lender has to sell the property to recoup the investment, they won’t want any clause that prohibits them from making it available to the largest pool of other buyers.
If you want to take a look at your refinancing options before deciding on an ROFR clause, then consider some of the lenders below.
Is the right of first refusal always a good idea? When is it not?
Entering into a right of first refusal can be either a good or bad idea, depending on what you value in the home-buying process, what your resources are, and the current housing market. A real estate agent and investor, Jon Sanborn points out that ROFR clauses may not be the best option in some cases, especially if that involves restricting business development.
“Right of first refusal can be beneficial to a company in certain situations, such as when the company needs to make sure that a certain asset or resource remains under its control,” says Sanborn. “However, it can also be detrimental if it restricts competition or inhibits innovation. In addition, [a] right of first refusal can lead to conflicts between parties when one party wants to obtain the asset or resource while the other party refuses to grant them access.”
Are there ways to get around a right of first refusal?
There are different opinions on whether you can get around a right of first refusal. On the one hand, Sanborn says that a ROFR clause allows for some negotiations between the seller and buyer.
“First, parties can enter into an agreement that allows the party with the right of first refusal to reject or accept any proposed offers before they become binding on either party,” he said. “Parties can also agree on a reasonable deadline in which they must respond to any offers presented. Lastly, parties could also agree to mediation or arbitration in order to resolve any disputes that may arise.”
However, as an attorney, Shawn Pappas says these negotiations aren’t always possible. “There is really no mechanism to get around the right of refusal. The holder has the right to be informed of the offer and either execute the same terms or waive its right.”
How to avoid ROFR problems
The best way to avoid right of first refusal problems is to consult a real estate attorney and spend time thinking through future problems that may arise.
Questions to ask yourself as a buyer
- How long should the right of first refusal last? How much time should the 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? How will a down payment be affected by an ROFR?
- Where is the market right now and where does seem to be going?
- Is potentially paying more worth not considering houses on the market or dealing with the sometimes usual stress of real estate?
Questions to ask yourself as a seller
- Will entering into a right of first refusal create any issues if you’re looking to refinance an existing mortgage?
- Where is the market right now and where does seem to be going?
- Is guaranteeing a future sale of the home to this buyer worth potentially selling it for less?
Key Takeaways
- A right of first refusal guarantees the right to either match or exceed an offer on a particular property. However, the ROFR holder can also pass up on a home when the owner decides to sell, providing control and strategic advantages.
- The main difference between an ROFO and an ROFR is that a right of first offer gives the party the opportunity to make the first offer, while a right of first refusal gives the party the opportunity to match an offer made by another party.
- Before incorporating a right of first refusal clause into a contractual agreement, consider the pros and cons for both the buyer and the seller.
- To avoid right of first refusal problems, consult a real estate attorney and think through potential issues that may arise.
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