What Is the Right of First Refusal?
The right of first refusal (ROFR) in the real estate is a contract that gives a specific right to a party to purchase a particular property. The right of first refusal must have at least three parties: the owner, the buyer, and the option holder.
The holder of the ROFR may claim the right in the case when an owner of the property sells the property on the market. If the owner sells the property to a third party without offering the holder the opportunity to purchase it first, the holder of the right has the option to sue the owner. After the process, a court can stop or reverse the sale.
What is the Right of First Refusal in Real Estate Contracts
The explanation of the right of first refusal (ROFR), or 1st right of refusal, can be complicated. In this post we discuss the term further to explain what the right of the first refusal means in the real estate business and how it applies to the holders of the right and the real estate owners.
One type of ROFR is essentially an option to buy a property for sale at the specific price and under specific terms. The seller and the holder may or may not agree to bind themselves to these terms. The option may end at some specific date in the future. Then, the seller can sell the property under different terms. Most importantly, at a different price when the option stops to be active.
The parties can negotiate the price of the property. If the property has a value of $100,000 in the first year, the holder and the seller can agree that the price can raise each year for 3%. Under these conditions, the option price will be 3% higher, either compounded or not compounded, during each succeeding year.
Depending on the contract, the holder of the ROFR has an opportunity to suggest a sale price without worrying about competition and bidding on the market. The holder can decide to accept or refuse to buy a property. The other case allows the seller to negotiate with other buyers with an expressed interest in the property.
When Is the Right of First Refusal Used?
The right of first refusal applies in a few situations. One of them is the situation when a property has a tenant. When a landlord (owner) decides to sell the property, he must first contact the tenant. The same applies when the tenant is interested in buying a property. An owner must consider the offer from a tenant before negotiating with other parties about the price and conditions.
Another case when the ROFR comes into use is when a family member wants to buy a property. An owner who is a relative to a potential buyer must offer the property to this party first, before offering the property to someone else.
Dealing with a homeowners association or condo board can also be the case when the right of the first refusal comes into force. Sometimes, the governing documents contain the right-of-first-refusal clause that allows the board to vet potential buyers before a seller can accept an offer. In some situations, discount sales can lower the value of the property. This is why communities use the FOFR clause to protect the value and reject the offer that is not acceptable.
How the Right of First Refusal Affects Sellers and Buyers?
If you are a seller of a property, you can benefit from the right of first refusal. In case that the market is full of similar properties that are generally low in price, you can sell the property to the holder of the right and get the price that might be higher than the price when selling it to someone else. The contract is drafted before the home hits the market and you might be able to persuade the holder of the right to buy the home at a higher price than the market value.
On the other hand, if you are a buyer, you have many possibilities to profit from the right of first refusal contract. You have the right to notice by the owner when the owner decides to sell the property. If you are a tenant, you can prepare for the transaction before the period of actual buying of the property comes. You have time to save money for a down payment, or to improve your credit score. As a holder of the ROFR, you can also discuss the price before it hits the market. This gives you a significant advantage when comparing to other potential buyers.
Both parties have an interest in making a contract that declares the ROFR clause. The holder can pay the lower price for the property, while the owner can have cash in hand at the right time when the ROFR agreement allows the transaction. The ROFR sets forth a future price. Both parties in the joint venture can have certainty about a future price, time, and other arrangements to avoid a bidding war. If the holder cannot meet the terms of the ROFR in the future, the seller is free to sell the property to someone else in the future.
How Long the Right of First Refusal Is Valid?
Most contracts only last one or two years. This period might appear to be short, but there is a reason why both parties decide to make the contract short. The prices on the market can significantly change over a specific period of time, and the value of the property can be completely different in the long run. Both parties usually decide to set the price for a shorter period. This ensures that the price won’t be much lower or much higher at the end of the specific period. This kind of contract duration protects both the holder of the right and the seller.
Both parties should get lawyers to make clear that each part of the right-of-the-first-refusal contract is clear and understandable. A lawyer can give the right advice to both parties about the price, conditions, and duration of the contract.
An interested party to a business transaction should try to use rights of first refusal agreements in the purchase price for any equity or real estate deal. Talk to your real estate agent, securities broker, or business lawyer for more.