What Is the Right of First Refusal in Real Estate?

The right of first refusal in real estate refers to a certain person having the right to purchase real estate for sale before it's offered to other buyers. A first right of refusal clause might be given to renters interested in purchasing the property from their landlord or families planning estate inheritances. The right for first refusal can give you options to move ahead on a purchase without competition, avoiding the potentially taxing and competitive real estate bidding process. Read on to understand how the right of first refusal could help your planning. 

Understanding the Right of First Refusal in Real Estate

The term right of first refusal or ROFR refers to a contractual right granting someone the option to purchase an asset or property before the seller enters a transaction with another party.  It's the legal real estate term for calling first dibs. That means that should someone else express interest in purchasing the property, the individual or company holding the right of first refusal can buy it themselves. If they refuse the opportunity, the seller can pursue other offers. 

Landlords use a right of first refusal as an incentive for lease tenants in buyer’s markets. The contingency gives buyers additional security. A right of first refusal is also used as an estate planning tool to prevent conflict among family members over an inheritance. For example, certain family members may have the first right to refuse to purchase a family home. If they decline the market offer, the estate can sell the home to a third party. 

Commercial real estate also uses the right of first refusal in many transactions. For example, a commercial tenant who has built a business in a particular location may want to buy the property rather than be forced to move if the landlord decides to sell. 

How Does the Right of First Refusal Work?

The right of refusal in real estate works like an options contract. The rights holder can have the option, but not the obligation, to purchase a property before other parties. The holder of a right of first refusal has the opportunity to sign a contract or purchase agreement on an asset before others can. 

Rights of first refusal are used in many business transactions or even by real estate investors. The prevalence in real estate makes them an important factor to consider whether you're a private or commercial tenant. 

For example, a landlord in a buyers’ market may offer their tenants the right of first refusal on a private home if they decide to sell. Likewise, commercial real estate properties often include a first right of refusal clause to protect the businesses that use their locations. And families use the right of first refusal to prevent conflicts over family homes and inheritances. 

Right of First Refusal vs. Right of First Offer

Right of first refusal (ROFR) and right of first offer (ROFO) may sound similar, but they are different opportunities. If you have the right to the first offer, you can submit the first bid on a potential property sale. The seller is not obligated to accept your offer, although in competitive markets, if you make a strong offer, you could increase the chances of a sale.

On the other hand, the right of first refusal gives you the right to match or refuse an offer already made to a seller. In that case, you cannot put in a lower offer, although you could always try to negotiate with the seller. Or, the seller could refuse the offer and still come back later to negotiate with you. 

Here's how ROFR and ROFO play out in the real world:

Sara has been renting a home in Portland, Oregon, for the past five years. In her contract, she has a right of first refusal on the property. The property owner receives an offer from an interested buyer for $450,000 and decides they want to sell. Sara can match that offer and purchase the home or decline with the understanding that the new owner may or may not allow her to continue renting the property.

Sara's neighbor Amy has a right of first offer on the home she's renting. Her landlord informs her that he's planning to list the property. Amy has the option to make an offer first. Amy offers $430,000. It's a little under market value, but Amy's landlord decides to accept the offer and go ahead with the sale instead of the hassle of listing the property and negotiating with other potential buyers. 

Pros and Cons of the Right of First Refusal

There are significant advantages as a tenant or buyer for the first right of refusal. The contract acts as a sort of insurance policy, assuring you that you won't lose the right to an asset or property without first having the opportunity to match an offer. Here are the pros of the right of first refusal. 

Pros

• Offers security
• Simplifies purchase opportunities
• Reduces conflict among family members over inherited properties
• Offers businesses the opportunity to build and grow in a commercial space
• You have time to consider options
• Landlords can set a predetermined purchase price
• It offers opportunities to buy a home you've been waiting to come on the market

For buyers or tenants, the only downside of the right of first refusal is that a landlord may receive an offer significantly above market value or that you're unable to match, and you lose the property. For property owners, the right of first refusal can make it more difficult to attract buyers who know the tenant has the first opportunity. It also limits bidding wars, keeping sale prices lower.  

Cons

• High offers can be difficult for some tenants to match.
• For potential new buyers, the tenants may act, making it difficult to purchase these properties.
• It doesn’t guarantee a purchase.
• If the price is predetermined, it can be overpriced if the home value drops.
• You could become over-attached to a specific property. 

How to Get Right of First Refusal

To get the right of first refusal, you'll need to work with real estate lawyers to ensure the correct phrasing and legality of the contract. In most cases, there will be a lawyer representing the owner and a lawyer representing the prospective buyer. In some contracts, the sale price is predetermined and stated in the contract, while in other cases, the sale price is left to be determined. 

If the sale price is locked in, the lawyers will work with real estate agents or other professionals to determine a fair price for both parties within a specified time frame. 

How to Ensure That Your Right of First Refusal Is Upheld

To ensure that your right of first refusal is upheld, it's essential to have a well-drafted and legally binding agreement that clearly outlines the terms, conditions and limitations of the right. You can work with a trusted real estate attorney to draft and review the contract before signing. 

If you believe the landlord is not upholding the right of first refusal, you can speak to them about the contract and opportunity. In most cases, if you took the time to draft and sign the right of first refusal, you should be able to resolve everything without resorting to legal action. 

Securing a Right of First Refusal

If you're a tenant, securing a right of first refusal can give you peace of mind and the opportunity to purchase a property that's not currently on the market at a later date. If you don't have a right of first refusal, you can speak to your landlord about the possibility. You can also consider the costs of the purchase and whether it makes sense. To start planning, find the best online mortgage lenders and how much you'll pay on a $200,000 mortgage.

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