What is the first right of refusal in real estate?

Any real estate transaction, whether it’s to rent or buy a property, has certain concepts that help to define the rights of both parties. One such concept is the first right of refusal, aka the right of first refusal (ROFR). Here, we’ll help you understand this terminology, how it works in the real estate industry, and ways to navigate it.

What is the right of first refusal or first right of refusal?

A right of first refusal is a contractual agreement often used in real estate transactions. It gives a specific party, typically a tenant or an existing owner, the first opportunity to purchase a property before the owner accepts an offer from another potential buyer.

The purpose of ROFR is to provide a degree of security to the party holding this right, allowing them to retain their interest in the property or take advantage of a potentially favorable purchase opportunity if they wish. 

It can be particularly relevant in situations where a tenant wishes to buy the property they are renting or when co-owners of a property want to establish a mechanism for one owner to sell their share to another co-owner before offering it to an external buyer.

ROFR agreements are legally binding and must be clearly defined in a contract or lease agreement. The specific terms and conditions, including the notice period and the process for exercising the right, should be clearly outlined to avoid misunderstandings and legal disputes.

What is a good example of the right of first refusal?

Imagine you live in a house, and the owner wants to sell it. If you have the “right of first refusal,” it means the owner must ask you first before selling to anyone else. You can choose to buy the house without worrying about others making offers, or you can say no, and the owner can then find other buyers. You don’t have to buy it if you don’t want to, but you get to decide before the owner talks to other potential buyers.

How does ROFR work?

A “Right of First Refusal” is like having the first chance to do something without being forced to do it. But usually, there’s a time limit to exercise this right, after which the property can be offered to someone else. Let’s understand the chronology of ROFR:

• The landlord or landowner decides to sell the house you’re renting or co-owning.
• A potential homebuyer makes a third-party offer to buy the property at a certain price. This offer could be, for instance, $300,000.
• The landlord/owner, as per the ROFR clause in the lease agreement, is required to inform the renter/co-owner about the offer from the potential buyer – including the sale price, closing costs, and other relevant terms and conditions.
• Now the renter or co-owner has a choice to make. They can notify the landowner about buying the house by matching the offer of $300,000 or opt-out within the given time frame.
• If the party decides to decline the offer, the property owner can then proceed to sell the house to the third-party buyer or the interested party.

ROFR vs. ROFO: What is the difference?

ROFO or right of first offer is not very different from ROFR; both of these clauses let a buyer have the first opportunity. However, ROFO works differently because it doesn’t force the seller to discuss the deal with the person who holds the right.

With ROFO, the buyer gets a specific amount of time to make an offer on the property. During this time, the seller is free to advertise the property to other potential buyers. When the seller receives the offer from the ROFO holder, they can choose to accept it or say no. If they don’t get a better offer from someone else, they can even go back and talk to the ROFO holder again, even if they initially turned down their first offer.

To whom does the right of first refusal apply?

There are various scenarios in which a right of first refusal can be granted to give one party the chance to make an offer on a property ahead of others:

Tenant and landlord

In lease agreements, a right of first refusal can be included to allow a tenant the option to make an offer on the property if the landlord decides to sell it. It can help avoid certain difficulties and expenses associated with changing property ownership in a rental scenario.

Co-op or condo and homeowners associations

Homeowners Associations (HOAs) or condominium boards may, in some cases, attempt to incorporate a right of first refusal clause into their agreements. In such instances, the HOA or board may have the authority to purchase the home or unit back from the seller before the seller can entertain offers from other potential buyers in the market.

Two-party arrangements

Right of first refusal clauses are occasionally used to maintain control of property within related parties or family members. This clause may be employed to provide a family member or relative the opportunity to purchase a property from someone before it is listed on the open market.

What are the pros and cons of right of refusal clauses?

A right of first refusal clause has both advantages and disadvantages for both buyers and sellers in the arrangement.

Pros for buyers

• It gives them exclusive opportunities. The buyer can purchase a property without competing in the housing market, ensuring they have the first chance to buy it.
• There are no bidding wars for a particular property. 
• It provides continuity for tenants who want to buy the property they currently live in. This allows them to build home equity without the hassle of moving.

Con for buyers

• The agreed-upon purchase price at the beginning of the contract might not reflect the current market value, potentially leading to overpaying for the property.

Pros for sellers

• The clause guarantees a prospective buyer for the home seller. And, peace of mind. 
• Parties with this right are often highly motivated to make an offer, increasing the chances of a swift transaction.
• It may attract tenants who are interested in eventually purchasing the property.

Con for seller

• Sellers may sell the property for less than its market value at the time the right is exercised, based on the initial first right of refusal agreement.

Last thoughts on the first right of refusal

The right of first refusal benefits tenants and prospective buyers by offering them the first shot at purchasing a property. It also helps sellers secure interested parties and ensures a prospective buyer is lined up when the time comes. However, it carries the risk of selling the property below its market value.

Read more: Exclusive right to sell

FAQs

Can I refuse my right of refusal?

Yes, you can refuse your right of first refusal. You have the option to buy a property before the owner sells it to someone else, but it doesn’t force you to buy it. You have the freedom to decline your right of first refusal if you’re not interested in buying the rental property or for any other reason.

Is there a time frame to decide whether or not to buy a property?

The time frame in an ROFR is typically specified in the contractual agreement and can vary depending on what the parties involved have negotiated. The time limit can range from a few days to several weeks, depending on the terms of the contract.

Should I consult with professionals for an ROFR clause?

If you’re thinking about using an ROFR agreement, it’s important to seek guidance from a real estate agent and a real estate attorney to help reduce potential problems and address any concerns that may arise in the future.

Who typically holds the ROFR in real estate transactions?

ROFRs can be held by tenants, co-owners, homeowners associations (HOAs), or other parties with a vested interest in the property.

Written by Ramona Sinha. November 3, 2023

Ramona is the Senior Content Writer for Kukun. This experienced blogger uses simple and succinct words to decipher the complex phenomenon called life. She has written articles covering a broad range of topics, such as real estate, lending and mortgage, finance, business, taxation, home designs, home improvement projects, decor concepts, and more. An avid traveler, she’s a digital nomad at heart and an animal lover from the depth of her soul.