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Let’s be honest: the home buying and selling process — whether it’s a property to live in or a real estate investment — is confusing.
What’s more, each term in the contract can have a big impact on the property itself, from its cost, how it can be used, and much more.
This is why it’s so important to understand real estate vocabulary. One of those terms is known as the right of first refusal (ROFR), a clause that can be inserted into a real estate contract.
In this article, we’ll discuss:
- What right of first refusal is
- Its advantages and disadvantages
- How right of first refusal differs from the right of first offer
- And more
What is the Right of First Refusal?
In terms of real estate, a right of first refusal is a contractual obligation that requires the seller to give the person who holds this right the first opportunity to buy.
In the event that the holder of these rights declines to buy, the seller is free to sell to the one who made the offer.
For example, if someone has their eye on a specific property but it isn’t for sale, a right of first refusal clause can give them the first right to buy the property in the event that it does become available.
Right of first refusal in real estate is useful in many instances, including:
A tenant’s lease agreement with the landlord may have a right of first refusal clause in it.
In this scenario, the tenant would have a chance to purchase his unit before the landlord sells to someone else — a situation that could force the tenant to move.
To ensure the property stays in the family, a right of first refusal could be helpful when doing business with relatives.
For example, let’s say a relative buys their grandmother’s house after she passes away. A short time later, that person is forced to relocate due to work and must sell the house.
A right of first refusal can provide them a buyer who is also in the family.
A right of first refusal can also be beneficial among friends.
If someone buys a few acres of land from a friend’s large tract, the two might use a right of first refusal in this transaction, because it gives the original owner the chance to repurchase the real estate if the friend decides to move.
High-end condominiums will include a right of first refusal clause in their contracts when selling a condo, because this allows the Board of Directors, or the HOA, to be involved in the transaction details and future occupancy.
Pros & Cons of Right of First Refusal
Right of first refusal real estate provides advantages and disadvantages, including:
Let’s take a closer look at some of these.
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A right of first refusal gives tenants a chance to test-drive the property before buying.
Since a potential sale would, in theory, come later in the lease, tenants also have time to save money before purchasing.
If the landlord’s health or financial situation changes, tenants could have an opportunity to buy the unit they’ve been leasing at a great price.
A right of first refusal can be useful to sellers in a buyer’s market.
When low-priced properties saturate the market, the seller has a potential buyer already on the hook thanks to a right of first refusal.
While there are advantages associated with the right of first refusal, it also comes with its fair share of disadvantages.
A right of first refusal can hinder a seller’s profit because they can’t entertain third-party offers.
For buyers, you never know when the property you’re eyeing will be for sale, so as the potential buyer of the right of first refusal real estate, you may not have much time to prepare financially.
Plus, you can’t sell to a third party until the holder of the right of first refusal formally declines to purchase at the same price. This — and the time it takes — can be a tremendous disadvantage in itself.
Third-party buyers who are approved and ready to buy may find another property during the time it takes the seller and holder of the right of first refusal to negotiate.
Right of First Refusal vs. Right of First Offer
As stated earlier, real estate terminology can have a tremendous impact on a given property. Another term to understand is right of first offer.
Although the right of first refusal and right of first offer seem very similar for homeowners and real estate investors alike, there are notable differences.
The primary difference between these contracts is the right of first refusal usually takes longer to exercise. The reason for this is because the rights holder always gets a chance to match the offer.
Right of First Refusal Example
Here’s how the action of a right of first refusal might look.
An owner decides to sell a property and finally receives an offer he’s willing to accept. However, a right of first refusal clause exists, so as the seller, he must give the rights holder a chance to match the price he received from the third party.
The rights holder either agrees to pay this amount or declines. If they decline, the seller is free to accept the offer he received from the third party.
Now, suppose that offer doesn’t lead to a sale, and the seller must entertain more offers.
When he once again receives an offer that he’s willing to accept, he must again give the right of first refusal holder a chance to match it or decline.
It doesn’t matter how many times this happens on this sale — the rights holder always gets the opportunity to match the offer before the property can be sold to a third party.
The right of first offer contract is similar but closes more quickly.
The stark difference is the point in which the seller reaches out to the rights holder — at the start.
Right of First Offer Example
Here’s how a right of first offer might look.
An owner decides to sell a property that has a right of first offer contract in it, so he informs the rights holder that he plans to sell and asks for a firm offer.
The seller can either accept or decline this offer.
If the seller declines this offer, he is free to receive offers from third parties and sell once an acceptable offer is received.
However, he cannot accept an offer equal to or less than the price he rejected from the right of first offer holder.
Again, the big difference lies in how quickly the rights holder’s involvement ends.
Right of First Refusal: The Bottom Line
Understanding a right of first refusal in the context of a real estate contract can help you avoid any unforeseen circumstances. It can also be advantageous to use in different scenarios.
Above all, understanding real estate terminology like right of first refusal will ensure that your real estate goals are achieved legally and with a profit.