Right Of First Refusal (ROFR): What Is It?
If you’re in the market to buy a home, you’ll likely come across different clauses and acronyms that define what you can and can’t do when buying (or selling) real property.
Let’s explore one popular acronym: ROFR, which stands for right of first refusal. We’ll discuss how it’s used in real estate negotiations and whether it’s right for you.
What Is Right Of First Refusal In Real Estate?
In real estate, right of first refusal (ROFR) is granted through a special contract that gives a home buyer the right to make an offer on a property before other buyers.
If you’re in the market to buy a new house and find the perfect property – but it’s not for sale – it may seem like a lost cause, but that’s not necessarily the case. A ROFR clause gives a buyer the first chance to purchase a property if and when the seller decides to sell.
Under this agreement, the seller is obligated to contact the buyer, also known as the ROFR holder, and offer them the first opportunity to purchase the property. If the ROFR holder decides they no longer want to buy the property, the seller can start to accept other offers.
How Does Right Of First Refusal Work?
Right of first refusal is negotiated before a homeowner lists a property. When the property comes on the market, there’s typically a time limit or window on negotiations between the buyer and property owner. If the deadline expiresor the buyer decides not to purchase the property, the seller is free to sell the home to another buyer.
Right of first refusal typically applies in several scenarios, such as:
- A real estate agent sees a property that’s highly desired by their client, but the property isn’t for sale yet.
- A tenant wants to purchase their rental property or unit from their landlord when their lease ends.
- A family member wants to give another family member a first pass at buying a family property.
ROFO Vs. ROFR
Right of first offer (ROFO) allows a buyer to make the first move when a homeowner wants to sell. Unlike a right of first refusal where an owner may be obligated to sell to the interested buyer under the contract’s terms, the seller is free to market the property to other buyers.
The prospective buyer has a specified window of time to put together an offer, which the seller can either accept or reject. If the seller can’t get a better offer from another buyer, they can accept the ROFO holder’s offer that they initially rejected.
How Do You Enter A Right Of First Refusal Agreement?
For the buyer and seller’s protection, both sides must have a lawyer involved to draft a right of first refusal agreement because it must be legally enforceable, and there is often a time limit set for when the ROFR agreement applies.
The contract typically includes an agreement on how to calculate the future sale price of a property. For example, the price may be a flat amount or a certain percentage above the current market value. The terms and rules of the agreement should be clear to all parties prior to anyone signing on the dotted line.
In the absence of a specific purchase price agreement, the prospective buyer may have the right to match a third-party offer the owner was going to accept from another buyer. If that buyer no longer wants the property, the seller can accept the prospective buyer’s offer.
Pros And Cons Of Right Of First Refusal
ROFR agreements have benefits and drawbacks for each party to the transaction. Let’s run through both sides of it for the buyer and the seller.
Before entering into a ROFR agreement, a potential buyer may need to take these factors into consideration:
Buyer ROFR Pros
The benefits for potential buyers are:
- No competition: The seller can’t accept any offers before allowing you the first chance to buy a property. You can avoid a bidding war because the offer is based on the terms of your contract.
- Prices are often pre-negotiated: Most contracts include pricing, so you may pay less even if the market value is higher.
- Time to work toward goals: Since you’ve locked in a purchase price, right of first refusal buys you time to build your credit and save for the down payment.
Buyer ROFR Cons
There are drawbacks for the buyer as well:
- ROFR time limits: When the seller lists the property, the potential buyer needs to be financially prepared to buy the property for the agreed price in the purchase agreement, typically within a matter of days.
- Prices often pre-negotiated: This can also be a con for a buyer. If prices have fallen in your area, you maybe overpaying, based on the terms of the original agreement. But if you let the property go to the open market, you run the risk that you may lose
- Not a guarantee: Sellers aren’t obligated to list their homes.
The seller has their own upsides and downsides to weigh. Let’s do a quick rundown.
Seller ROFR Pros
There are a few potential benefits for the seller:
- No listing required: A ROFR can save you time and money by allowing you to sell your property without ever listing it – avoiding home staging, open houses and negotiating multiple offers.
- May make a windfall: If the buyer really wants your home without the possibility of competition, you may be able to sell the property above its market value
- Give preference to certain buyers: You can prioritize relatives or current tenants and weigh an offer before the property hits the market to secure the best deal.
Seller ROFR Cons
Just as there are drawbacks for buyers, there are drawbacks for sellers as well:
- Limiting your market: Typically, the more buyers that participate, the better chance a seller has to successfully sell a house
- May take a loss: You may lose money if the price point in the contract is lower than the property’s current market value.
- Potential lender issues: Right of first refusal can cause issues if you’re considering refinancing. Since your property serves as collateral for the loan, the ROFR holder has the right to match any new loan offer and purchase the home.
- Potential burden: Since the buyer isn’t obligated to purchase the house, you may have to start from scratch and spend time, money and energy to market the property.
A Right Of First Offer (ROFO) Vs. A Right Of First Refusal (ROFR)
A right of first offer (ROFO) allows someone the opportunity to make the first move when a homeowner is looking to sell. Unlike a right of first refusal where an owner may be obligated to sell to the potential buyer under the original contract’s terms, the seller is still free to market the property for sale to others. The prospective buyer has a time limit to put together an offer, which the seller can accept or reject. The seller is also free to go back after initially rejecting the offer if they can’t get a more favorable deal from another interested party.
The Bottom Line: Consider Your Options Before Pursuing Right Of First Refusal
A right of first refusal clause is a useful tactic, but depending on the situation and the state of the housing market, it may or may not be worth negotiating.
Right of first refusal doesn’t guarantee the sale will work in favor of both parties. Sellers should research market conditions in their area to make sure they get the best deal. And buyers should browse through home listings to see if their dream home is finally on the market. If an interested buyer and homeowner decide to enter into a ROFR agreement, it’s important to have real estate lawyers draft and review the contract.
Have you found your dream home? Start on your mortgage application today and see what you may qualify for.