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You know how the story begins: You’ve found your dream home. But, plot twist: It’s not even on the market yet! But you love the home, and you’re a highly motivated buyer, so you decide you want to be first in line to buy your dream home if the owner ever decides to sell.
To secure your spot at the top of the line, avoid bidding wars and potentially lessen some home buyer angst, you consider entering into a right of first refusal agreement with the homeowner.
If you have the right of first refusal (ROFR) on a property, you’re first in line to purchase before anyone else. In short, you’ve got first dibs.
Yes, a right of first refusal can be a golden ticket for ROFR holders (aka prospective buyers). And it can be great for sellers, who can potentially avoid the time and effort they would normally put into open houses, negotiating repairs and combing through offers.
But while an ROFR can be a win-win, there are pros and cons for both buyers and sellers.
How a Right of First Refusal Works
A right of first refusal – which is usually executed before an owner puts their property up for sale – gives a potential buyer the right to purchase the property before the owner can entertain any other offers.
While an ROFR doesn’t prevent a homeowner from listing their property, the homeowner is obligated to give the person with the right of first refusal (aka the ROFR holder) the chance to buy first. The ROFR holder can either purchase the property according to the terms of the agreement or refuse the terms and waive their opportunity to buy the property. If the ROFR holder refuses to purchase, the homeowner is free to entertain offers from other interested buyers.
Sometimes a predetermined sale price is specified in the right of first refusal agreement. It might be a set, flat price or a certain percentage over the property’s current market value. When there is no price specified in the ROFR contract, the buyer can match the offer submitted by another buyer.
The ROFR holder typically accepts or refuses the deal within a set window of time. This gives the buyer the chance to make a decision and get their finances in order if they decide to buy. If the buyer surrenders their right of first refusal, the seller can pursue other buyers and offers.
When Is a Right of First Refusal Used?
A right of first refusal is usually a clause in a larger contract like a lease, but it can also be a standalone contract. It all depends on the buyer, the seller and the situation.
Right of first refusal is most commonly used between:
- Tenants and landlords: You’ll commonly find right of first refusal clauses in lease agreements. If a tenant is interested in purchasing a property they’re renting, they may have an ROFR clause written into the lease. If the owner decides to sell the property, they must allow the tenant the opportunity to buy before they can field other offers.
- Family members: Right of first refusal contracts are also common among family members with a shared connection to a home. If the family member who owns the home decides to sell it, they must give each ROFR holder a chance to buy the home before considering bids from any other potential buyers.
- Homeowners and homeowners associations or condo boards: Homeowners associations and condo boards sometimes put right of first refusal clauses into their governing documents. In most cases, the association or board doesn’t intend to buy the property – they essentially use the ROFR clause to prevent a discounted sale that could lower the value of other properties.
Pros and Cons of the Right of First Refusal for the Buyer
Right of first refusal clauses have advantages and disadvantages. Here’s a look at the pros and cons for buyers.
What are the benefits of an ROFR for the buyer?
For buyers, a right of first refusal is almost always a good bet for several reasons:
- It gives you time to prepare financially: If you aren’t financially ready to purchase a property, a right of first refusal can give you time to get your finances in order. This is especially useful if you’re renting the property you’re interested in, but you’re still working on your debt, savings and credit. That window of time could be a window of opportunity to be in a better financial position when the owner is ready to sell.
- There aren’t any bidding wars: Sellers might love bidding wars, but they’re not so fun for buyers. With a right of first refusal in place, there are zero chances of a buyer who accepts the ROFR getting pulled into a back-and-forth with another buyer. You have the right to accept or refuse before anyone else.
- The price is predetermined: This one is a wild card. It may qualify as a pro and a con for both buyers and sellers, and it all depends on the real estate market. It works in the buyer’s favor if property values have increased, but the home’s purchase price was already determined in the ROFR clause. In this case, the buyer is getting first dibs on a hot property at a lower sale price than market value.
What are the drawbacks of an ROFR for the buyer?
There are a few drawbacks for buyers:
- Limited decision window: If your finances aren’t quite in order yet and the seller is ready to put the property on the market, you’re essentially in a battle against the clock. Depending on the terms of the ROFR, you could have over a week to decide or as short as a few days. You may have to work fast to get the funds or secure financing before time runs out. Otherwise, the owner can look at offers from other interested buyers.
- Sellers can sell their properties on their schedule: Another downside for potential buyers is that, should they refuse the price in the ROFR, the seller isn’t obligated to list the property by any set timeframe. Why does this matter to the buyer? If they decide they want the house at a lower price or aren’t quite ready to buy yet, the seller isn’t obligated to list the property to accommodate their wishes, or at all.
- The price is already determined: If the price is set, there’s typically no wiggle room. You can’t make a lower offer if you notice the home needs repair or you’re no longer as excited about the neighborhood as you once were. If you decline the offer, the seller isn’t obligated to sell the house to you.
Pros and Cons of an ROFR for the Seller
Buyers generally benefit the most from ROFR contracts, though, in some situations, sellers are clear winners. Here are some of the ways a right of first refusal can affect the seller.
What are the benefits of an ROFR for the seller?
A right of first refusal does offer a few benefits to sellers:
- Avoid property listing fees: Listing a property and hiring an agent doesn’t come cheap. If a seller isn’t quite ready to sell yet, a right of first refusal agreement isn’t the worst idea. They can negotiate a purchase price, sign an ROFR contract and, once they’re ready to sell, skip the agent and the listing fees and close the deal.
- Give preference to friends, family or acquaintances: Sometimes a seller will agree to a right of first refusal to give someone they know a chance to buy property before it’s on the market. It might be a friend, a tenant or a relative. An ROFR might help them buy a home at a lower price.
- The price is predetermined: If the real estate market takes a downward swing when an owner is ready to sell, the fixed price in an ROFR clause can provide above-market value to the seller. If the buyer is committed to buying the home, there’s a good chance they’ll buy the house for more to keep it from hitting the market.
- Less stress and more peace of mind: A right of first refusal clause can potentially alleviate a lot of stress. You know your asking price and what the potential buyer will pay. The buyer is probably also less likely to walk away. For some sellers, not dealing with listings, showings and real estate agents is reason enough to sign an ROFR contract.
What are the drawbacks of an ROFR for the seller?
There are potential drawbacks for sellers:
- Other interested buyers might move on: Since the potential buyer on the other end of a ROFR contract has a set period of time to consider your offer, get their finances in order and make a final decision, it can sometimes take a while. And if the buyer does refuse, other interested parties might have already moved on.
- The price is fixed: If the real estate market is hot and you’re ready to sell, you could end up leaving money on the table if you’re in a right of first refusal contract with a fixed price.
- If an offer you like better comes along, your hands are tied: If someone else – like a family member or friend – approaches you with an offer, you can’t do much about it if you’re bound by a right of first refusal clause. You’ll have to give the ROFR holder a chance to buy before you sell it to the person with the better offer.
Fight for Your Right of First Refusal
If you’re a buyer with your eye and your heart set on a property and there’s a right of first refusal on the table – go for it! In most cases, you stand to benefit.
If you’re a seller who doesn’t want to deal with listing your property and other home selling tasks, it might be worth offering an ROFR to an interested buyer.
Either way, both buyers and sellers should pay close attention to the clause and be wary of any details that could make the deal unfavorable for either of them. As with most real estate transactions, the pros and cons for buyers and sellers largely depend on market forces.