Imagine being able to make an offer on a house before any other interested home shoppers can even have a look-see. If you have a right of first refusal negotiated into a lease or other housing agreement, you get to be the first in line to buy the real estate.
But is this truly an advantage for the right-of-first-refusal holder? And how does it work? Let’s take a closer look at right-of-first-refusal agreements and what they mean for both buyers and sellers.
What is a right of first refusal?
In real estate, right of first refusal is a provision in a lease or other agreement. It gives a potentially interested party the right to buy a property before the seller negotiates any other offers. It’s typically written up before a homeowner puts a property on the market.
This clause allows the sellers to market the home at will, but it might end there.
They can list the house, but before they can even think about accepting that big first offer that rolls in, the owner must notify the person entitled to right of first refusal. At that point, the contract holder can decide whether or not to buy the property.
If this person declines, the homeowner is free to negotiate with other potential buyers interested in the property.
When is it used?
There are a few situations in which a right-of-first-refusal clause is relevant.
- Between a tenant and a landlord: If a tenant or tenants are interested in buying the rental property they live in, and have a right-of-first-refusal clause written into the lease, the landlord must consider their offer before negotiating with other potential buyers.
- Between family members: Usually, this clause is used when a family member wants to buy the home. The family member (or members) in question have a chance to submit their first offer when the house goes on the market. But if the family isn’t interested in the real estate at that time, the owner can open it up to a third party.
- When dealing with a homeowners association or condo board: Sometimes a homeowners association or condo board will put a right-of-first-refusal clause into its governing documents. This allows the board to vet potential buyers before a homeowner can accept an offer. Many communities use the clause to prevent situations like discount sales that would lower their value. In some cases, it even gives the board the option to reject an offer entirely.
How a right of first refusal affects buyers
A right-of-first-refusal clause in a leaseholder’s contract gives the leaseholders the right to first dibs on a home they’re living in, should the landlord decide to sell it.
The clause is negotiated into the contract from the beginning of the lease, so the tenants potentially have a good amount of time to save for a down payment, or to improve their credit score, before they have the opportunity to buy the property.
While the right to “first dibs” and the benefit of time may already be enough to make a right-of-first-refusal a big perk for tenants, there could also be financial incentives to get excited about.
Contract holders might end up with the opportunity to buy their rental for a steal.
“Depending on the specifics of the contract, the interested party may have the opportunity to suggest a sale price without worrying about immediate competition,” explains Kathryn Bishop, a Keller Williams real estate agent in Studio City, CA. “There’s less of a chance that the price will get driven up by a bidding war.”
That doesn’t mean, though, that right-of-first refusal holders always have it easy.
The main disadvantage for a buyer with first refusal rights is that, since the seller could receive an offer at any time from a third party, the buyer might need to be ready on short notice to move forward with a sale.
It’s a “you snooze, you lose” situation. If the right-of-first-refusal holders are surprised by the timing of the listing, and don’t have time to prepare the funds they need, they could miss out.
How a right of first refusal affects sellers
In a buyer’s market, when homes are plentiful and prices are low, right-of-first-refusal agreements can directly benefit sellers.
Since this agreement is drafted before the home hits the market, the homeowner might be able to persuade the original interested party to pay more than the home’s current value.
Ultimately, though, sellers tend to be wary of a right of first refusal because it hinders their ability to work with other buyers.
They can’t negotiate with a third party until they’ve received a formal termination of this contingency from the right-of-first-refusal holder.
In the time it takes to get a response from the contract holder, the more secure buyers might lose interest as they tour other properties.
Should you agree to a right-of-first-refusal clause?
No two right-of-first-refusal clauses are the same; although a buyer gets the first option to buy a property, the terms of each right-of-first-refusal clause can vary.
Some set rules for how long the contingency can last, for the proof that the interested party must provide in order to move forward with purchasing the property, or for any exceptions based on a cash offer.
To determine if a right-of-first-refusal agreement is right for you, make sure all of the details suit you.
Consult with an attorney before entering into a right-of-first-refusal agreement. And as with any contract, read your contingency thoroughly to get an idea of the deadlines, limitations, and/or obligations it entails, before signing on the dotted line.