Property Investing Basics – The Right Of First Refusal

One more useful tool of the trade…

The right of first refusal (or ROFR) is another excellent tool a property investor can use to manage risk and rewards. As a seller of investment property, the first right of refusal allows you to get something extra in return for providing a legal option for the potential buyer. As a buyer, this first refusal option allows you to lock down a property at some point in the future…sometimes at an agreed upon price, sometimes at a price to be negotiated later. In either case for a buyer, this right of first refusal real estate essentially creates a monopoly for one – you. All your competition gets eliminated in the process…a nifty arrangement for any buyer.

ROFR = financial benefit gained

In the case of a seller offering the right of refusal, some financial benefit usually accompanies the largesse of providing right of first refusal language in a formal agreement. Many times, it is a tenant who wants to take advantage of the prospect of a “rent-to-buy” scenario. I have done this on occasion with tenants for my single family houses. A fixed purchase price is arrived at between the parties, and incorporated into their lease as a first right of refusal real estate option. The tenant then has the right to purchase the property at the pre-negotiated price. They are usually given a set time window in which to exercise this ROFR option. At the end of that window, if they have not exercised their option, or if they have turned it down, then the seller has the right to place the property on the open market for sale.

Above market rents as option fee

In this scenario, the seller may be able to receive a higher rent from the tenant for their “buying” of the legal option. In addition, many times a portion of the increased (above market) rent can be applied towards the purchase price as part of their (already paid in) down payment on the property.  Another point of negotiation between the parties may be the percentage of rent that will be applied to the down payment.  If they choose not to exercise the option, the buyer effectively “loses” the amount they have been paying for rent that is greater than the “normal” market rent for the property.

Buying time to secure financing

If the property investor is the potential buyer of a piece of rental property, a right of first refusal gives them time to secure financing for the property, over and above a normal sixty to ninety days. Usually, a property investor buyer will need to pay some sort of ROFR option fee for this privilege. As mentioned above, this legal option effectively eliminates any competition for the property. Therefore, it has some value attached to it. And that option fee is a negotiated amount between buyer and seller.

The importance of the written agreement

All right of first refusal language should be written by an experienced real estate attorney. Language must be very specific to cover many possible scenarios. The stronger the language, the less chance the transaction can end up in court somewhere down the road. There are many variations and conditions that an attorney will make sure are clarified prior to the parties signing the agreement. As an example, there will traditionally be a limited amount of time in which the transaction must close once an option is exercised. Also, the ROFR option may be transferrable to another party (known as assignment).  Again, all conditions need to be negotiated prior to the agreement being fully executed. Overall for the real estate investor, right of first refusal makes for another useful tool in their property investing arsenal.

 

photos courtesy of landthink.com, thompsonburton.com, pittsburghlegalbacktalk.com,  jayfalone.com, robertgsarmiento.org