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're first in line to get the option to buy. So how does it work? Let's take a closer look at right-of-first-refusal agreements and what they mean for 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 seller puts a property on the market.
This clause allows the seller to market the home at will, but before any offers can be accepted, the seller must notify the original interested buyer who has the right of first refusal. At that point, the person with the right of first refusal can decide whether or not to buy the property. If this person declines, the seller is free to negotiate with other people who are interested.
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 is interested in buying his rental property and has a right-of-first-refusal clause written into the lease, the landlord must consider his offer before negotiating with other potential buyers.
- Between family members: Usually, this clause is used when another family member wants to buy the home.
- 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. It allows the board to vet potential buyers before a seller 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 leaseholder the right to have first dibs on the home should the landlord decide to sell it. The clause is negotiated into the contract from the get-go, so the tenant potentially has a good amount of time to save for a down payment or improve his credit score in the event he decides to buy.
There could be a financial incentive as well.
"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."
The main disadvantage for the buyer with first refusal rights is that, since the seller could receive an offer at any time, the buyer might need to be ready on short notice to move forward with the sale.
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, a seller 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 another party until they've received a formal termination of this contingency. In the time it takes to get a response, the more secure buyers might lose interest.
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 on things such as how long the contingency can last, proof the interested party must provide in order to move forward with purchasing the property, or 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, or obligations it entails before signing on the dotted line.
