If you are interested in buying the property you’re renting, but aren’t able to do so immediately, you may benefit by negotiating a right of first refusal from the property owner. A right of first refusal for real estate can create value for buyers and sellers alike. But what is “right of first refusal” in real estate, and how should you negotiate one?
Right of First Refusal for Real Estate and Beyond
What is a right of first refusal? Broadly speaking, a right of first refusal, also known as a matching right or right of first offer, is a contractual guarantee that one party to a business deal can match any offer that the other side later receives for the item or issue being negotiated, according to Harvard Business School and Harvard Law School professor Guhan Subramanian. Rights of first refusal are common in real estate as well as in mergers and acquisitions of companies.
Here’s how a right of first refusal for real estate could work. Imagine that you’re a tenant negotiating an apartment lease with a prospective landlord. You could imagine yourself bidding on the apartment down the road, if the landlord ever decides to put it up for sale. Before signing the lease, you might ask the landlord for a right of first refusal—the right to match any legitimate third-party offer she receives for the apartment if she puts it up for sale.
In this scenario, negotiating real estate right of first refusal could be a win-win for you and the landlord. If you are able to match the offer, you could avoid the disruption of a move. At the same time, as it would give the seller easy access to an interested buyer while preserving her flexibility to sell to the highest bidder.
Negotiating a Right of First Refusal for Real Estate
A right of first refusal for real estate can create value for both parties, but it needs to be negotiated with care.
It’s often the case that an agreement that seems to guarantee a right of first refusal is overly vague about what will happen when a right holder (such as a tenant) exercises that right, cautions Subramanian. For example, when you match a competitor’s bid, will this end the competition or launch a bidding war? Obviously, from the tenant’s perspective, it would be helpful to negotiate a right of first refusal that would award the property to you if you match the competing bid. However, the seller may be reluctant to agree to such terms, preferring instead to leave open the possibility of further competition.
As the potential holder of a right of first refusal for real estate, it is also important to negotiate how long you have to decide whether to match a competing offer. If it’s unclear how much time you have to match the right of first refusal, warns Subramanian, another bidder “could short-circuit your right by making an exploding offer with a short fuse.” For this reason, it’s smart to negotiate ample time to respond to a competing offer.
Will You Have to Compete?
At times, the terms of a right of first refusal for real estate require the right holder to accept or reject the seller’s specified price before other potential buyers are offered the same deal. If the right holder refuses the price, she forfeits the chance to match other offers.
In their research, Brit Grosskopf of Texas A&M University and Alvin Roth of Harvard University warn that this language may negate the benefits of a right of first refusal for real estate for the right holder.
Suppose that you are a tenant who holds a right of first refusal for your apartment that you value at $250,000. If the market is weak, and you only have to match the highest bid to get the prize, you may get a bargain—say, $150,000. But what if the owner demands $200,000, and according to your right of first refusal, you have to respond before he puts the property on the market? You’d risk overpaying, yet be reluctant to risk losing the property.
This example offers further evidence that not every right of first refusal for real estate is the same. If you’re inexperienced in this realm, consult a real estate attorney who has experience negotiating rights of first refusal.
Have you considered negotiating a right of first refusal for real estate?