Did you know that, when buying or selling a home, there may be clauses involved that legally determine what you are allowed to do with that particular piece of real property? There are many of these clauses, usually identified by ambiguous acronyms, but the right of first refusal, or ROFR, is what realtors are asked about most frequently. It is a subject that few buyers or sellers really know that much about, though the idea is not that uncommon. As a matter of fact, both buyers and sellers use this type of contract to their advantage all the time, unaware of how it can actually be harmful to each of them. Here is a bit of clarity on the topic, including how the agreement differs from other contracts, and what should be considered before entering into one:

What is ROFR in Real Estate?

As stated above, ROFR stands for the “right of first refusal,” which is sometimes referred to as the “first right of refusal.” It is a right, backed by a contract, of an interested party to submit the first offer on a particular property that has been put on the market. Only after the ROFR holder states that he or she is no longer interested in bidding on the real property, can the owner accept any other offers to purchase it.

These situations typically occur when an interested buyer desires a property that is not for sale at the moment, yet would like a solid clause stating that he or she gets the first option to purchase the property if the owner ever does decide to sell his or her home. The agreement states that the contract holder must be contacted immediately after the home goes on the market, and he or she must bid or pass on the property before any other potential buyers.

Another situation where this occurs is in a landlord and tenant agreement, or lease. Many landlords stipulate ROFR clauses to attract serious, trustworthy tenants who will be offered the ROFR on rental property if the landlord ever decides to sell.

Regardless of the reasoning behind the clause, there is usually a time limit on invoking your ROFR on real estate, and a predetermined amount that is agreed upon by both parties.

The Difference Between ROFR and ROFO

An ROFO, or “right of first offer,” is a clause that gives a buyer the first opportunity to submit an offer on real property as soon as an owner decides to sell it, but, unlike a ROFR, the seller is allowed to market the property freely to others at the same time.

Another difference is the fact that there is no pre-existing offer, so the ROFO holder will have to construct a reasonable bid based on his or her financing options and the current market. The seller can openly refuse the offer, however, and sell the property to another buyer.

That said, if the seller is unable to find a buyer offering a favorable bid, he or she can always go back to the person holding the ROFO and accept his or her offer afterwards.

Issues to Consider with ROFR

While ROFR contracts may have certain benefits, such as the seller possibly having a guaranteed buyer, and the buyer locking in at a particular price, there are many drawbacks involved as well.

For example, without immediate competition from other buyers, having a ROFR holder limits the market drastically for sellers. The more potential buyers a seller has, the better the chance for him or her to sell at a higher price.

Another issue is the pre-negotiated prices and terms that many of these contracts come with as a standard. Because the real estate market is constantly in flux, either party may lose in this scenario. The buyer may end up paying more than if the property was bid on in the open market, or the seller may end up leaving money on the table if prices have gone up since the agreement was signed.

For buyers, the limited time window to make a decision, that is typically spelled out in the agreement, is also troubling. There may be a change in their circumstances since the contract was signed, and it may be more difficult to secure financing for them at the present time.

Finally, homeowners need to know that agreeing to a ROFR may potentially cause lending issues in the future. If they should ever decide to refinance, or obtain an equity loan, the property is needed as collateral. That means, if the borrower should default, the bank cannot quickly sell the house on the open market, and it may lose money due to the ROFR, so financial institutions are quite wary of such deals.