Future Rights in Real Property, Part I: Options, Right of First Refusal, Right of First Negotiation, and Right of First Offer

Whether as part of a lease or purchase and sale transaction or otherwise, real estate professionals often negotiate future rights with respect to real property. Sophisticated parties have varying motivations that lead them to focus on one right or another, but generally these rights are meant to decrease uncertainty and increase flexibility for the beneficiary. Part I of this two part series on future rights will focus on the the four primary types of future rights:

Future Rights in Commercial Real Estate

I. Option:

Example: In consideration of receipt of a $1 million option fee, Wes is hereby granted the option to purchase all, but not less than all, of Seam’s building located at 999 Peachtree Street, Atlanta, Georgia, legally described on Exhibit A attached hereto, for a price of $150 million in cash, exercisable at anytime within 24 months after the date of this agreement. The parties will have 60 days to close after the date that Wes notifies Seam of his intent to exercise this option. Closing costs and related expenses will be split between the parties according to local custom.

The option represents an absolute right, but not an obligation, to take an interest in real property.  The great benefit for the holder of the option is that he or she will dictate the timeline with respect to purchase or leasing of the property.  For an option to be enforceable in most states, it must contain the typical details of a normal purchase and sale or lease transaction. There must be agreed upon terms regarding purchase price, timing of sale, due diligence (if any), identification of property to be conveyed, and option period. The parties should also be clear regarding whether the option merely binds the current owner (a personal right) or runs with the land and binds successors in interest.  I’ll focus more on this concept in Part II of this series on future rights.

II. Right of First Refusal (RFR):

Example: Landlord grants to Tenant a right of first refusal to lease Unit A within the Building (the “RFR Space”), for the same terms and conditions as Landlord is prepared to accept from a third party tenant at any time between the date hereof and the third anniversary of the Commencement Date of this Lease. Landlord agrees to promptly notify Tenant after it receives any bona fide third party offer on the RFR Space. Tenant shall have 15 days after receipt of such notice to notify Landlord whether Tenant elects to exercise its right of first refusal and lease the RFR Space on the same terms and conditions as the offer.

The RFR doesn’t grant nearly the degree of control that the option provides. The beneficiary of the RFR is dependent on the owner taking some action that vests the beneficiary’s RFR rights. Unlike the option, the holder cannot unilaterally force a sale. Typically, the RFR does not include a set purchase price or rental rate at the time of granting of the right. The purchase price or rental rate is usually set by whatever the market price may be at the time the owner receives a third party offer with respect to the RFR Space. Most RFRs are triggered by receipt of some “interest” or an “offer” on the property—accordingly, it is always a good idea to provide details within the RFR provision regarding what exactly qualifies as “interest” or an “offer”. In the leasing context, should a mere phone call regarding vacant space trigger the right or is a signed letter of intent required? Another important deal point that parties typically address in the RFR is whether the RFR is a one-time right or whether it remains an encumbrance on the RFR Space until the space is actually sold or leased. Usually, the RFR provision will state how long the owner is given to lease or sale the space after the beneficiary passes on the RFR before the RFR is reinstated. One of the primary downsides of the RFR, and the reason many owners try to avoid it, is the chilling effect an RFR can have on marketability of real property. No buyer wants to heavily negotiate a term sheet only to have the beneficiary of the RFR swoop in and buy the property.

III. Right of First Negotiation (RFN):

Example: If Ben plans to sell certain real property located at 2500 West End Ave, Nashville, Tennessee, Ben must first notify Justin, and Justin will have 10 days to exercise his right of first negotiation hereunder. If Justin invokes such right, then Ben and Justin shall enter into exclusive good faith negotiations for up to 30 days to reach mutually agreeable terms with respect to the sale of the property from Ben to Justin.

From the owner’s standpoint, the RFN is more advantageous than the RFR because the right is triggered prior to deal terms being negotiated between the owner and a third party, so the owner is not burdened by the chilling effect that an RFR can have. Also, the RFN doesn’t necessarily require that the parties reach agreement, it merely requires the parties to negotiate in good faith. Sometimes, parties will add contractual provisions to ensure the owner acts in good faith with respect to the RFN. For instance, if the parties don’t reach agreement, some contracts forbid the owner from selling or leasing the property to a third party for less than the final price discussed in negotiation between the owner and the beneficiary for some period of time. In addition, in some states, failure to negotiate in good faith can create a cause of action benefiting the holder of the RFN.

IV. Right of First Offer (ROFO):

Example: Tammy is hereby granted the right to make the first offer for the purchase of certain vacant land located at 2500 La Jolla Village Drive, San Diego, California, as more fully described on Exhibit A attached hereto, if Bob elects to sell the property within the next 5 years, commencing as of the date of this agreement. Bob agrees to notify Tammy at least 30 days prior to placing the property on the market, and Tammy shall have the right to make an offer for the purchase of the property during such 30 day period. Bob shall have 5 days from receipt of Tammy’s offer to reject or accept such offer; provided if Bob rejects Tammy’s offer, then Bob will not be permitted to accept any offer less favorable to Bob than Tammy’s offer for a period of at least 6 months. If Bob does not sell the property during such 6 month period, then Tammy’s RFO will be reinstated.

The holder of a ROFO has the right to make the first offer on a piece of property once the owner decides to place the property on the market.  The ROFO is very popular among landlords because it grants a contractual right to a prospective tenant who may be interested in the property (and is asking for additional rights), but it doesn’t force the owner to do anything. Holders of ROFOs are typically in a weak bargaining position because they are obligated to make the first offer.  In some cases, market price may be difficult to ascertain.  This risk can be mitigated by requiring the owner to make the first offer to the holder, but most owners would never agree to this concept. Other disadvantages of the ROFO are that beneficiaries don’t control timing and can’t force the owner to negotiate once the ROFO is actually triggered.

I’ll discuss strategy and typical additional concerns related to future rights in my next post.