Understanding the Differences: ROFO, ROFR, and Purchase Options in CRE
By Tony McDonald, CCIM, SIOR | Partner, Broker
Right of First Offer (ROFO), Right of First Refusal (ROFR), and Purchase Option are legal mechanisms commonly used in real estate and other contractual agreements to grant certain rights to parties involved. These rights can significantly affect the transfer or sale of property or assets. Many people mix these terms up, even some attorneys, but they are very separate tools. Here are the key differences between these three concepts:
Right of First Offer (ROFO):
- ROFO is a contractual provision that gives the holder (typically a tenant or a party with a pre-existing relationship) the first opportunity to purchase a property or asset before the owner can sell it to a third party.
- When the owner decides to sell the property, they must first offer the property to the ROFO holder, who has the choice to either accept or decline the property at the offered price. If they decline, the owner is free to sell the property to someone else.
- ROFO does not obligate the ROFO holder to buy the property; it merely provides them with the opportunity to do so at the offered price.
- ROFO is often used in commercial real estate leases or partnership agreements.
- A more sophisticated twist adds language that should the seller find a buyer at a price other than the price offered to the ROFO holder, even after the ROFO holder passed at the originally offered price, the seller must go back to the ROFO holder again at the new lower price. Usually there is a small range of pricing allowed the seller for negotiation so, for example, the seller offers the ROFO holder the property at $5.0 million and the ROFO holder passes. If the seller ends up with a deal within, say, 10% of that originally offered price, they do NOT need to go back to the ROFO holder whereas if they end up with a price at LESS than a 10% discount to the originally offered and declined price, they need to go back to the ROFO holder at that reduced price.
- An even more sophisticated addition would be that, in addition to all the ROFO terms discussed above, the ROFO holder ALSO has a right of first refusal (ROFR) as discussed below.
- A ROFO can be difficult to administer in the case a seller receives an unsolicited offer to buy the property (or claims it was unsolicited) which kind of eliminates the idea of having the first crack at the property. That’s why the addition of an ROFR is beneficial.
- A ROFO is often granted to a tenant at no charge as part of the inducement to lease the property.
Right of First Refusal (ROFR):
- ROFR is another contractual provision that grants a specific party the right to match the terms and conditions of a third-party offer before the owner can sell the property to that third party.
- Unlike ROFO, which involves an owner’s initiation to sell, ROFR is triggered when the owner receives an offer from a third party. The holder of the ROFR then has the option to step in and purchase the property on the same terms as the third-party offer.
- If the holder of the ROFR chooses not to match the third-party offer, the owner is free to sell the property to the third party. However, like above, if the deal changes along the way and the price drops by , say, 10% or more, the ROFR holder gets another bite at the apple at that lower price.
- A properly written ROFR is a very powerful tool for you to control a property as it makes sure you have last crack at the deal as the price and terms vary.
- Where it can get murky is when comparing not just price, but terms as well. For example, if a seller receives an offer for $5.0 million with ZERO conditions, an offer for $5.0 million from the ROFR holder but subject to getting financing or subject to securing water rights from an adjacent landowner or some such condition is NOT a matching offer to the offer received with no conditions.
- You might get a ROFR for free if you are a tenant on the property. If you are an unrelated third party then you might need to pay something for it, either in a lump sum or on an annual basis.
- A purchase option is a contract provision that gives a party (the option holder) the exclusive right to purchase a property or asset from the owner at a predetermined price and within a specified time frame.
- Unlike ROFO and ROFR, a purchase option obligates the owner to sell the property to the option holder if the holder decides to exercise the option.
- The option holder pays a fee or premium for this exclusive right, which is typically non-refundable and may or may not be credited toward the purchase price.
- The owner cannot entertain offers from other parties during the option period unless the option holder chooses not to exercise the option.
- An option is total control for the holder. The cost of an option is often looked at as relating to the property value. So, for example, for a property worth $5.0 million, it might cost say 1-2% of its value ($50-100,000/year) to hold that option or it could be done monthly at say $4-8,000/month.
In summary, ROFO and ROFR provide parties with the opportunity to purchase property or assets before they are sold to third parties, while a purchase option gives a party the exclusive right to buy at a predetermined price. ROFO and ROFR are often used in existing relationships or agreements, while a purchase option is a standalone contract. The key difference lies in when and how these rights are triggered and whether they create an obligation for the owner to sell. The world of commercial real estate can be confusing with nuances like these. Don’t hesitate to reach out to The Boulos Company if you need help with planning your commercial real estate strategy.
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