Option Versus First Refusal: What's The Difference?

By Peter G. Miller
OurBroker®
July 15, 2003

It's been a good time to be a real estate owner in my community. During the past few months several would-be purchasers have approached with offers to buy property we own, even though the properties in question were not listed for sale. It's flattering to have someone court you, check in hand, seeking your interest and attention. And one gets the sense that more than a few properties are attracting buyer attention.

According to the National Association of Realtors, it looks like 2003 will be another banner year for real estate re-sales. David Lereah, the group's chief economist, predicts that we can expect "5.73 million existing-home sales this year, up 2.9 percent from a record 5.57 million sales in 2002." As to prices, NAR says "the national median existing-home price is projected to rise 6.0 percent this year to $167,800, while the median new-home price should increase 3.8 percent to $194,700."

Given the choice of being a buyer or a seller, the role of property owner in a strong market sure seems easier. People seeking the opportunity to give you money, no one is asking what you earned last year, and you absolutely know that your favorite rug really does fit in the living room. But sometimes it happens that properties are simply not for sale. In our case, given a rising population and a strong local economy we feel prices for these particular properties will continue to rise above the rate of inflation and so now is not the best time to sell.

But that doesn't mean we're closed to offers....

For instance, for a property with development potential it might be interesting if a buyer asked about a purchase option. It could work like this: Suppose someone wanted an option to purchase during the next two years in exchange for a given fee. We would look at the current market value, add a given percentage, and charge a non-refundable option fee. The holder of the option would then have the right to purchase during the next two years at a given price. If they didn't purchase, the value of the option fee would be lost. Matters such as the current market value, percent increase, agreement length, option fee and other terms would all be negotiated.

Why would someone want an option? It may be because a given property has a key location, size or price. With an option, a buyer has locked-in the opportunity to purchase under given terms. If the market rises sufficiently, the option itself may represent a bargain for the purchaser. As to sellers, a sufficient option fee and/or a guaranteed price can be hard to ignore. 

An alternative approach might involve a "right of first refusal." In this situation, there is no particular sale price, merely an agreement that the right holders can match any legitimate purchase offer that would otherwise be accepted during a given period, say the next five years.  

With a right of first refusal a seller could not offer the property for sale without noting that the purchase was "subject to" the right of first refusal. Such a claim, in turn, might make the property harder to sell and might be a drag on the price.

With a right of first refusal there would be a fee paid by the prospective buyer. The fee, the length of the agreement and all terms would be negotiable. Owners also need to recognize that sometimes what looks like a purchase offer is something else. For example, a "purchase offer" to buy a property that includes a small deposit, a lengthy "study" period, and no deposit penalty if the property is ultimately found to be unacceptable are really looking at an option. In such a situation, the "buyer" can get back their deposit after shopping your property to other buyers. Meanwhile, the owner may have missed an opportunity to sell to other purchasers. Someone holding a purchase option or a right of first refusal would be wise to log such documents in the local property records office. This will assure that in the event of a title search that the claims of the option or rights holder will be known.

A purchase option and a right of first refusal are not the same thing, but both may ultimately result in a transaction on terms which work for both buyers and sellers. Such documents, however, can be complex and should be reviewed by an attorney before acceptance. 

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