Right of first refusal

Understanding the Right of First Refusal and Option to Purchase 

In today’s market, real estate is a valuable asset. Owning the building where your business is located can be a great financial investment. In today’s market however, it is difficult to acquire real estate in a good location, at an affordable price.

Business owners don’t always have the option to purchase a property outright, instead, they rent or lease the premises where their business is located. Choosing to rent does not dictate that ownership is impossible for that property; lease agreements can contain provisions which lead to ownership, allowing a business owner to start their business now, and buy the property later. If a lease contains an “option to purchase” and/or a “right of first refusal,” a business owner will be on his or her way to becoming a real estate owner, and perhaps a future landlord.  

What is an option to purchase and a right of first refusal?

An option to purchase provides that a tenant can request to purchase the real estate on or after a certain date. A right of first refusal (ROFR) states that before a landlord can sell the real estate to anyone else, he or she must first offer to sell it to the tenant. When drafted correctly and combined, a lease with both of these provisions can almost guarantee eventual ownership of the real estate where the business is located.  Securing a lease containing both these provisions can be difficult, because together they provide the tenant with the power to demand the sale of the real estate, regardless of the landlord’s preference, at the time specified by the contract.

It is not likely that a landlord will offer such terms voluntarily, however, business owners that has a good leasing track record have more negotiation leverage than other renters because they are known to be good tenants with long term, guaranteed rent, unlike retail stores whose rent is variable and based on sales. Knowing this advantage, the best time to negotiate for an option to purchase is during the initial negotiation of the lease, when 10 years seems distant to the landlord, and they are swayed by seeing their potential consistent income during the interim between execution of the lease, and eventual date of option to purchase.      

Why would a business owner want to own their building?

The primary reason business owners want to own their businesses real estate is for financial benefit. Owning property can act as a savings account for retirement as it builds equity. Equity is the difference between the price paid for the building, versus what it is worth at the time of sale.  This appreciation could equal hundreds of thousands of dollars by the time of an owner’s retirement. Alternatively, if a business owner also owns the building, they have the option of selling their business and renting out the space to the buyer for additional, consistent income after retirement.

Additionally, owning property can offset the payment of taxes. This is slightly more complicated than building equity or collecting rent but can be financially beneficial.  Business owners who also own the building can offset their tax liability by creating a corporation (CC), which rents the building to the corporation that owns the business. The corporation then reduces its profits by paying rent to the CC, and the CC gets to deduct any interest payments made on the mortgage, despite being owned by the same member  and  shareholder (corporation). These tax benefits significantly reduce or potentially eliminate taxes owed by the building owner. 

Why wouldn’t property owners want to give an option to purchase or the right of first refusal to their tenants/lessees?

The reasons property owners don’t want to sell the building are the same reasons why business owners want to buy. They too can include in their retirement plan the income received from renting or selling the building and can save on their tax liability.  Additionally, by giving tenants the option to purchase and/or the right of first refusal, they lose the right to sell to whomever, whenever they want. For these reasons, an option to purchase and/or the right of first refusal can be elusive, but not impossible to obtain.    

What to look for when you want to own your business building:

The main thing to seek is the opportunity to enter into a lease agreement that contains both an option to purchase and the right of first refusal. A key opportunity can be finding a building owned by another business owner, who may be retiring or otherwise looking to sell. You’ll then want to seek expert guidance to ensure that the terms include the option to purchase and right of first refusal, guaranteeing you can own the building.

What terms should you seek?

The terms of the provisions cannot leave any loopholes which could allow a landlord’s exit from the agreement. This means excluding any terms that allow for a landlord’s (future) exit in the event of variables causing disagreement, such as the purchase price. As for the option to purchase, you and your agent/legal council need to make sure the contract doesn’t give the landlord the right to transfer the property to others before the option can be exercised. 

While neither an option to purchase nor a right of first refusal are common, they are not impossible to obtain. The first step is knowing what they are, and their value to you, and the property owner. The next step is finding a landlord who is ready to move on and sell the property in the foreseeable future. Finally, the terms of a formal contract must pin a landlord in a corner, so they can’t get out of the sale. Owning property can be competitive for anyone, but potentially more so for new business owners. It is vital that you have competent  agent/legal counsel who are well-versed in lease negotiations. The right lease terms can change the course of your career’s profits, and strong counsel will steer you to the best opportunities, while protecting you from poorly-worded or manipulative contracts.