A Right of First Refusal (ROFR) is a contractual right that grants an existing tenant the opportunity to match an offer that a landlord receives from a third party before the landlord can accept. In a leasing scenario, the holder of the ROFR has the first opportunity to lease additional space under the same terms offered to a third party. When the landlord provides notice, the tenant is given the choice whether to match or decline the offer. As discussed further below, there are several advantages to a ROFR but with that, comes challenges as well.
Advantages of a ROFR:
Flexibility in Space Usage:
Allows the tenant to lease only the space they currently need while retaining the option to lease additional space later. This is crucial for businesses anticipating growth, enabling them to secure more space within their current building without rushing into a decision.
Strategic Planning:
Provides the tenant with the ability to plan ahead. When the ROFR is triggered, the tenant can better assess their future needs and choose to either secure the space or pass on it.
Deters Competition:
Prospective tenants may be less inclined to pursue negotiations for a space if they know an existing tenant holds a ROFR, which could deter them from wasting time on a deal that may not materialize.
Improved Negotiation Leverage:
Knowing that an existing tenant has a ROFR, a landlord may offer more favorable terms from the outset, avoiding the negotiation process with another party. This gives the existing tenant the benefit to secure better terms upfront.
Support for Growth:
Provides flexibility for a growing company, offering the opportunity to expand within the same building instead of relocating or considering additional locations.
Additional Security:
Even if the tenant isn’t immediately interested in additional space, the ROFR offers security by ensuring they won’t be surprised by a lease to a third party that could disrupt their operations.
Influence Over Neighbors:
Exercising the ROFR can give the tenant a say in who occupies neighboring spaces, which is especially beneficial in multi-tenant buildings.
Encouragement of Fair Offers:
The presence of a ROFR might discourage lowball offers from third parties, leading to more serious and fair offers. This can be advantageous if the tenant decides to exercise their right since they only need to match, not exceed, the offer. If the offer is below market value, it’s a win for the tenant.
Potential Limitations with a ROFR:Â
Limited Control Over Terms:
The tenant has less control over the terms of the expansion space, as they must decide whether to match the offer under the existing conditions and stipulations.
Market Risk:
If the offer is above market value, the decision becomes more difficult and might not make financial sense for the tenant.
Quick Decision-Making:
The tenant must act quickly once notice is received from the landlord, which can add pressure to the decision-making process.
One-Time Opportunity:
Typically, a ROFR is a one-time right. If the tenant declines the space, the right is considered fulfilled and doesn’t apply to future offers.
Difficulty in Obtaining:
It can be challenging to get a landlord to include a ROFR in a commercial lease, as it can limit the landlord’s flexibility in leasing the space.
Unpredictable Timing:
The timing of when a ROFR might be triggered is uncertain. The landlord could receive an offer from a third party shortly after the lease commences or years later, which might not align with the tenant’s ideal timeline.
Example: For instance, in a tight market with low vacancy, the landlord may approach the tenant sooner rather than later, potentially disrupting the tenant’s ideal timeline.
Conclusion:
A Right of First Refusal (ROFR) can be a powerful tool for businesses that anticipate growth, without having to take on more space than is needed at the time of the lease signing. In addition to allowing the holder of the ROFR to gain a better understanding of what growth will look like over time. In a more extreme case, a tenant may lease far more space than needed and if the anticipated growth doesn’t come to fruition than the real estate costs for leasing a larger space can become a hinderance for the business. However, the ROFR comes with its own set of challenges, including the need for quick decision-making and unpredictable timing. When negotiated and planned for effectively, a ROFR can be a valuable asset in a tenant’s long-term business planning.
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