The world of commercial real estate can be overwhelmingly competitive at times. Whether there are a lot of properties on the market or many tenants looking to lease commercial space, finding ways to close the deal will become something of an art for seasoned landlords and property investors.
One clause that can help make a deal happen is the tenant right of first refusal clause, but this addition is generally thought to be very bad for landlords. What is this clause, how do you implement it effectively, and why are so many landlords afraid of using it?
Today, we’ll learn about the right of first refusal lease (and how it differs from the right of first offer). Gaining a better understanding of this lease condition is essential for being able to properly leverage future deals, so pay close attention!
A Table of Contents for Tenant Right of First Refusal Forms
- What is the Right of First Refusal Cause in a Lease Agreement?
- Why Do Commercial Tenants Want a Right of First Refusal Lease?
- When Should Landlords Implement this Clause?
- Our Sample Right of First Refusal Contract
What is the Right of First Refusal Cause in a Lease Agreement?
The right of the first refusal lease clause or addendum is a legally-binding document that gives a tenant the first right to purchase a property if it goes up on the market. This means that if a landlord decides to list the property for sale, they will have to accept the tenant’s reasonable offer if the tenant decides to make one.
Often, the property in question in this clause is not only the currently leased space but also contiguous, vacant property.
You might be wondering what about this clause makes it a “refusal.”
Usually, this clause is enacted whenever a property owner gets an offer to lease or purchase a specific space. The tenant would then have the opportunity to either accept or “refuse” the offer from a third-party. That’s right – the current tenant, not the landlord, would have the chance to decide that.
Right of First Refusal vs. Right of First Offer
There are two different clauses that are similarly named but have very different effects: the right of first refusal and the right of first offer.
The right of first refusal, explained above, gives the tenant a certain amount of time to purchase or lease a property if it becomes available.
The right of first offer, on the other hand, does not guarantee any such sale or deal to the tenant. Instead, this contract ensures that they will be the first ones to know about a property becoming available. This gives them an insider tip, allowing early offers and negotiations that could help them beat out hungry competitors.
Why Do Commercial Tenants Often Want a Right of First Refusal Lease?
Generally speaking, the right of first refusal clause commercial lease addendum is far more common than similar residential clauses. Why is this?
First off, this clause often gives commercial tenants the first opportunity to expand into neighboring spaces on a commercial property or to become the permanent owner of a space if they like it. Commercial tenants like this idea because it gives the future of their business an added layer of security.
A similar aspect of security provided is that the tenant has a chance to buy the property if the landlord is going to sell. Sometimes, a landlord selling would mean that a commercial tenant will be evicted, so having this added security helps commercial tenants feel more comfortable.
Second, it helps them to secure a long-term deal and the chance to re-negotiate without doing the work of the negotiation. In cases where a third-party negotiates with the landlord about a lease agreement, the tenant can actually refuse the third-party and accept the negotiated lease for themselves.
Finally, this addendum simply gives them power in the commercial agreement. While landlords know that leases do not simply favor one party over another, many tenants feel that commercial leases do not give them enough power in the tenant-landlord relationship. This clause, in their minds, restores that power.
When Should Landlords Implement this Clause?
As you’ve probably already noticed, this clause can take a lot of power out of the landlord’s hands. Why, then, would any landlord enter into this type of agreement?
While the use of this clause is becoming less frequent, there are still some solid reasons for choosing to enter into this contract with your tenant.
The first and most common reason that this addendum is used is in cases of joint ventures or shareholder agreements. Sometimes, one business will lease a property to a sister business, and these contracts will include this right of first refusal to ensure the security of the property for both companies long-term.
Another very common reason for using this clause is to close a difficult deal with a large tenant. If, for example, you are trying to rent out the floor of an office building but cannot close the deal without offering this right to the tenant, you might never close the deal.
In that way, this right of first refusal can be thought of a negotiation tactic that should be used wisely and sparingly. This agreement is, after all, a binding contract. Should you ever decide to lease or sell spaces affected by the lease addendum, you will have to follow through with the contract’s terms, which could prove for a long and difficult transitory process.
Our Sample Right of First Refusal Contract
| Tenant Right of First Refusal Sample |
Overall, this is a relatively simple form. This clause can be incorporated into a lease if you are signing a contract with a prospective tenant or it can be signed with a tenant at a later time than when the lease is signed to guarantee that they’ll be the first to have access to an available property.
Let’s work through each section to understand what information must be included and why each segment is important.
Date, Property Address, and Tenant Name(s)
All of this basic identifying information is the first thing that should be included on the contract. This information is necessary to clearly state who is agreeing to this contract, when the contract is going into effect, and what property the contract pertains to.
Right of First Refusal Details
The next section of the contract outlines what this contract is giving to the tenant. This section should clearly state all of the following:
- What will happen if the property goes up for sale
- How long the tenant will have to let the property owner know if they will exercise their right to purchase
- How the tenant must identify the landlord of their decision
- Who will be responsible for the brokerage fee
- How much that brokerage fee will be
Additionally, you could expand this section to have more specific requirements. For example, you might want to require a tenant to match any third-party options in terms of a financing method. If a third-party offer is all cash, the tenant would then only be able to refuse the third-party offer if they can also finance an all-cash deal.
Including all of this information ensures that a smooth process will occur if the property should go up for sale. It is important to have this information in a legal contract to ensure that both parties know the requirements and act accordingly to the document. This keeps the process both fair and orderly.
Signatures
Finally, the form must be completed with dated signatures from all tenants as well as the landlord or rental agent of the property. These signatures make the contract legally binding.
Conclusion
While the right of first refusal isn’t something that landlords often try to include in their lease agreements, this addendum can help to secure a deal with a big tenant. If you are renting out a lot of commercial space or simply need something to sweeten the deal, consider if this lease clause makes sense for your business.
If you do use this form, be sure to complete all of the information thoroughly so that all parties are completely and equally informed. With the right form and the right circumstance, including the right of first refusal can make for a great business decision.