Options to Purchase

April 2013

by Jennifer E. Schulz


Negotiating Options to Purchase Real Estate

There are several ways for a lease to give a tenant a right to purchase the leased property, such as an option to purchase or a right of first refusal or first offer.  These rights give the tenant the exclusive right to purchase the property, so that the landlord may not sell the property to another party while the option or right is valid (or until the tenant waives or declines to exercise the option or right).  An option to purchase might state the purchase price at which the tenant may buy the property, or it might set forth a formula to use to determine the price, such as fair market value.  A right of first refusal, on the other hand, uses the terms set forth in a third party offer that is acceptable to the landlord to govern the purchase price and other terms of the transaction.  A right of first offer will not include the purchase price in the lease itself either; rather it requires the landlord to approach the tenant when the landlord decides to sell and to give the tenant a chance to offer a purchase price that would be acceptable to the landlord.

An important distinction between a right of first refusal or a right of first offer and an option to purchase is that under the first two, the tenant has no ability to force the sale of the property—he or she can only buy it once the landlord receives an acceptable offer from a third party or the landlord informs the tenant that the landlord is willing to sell.  An option to purchase, in contrast, gives the tenant the ability to determine when (and if) the sale will take place.  An option to purchase might be used when the tenant knows he or she wants to buy the property but needs some additional time to pull together the required finances.

There are many considerations to take into account when negotiating these types of provisions, a few of which are discussed below.  Although not legally necessary, in order to avoid a dispute later on when these rights are exercised, the parties should consider negotiating the purchase agreement that will be used in the sale and attaching it as an exhibit to the lease.

Timing of the Transaction

One of the main items to consider is when these rights are available.  The lease may provide that they can be exercised at any time during the term of the lease or only during a specified window during the term, either in the first few months or years of the lease term (e.g., only during the first 18 months of the lease term) or after a specified period of time has passed (e.g., after the 5thlease year).  In addition, the parties should consider whether a default under the lease voids the tenant’s right to purchase.  Other considerations include the consequences of a tenant declining to exercise their rights.  For example, will declining to purchase the property terminate the tenant’s right of first refusal from that point on, or will the tenant’s right to purchase survive in the event the third party transaction does not take place, thereby requiring the landlord to go back to the tenant the next time landlord receives a third party offer?

If the lease contains a right of first refusal or first offer, it should also set forth the time frame within which the tenant must decide whether it wants to buy the property once the landlord approaches him or her with a third party offer or a request that the tenant make an offer.  In addition, the parties may want to specify how quickly the sale should close after the tenant exercises his or her rights to purchase.

What Property Is Subject to Tenant’s Rights?

Most owners of property with leases containing a right of first refusal or first offer will want to limit a tenant’s ability to exercise those rights to a sale of the single piece of property, as opposed to allowing the tenant to enforce their rights in connection with a portfolio sale of several pieces of the owner’s property.  As noted above, when a tenant exercises a right of first refusal, the tenant must purchase the property on the same terms and conditions that are set forth in a third party offer. If the lease does not carve out portfolio sales from the types of transactions that trigger the tenant’s right of first refusal (thereby giving the tenant the right to purchase the single property even though the third party offer is for several of the landlord’s properties), the lease should set forth a method for determining the price and other terms for the sale of the specific piece of property separate and apart from the rest of the portfolio.   Further, landlords may want to carve out certain types of transactions to which the tenant’s right of first refusal or first offer will not apply.  For example, if the landlord transfers the property to an affiliate, the parties would typically agree that such a transaction would not count as an offer triggering tenant’s right of first refusal.

Recording a Lease Memorandum

Tenants with a right of first refusal or first offer or with an option to purchase should record a memorandum of the lease setting forth their rights so that third parties will be put on notice that the tenant has an exclusive right to purchase the property.  A recorded memorandum will prevent third parties from being able to claim bona fide purchaser status (i.e., a buyer without notice), which could allow a third party to buy the property despite the tenant’s rights and without any liability to the tenant.