How do option contracts and rights of first refusal work, and what is the difference between them?
An option contract gives one party the right to purchase (or lease) property at a set price within a specified time period, with no obligation to do so. A right of first refusal gives one party the right to match any offer a seller receives from a third party before the seller can sell to that third party. Option contracts require consideration (payment); rights of first refusal may not.
Key Takeaways
- An option contract gives one party the right to purchase (or lease) property at a set price within a specified time period.
- Option contracts require consideration (payment); rights of first refusal may not.
- Exam questions test whether you know that these are separate, enforceable interests distinct from a standard purchase contract.
- Rules vary by state; always learn your specific state's requirements.
Contracts on the Real Estate Exam
Option contracts and rights of first refusal are specialized real estate interests that protect buyers and tenants. Real estate agents need to understand how these work because they appear regularly in transactions, especially in commercial real estate and lease situations. Exam questions test whether you know that these are separate, enforceable interests distinct from a standard purchase contract.
Understanding Contracts: Key Concepts
What It Means
An option contract is a unilateral agreement in which one party (the optionee) receives the right to purchase or lease property at a predetermined price and terms within a specified time period, while the other party (the optionor) is bound but the optionee is not. The optionee has the right to exercise the option or walk away. The optionor cannot refuse if the optionee decides to exercise within the time period.
Requirements
Option contracts require consideration (typically a payment called an option fee) to be enforceable. The consideration compensates the optionor for tying up the property and removing it from the market. Once the optionee pays for the option, they have the exclusive right to purchase at that price for the stated period. If they do not exercise the option by the deadline, the right expires and the optionor is free to sell to anyone else.
Example: A tenant pays $1,000 for a one-year option to purchase the property at $500,000. If the property value skyrockets to $600,000 during that year, the tenant can still purchase at $500,000 because they hold the option. If they choose not to exercise it, the property reverts to the owner.
Additional Considerations
A right of first refusal (or right of first offer in some states) is different. It gives one party the right to match any offer the owner receives from a third party. The party holding the right does not have the power to set the price; instead, they have the right to match whatever terms a third party offers. If the owner receives an offer to sell at $500,000, the holder of the right of first refusal can match that offer or decline. If they decline, the owner can sell to the third party on the same terms.
Requirements
Rights of first refusal typically do not require consideration, though this varies by state. They are valuable for tenants or neighbors who want the opportunity to purchase if the property ever comes on the market, but without the expense of holding an option.
The key differences: An option gives the holder the power to set the terms and price (for the duration of the option); a right of first refusal allows the holder to match whatever terms appear from a third party. An option requires payment; a right of first refusal often does not. An option is enforceable even if the owner wants to sell the property; a right of first refusal only gives the holder a chance to match external offers.
Contracts Rules by State
Each state has its own rules when it comes to contracts. Here are a few examples of how requirements differ:
California
California law recognises option contracts and rights of first refusal as separate enforceable interests. California requires consideration for option contracts. California courts enforce right of first refusal clauses in leases and purchase agreements, even without consideration. These interests must be in writing under the Statute of Frauds.
Texas
Texas Property Code recognises option contracts and right of first refusal agreements. Texas requires written agreements for both. Option contracts require consideration. Texas courts enforce these provisions strictly according to their terms. TREC forms may include option and right of first refusal provisions.
Florida
Florida law recognises option contracts and right of first refusal as binding interests in real property. Florida requires written agreements. Option contracts require consideration. Florida courts enforce these agreements as drafted, provided they include the essential terms and are properly signed by both parties.
Expect scenario questions asking you to distinguish between an option contract and a right of first refusal. Know that an option requires consideration (a payment) and gives the holder the right to purchase at a set price for a set period. Know that a right of first refusal gives the holder the right to match any offer without necessarily requiring payment. Understand that an option is a unilateral right to purchase; a right of first refusal is a right to match external offers. Pay attention to scenario language that describes someone getting 'the right to purchase at a set price within 90 days' (option) versus 'the right to match any offer before the owner sells to someone else' (right of first refusal).
Rules vary across all 50 states
When you join LicensePrep, you get study materials tailored to your specific state so you only learn what you need for your exam.
Start practising →