When it comes to choosing a location for their business, most companies and individuals choose to lease commercial space rather than purchase. There are a number of factors that contribute to this decision, but one of the most important is growth. New/expiring contracts, market conditions, etc. can cause companies to grow or contract, which can affect the amount of space they need or can afford. Due to the long-term nature of most commercial leases (5 years plus) companies must account for these factors to ensure that they do not take too much space or too little.
Of paramount importance to most companies is the ability to have their employees in one location, building, and space. Being in a contiguous space contributes to company culture, collaboration, etc. and while landlords are generally inclined to accommodate growing tenants, situations can arise making this either impossible or undesirable. As a result, tenants must plan for growth and negotiate terms/projections prior to signing a lease.
Two such protections are Rights of First Offer and Rights of First Refusal. While similar in their objectives, they have subtle and important differences that affect a landlord’s willingness to grant them.
Right of First Offer (ROFO)
With a ROFO, tenants are granted the right to make a first offer on a property or space. The space covered under the ROFO is generally contiguous to the tenant’s existing premises, but may also be on other floors that can accommodate their expansion needs. Landlords are required to approach the tenant before offering the space to the general public. Landlords can reject the terms if they feel that they are below market; however, both parties are incentivized to reach an agreement. Tenants benefit from the ability to expand contiguously while landlords reduce their transaction costs and risk from leasing to an unknown/new tenant. Landlords are generally willing to agree to a right of first offer subject to the rights of preexisting tenants.
Right of First Refusal (ROFR)
A ROFR gives a tenant the right to review all other offers on a particular property/space before a landlord can lease the space the space to a third party. The tenant has the opportunity to lease the space simply by matching the terms of the highest/best offer on the table. Potential tenants may be deterred from a space when they know that an existing tenant can simply match their offer. Rights of first refusal encumber the subject property/space and, as a result, primarily benefit the tenant. Because of this, landlords are generally hesitant to agree to rights of first refusal.
The ability to expand on the same floor, within the same building, or within a landlord’s portfolio is crucial for tenants who expect to outgrow their leased premises within their initial lease term. Businesses do not want to incur the costs of taking too much space up front but may be required to sign long-term leases for a variety of reasons, i.e. tenant improvement allowances, landlord requirements, etc. Rights of First Offer and First Refusal are two strategies that a tenant can employ to accommodate growth while remaining economically conservative.