Right of first refusal ordinance brings complexities

The ordinance creates many challenges for owners attempting to sell their property if the property is subject to the ordinance.

Craig Stack
Senior vice president, multifamily investments, Colliers International

The city of Denver predicts that nearly 2,000 apartment units within the city and county limits are at risk of converting from affordable-restricted units to market-rate units in the coming years; potentially displacing residents in need of affordable housing. As one of the city’s efforts to help preserve affordable housing, an ordinance was passed in 2015 that granted the city the right of first refusal to purchase multifamily properties with affordable restrictions that were put up for sale.

Is the city actually going to buy the property? Most likely not. The city put out a request for proposals for affordable housing providers to become a qualified designee to whom the city could or would ultimately assign their right of first refusal with the goal that the designee would acquire these apartments and extend the affordability for a much longer term.

We have recently completed several apartment building sales that were subject to the ordinance so we’ll provide a brief outline of the ordinance and highlight some of the questions and concerns that owners have raised regarding the ordinance and process.

What properties are subject to the ROFR? Title companies now are requiring owners sign an affidavit that they have complied with this ordinance; therefore, owners of property in the city and county of Denver need to be proactive in determining whether they are subject to the ordinance. In brief, the ordinance broadly defines properties that have some local or federal income restrictions on 10 or more units. Another draft revision of the ordinance is contemplating lowering this to five or more units.

Examples of restrictions that could trigger the ROFR include:

  • Land-use restriction agreements;
  • Properties developed with low-income housing tax credits;
  • Project-based Section 8 HUD subsidies; and
  • Properties financed with federal or local institutions that received an interest rate reduction with regard to providing affordability.

There are myriad grants and other financing mechanisms that could potentially put a property in this category. On the question of tenant-based Section 8 vouchers, the surface of the ordinance appears to only apply to project-based (subsidy stays with the property) vouchers versus tenant-based (the subsidy stays with the tenant) vouchers. However, owners with tenants receiving Section 8 vouchers should make sure to reach out to the city to receive affirmation that their property is not subject to the ROFR.

The basics of the ordinance. The city is working on updating the ordinance that will provide additional rules and regulations to more clearly define the process so that owners will have a clearer understanding of the process and timeframes.

  • Owners must provide the city and the property’s residents up to a one-year advance notice of intent to sell or to opt-out of an affordable program. Certain provisions only require a 90-day advance notice.
  • After the notice period has passed and a contract with the ROFR contingency is signed with a prospective buyer, the seller must provide the contract to the city, which starts a 120-day review period for the city or its designee to determine whether or not to exercise its ROFR.
  • If the city or its designee decide to exercise the ROFR, it will have an additional 120-days to close on the purchase of the subject property at “substantially identical to the terms of the contingent purchase and sale agreement.”

Owner concerns. The ordinance creates many challenges for owners attempting to sell their property if the property is subject to the ordinance. The process alone will deter some buyers from pursuing properties. Many buyers won’t have the ability to wait through the time frames. The timing also makes it very difficult to participate in a 1031 exchange for both the seller and potential buyers. The 120-day review period poses a challenge for buyers regarding interest rate risk during the 120 days and whether to spend significant money for due diligence and third-party reports.

Another owner concern is regarding the city’s ability to terminate the purchase agreement after exercising the ROFR subject to certain contingencies in the purchase contract. The owner still could be subject to the ROFR on future sale attempts if the city terminates under a contingency or if the original buyer decides to terminate the contract.

Another potential pitfall for sellers is with existing financing. If a loan is maturing and the seller is unable to refinance or pay off the loan through a sale, they might default on the loan while working through the time frames.

Navigating the Sale with a ROFR

Setting aside some of the aforementioned challenges with the proper knowledge and approach, a sale subject to the ROFR can be run fairly smoothly with a reasonable amount of patience.

Get started early. It is very important to proactively work with the appropriate parties at the city to ensure you are ahead of the process and in compliance with the ordinance.

Request an early waiver. Working with the city and running the right process might allow for an early waiver of the ROFR. There are certain property and buyer specific exceptions that could expedite the process.

Run the sale like a request for proposals. Get the list of approved designees to solicit interest in the property early. This will help determine if the affordable housing community deems the property as an ideal preservation candidate, which could help move the process more quickly.

Get help. Simply put, going the process alone can be daunting. Select your team of experts, legal, real estate, accounting, etc.

Visit this URL to review the ordinance: https://tinyurl.com/y99zpxt7.

Featured in CREJ’s February 2019 Multifamily Properties Quarterly

Edited by the Colorado Real Estate Journal staff.