The First Right of Refusal

About 35 years ago, my brother and I were looking for a ranch. We had little money, but lots of time and energy.

We heard about a property we might be able to buy at an affordable price. It was listed for sale with a real estate broker with whom I was acquainted. He explained the situation like this.

Two brothers, Frankie and Al, had owned a ranch for many years. They had purchased it primarily as a hunting club. One of the brothers ran the business affairs and the other had made a hobby of making physical improvements like dams and roads. Over time they purchased additional property and the ranch grew to over 1,000 acres. In addition, it was adjacent to two land-locked sections of BLM ground – giving them almost 2,000 acres on which to hunt. The had it almost to themselves.

They had also built a very nice home on the property and they invited family members to hunt. Some of their guests actually paid a fee which allowed them unaccompanied access to the ranch.

Over the years, the brothers agreed that in their old age, they would sell the ranch if they needed money for retirement. Little did they know that Albert would drop dead from a heart attack at about the age of 50. Al was married and his portion of the ranch went to his wife. Having no other means to support herself, Albert’s wife asked Frank to purchase her interest in the property, or (at least) allow her to sell her half.

Although Frank did not agree to purchase her half, he did agree to letting her subdivide and sell subject to Frank having a first right of refusal to purchase.

Their agreement included a division of half the ranch into five 120 acre parcels. The parcels were put on the market for about $100,000 each with seller financing. As offers came in, Frank had the right to either match the offer or let Albert’s wife sell to the buyer.

The price was acceptable, but nobody wanted to be the guinea pig for Frank. It became clear to us that the agent and Albert’s wife were frustrated by their inability to obtain a viable offer.

My agreement with the seller’s agent was that we would split a 10% commission, but I couldn’t see making an offer just to watch Frank take the opportunity away from us. The $100,000 price was a little too rich for Rob and I to handle on our own, so we found a partner who would become  co-owner if the deal came together.

Then I got an idea that made a lot of sense. If the seller wanted to get the property sold, she might need to pay a higher commission. If she were willing to pay 20% and the selling agent was willing to accept 5%, we could pay me 15% even if Frank purchased the property. That would fund a pay out of 5% to me and each of my partners. Once I proposed this idea, my partners were a go. If Frank acted on the first right, we would each be compensated for our efforts.

The seller’s agent and the seller were fine with idea. At this point we made our $100,000 offer and waited to hear from Frank. He acted upon the first right.

There were  four remaining parcels available and we still didn’t know exactly what to expect from Frank, so we made an offer that would repeat itself on each of the remaining parcels with a commission being paid to me (and indirectly my partners) each time Frank acted.

Frank not only exercised his first right, but he became so annoyed that he outright purchased the remainder of the ranch. I received a commission of 15% on all five parcels. My partners and I were disappointed that we couldn’t own the property, but we were compensated for our disappointment.

Some significant information can be gleaned from this story. First of all, it is clear that a first right of refusal has a negative impact on one’s ability to sell property. And, it is clear that the first right decreases the value of the property – in this case about ten percent. In my opinion the actual decrease in value was even higher than that.

Endowments as a Land Management Tool

My first involvement with endowments started during my tenure as a director for the Mule Deer Foundation. In the non-profit world, an endowment fund was thought of as a guarantee of survival. With a few million dollars in an interest-bearing account, the organization would be perpetually secure.

Then along came Conservation Banking and a different twist on endowments – perpetual funding for land management. A requirement of the US Government, via the Fish and Wildlife Service,  and California, via the Department of Fish and Game, endowment funding is used to create a steady stream of funds for use in management of privately-held conservation properties.

In this scenario, money held in trust by a third party yields a return of cash at a predetermined rate in order to produce an income stream. The revolving fund pays the  cost of activities necessary to maintain healthy habitat for wildlife. If all goes right, the program continues in perpetuity.

Since the endowment guarantees that the cost of maintaining the land is covered, the developers of the conservation project can pass the property on to caretakers such as agencies or non-profits.

Endowments provide other side benefits to the project developers and approval agencies. In order to determine the size of the endowment fund, other factors must be defined.  The first is, “How much money will the project require each year in order to sustain itself?”

In order to answer this question, information about the land and associated management activities must be determined. In the case of a Conservation Bank, surveys must be completed to determine existing species, habitat types and maintenance activities.

Physical features that require periodic maintenance, such as fences, dams and roads must be quantified into units. The useful life of land improvements must be estimated as well as replacement and maintenance costs.

The costs of other practices must be estimated by creation of a management plan that determines work to be done and the time needed to accomplish tasks. Wages,  fees, supervision and administration must also be included in the mix.

With a management plan and annual budget nailed down the rate of return on endowment fund is the next critical item in determining the size of the endowment account.

The process of creating an endowment account is very revealing. Public and private landowners create management plans and budgets when acquiring property, but if a formal endowment creation process were a prerequisite to government acquisition of land, the public would be better served.

“Buy  now and figure out how to fund management later,” is a poor way to run any organization and in California that attitude has helped to put the taxpayer in the hole or facilitated the purchase of property that remains locked up because there is no funding available to pay costs associated with public use.

It seems to me that endowment creation as a prerequisite to California land purchase would be good business practice and serve decision makers well by unmasking the true cost of property acquisition.