LOIs are beneficial for many reasons, which we’ll discuss in more detail below. Namely, they help the prospective buyer and seller (or landlord and tenant) come to general, high-level terms before moving forward with a more stringent due diligence process. Those who use an LOI often have a leg-up when negotiating the terms of a sale or lease relative to their peers bidding on the same assets.
In this article, we look at what is a letter of intent in commercial real estate, including how to write one using the templates provided.
What is a Letter of Intent in Real Estate?
A letter of intent, commonly referred to as an “LOI,” is a simple, 1-3 page document that prospective buyers or tenants use to outline the terms of their offer for a property. It includes the basic terms of what they’re willing to pay for a property and under what conditions.
The main purpose of an LOI is to help the owner and buyer reach a mutual understanding on deal terms before moving into a longer, more formalized due diligence period.
It is important to note that LOIs are non-binding. This is a major difference between an LOI and a purchase and sale agreement (PSA), the latter of which is a formal contract between the two parties. Because PSAs are legally-binding, they tend to be much more robust and significantly longer (often 20+ pages long with language crafted by both brokers and attorneys). Using an LOI is a great way to iron out big-picture items before moving to the longer, more time-consuming PSA negotiation phase. Although non-binding, both parties should be reviewing the LOI in good faith.
LOIs are often used for both the purchase of commercial real estate as well as the lease of commercial property.
When is a Letter of Intent Used for Commercial Property?
A letter of intent is used in commercial real estate transactions whenever negotiations are expected to be complex. They are typically drafted after someone has already viewed the property and had preliminary conversations with the owner and/or broker about moving forward with the transaction. The LOI will then serve as an initial offer that is prepared based on any preliminary information that has been provided by the seller or seller’s broker.
Letters of intent should be used to start the negotiation process and nail down key terms. They are a way of formalizing what has been discussed verbally by putting the specifics of those conversations down on paper.
Once an LOI has been agreed to and signed by both parties, the next step will be to move forward with a legally-binding lease or purchase and sales contract prior to closing on the deal.
The Benefits of Using an LOI on Commercial Real Estate
While LOIs are useful, they are not required. Many people lease and/or purchase commercial real estate without using an LOI at all. That said, there are a few key reasons why someone would want to use a letter of intent, including:
- Ability to make multiple offers. Because LOIs are non-binding, sellers can submit LOIs on multiple properties at once. This is especially beneficial for those who are looking at properties in red-hot markets where assets move quickly. An LOI is a way to get ahead of the competition and show the owner you are serious, while simultaneously looking at multiple properties.
- Gauge an owner’s willingness to negotiate. LOIs are a great precursor to the more formal PSA. Using an LOI can help prospective buyers and/or tenants test the waters before committing to the purchase or lease of a commercial property. An LOI can gauge an owner’s willingness to negotiate moving forward. It can also help identify what issues may be sticking points that the parties may be unable to overcome.
- Gain leverage during negotiations. Someone who has multiple LOIs out at the same time will have a strong read at current market conditions and therefore, can use the responses from other owners as leverage to keep sellers and landlords honest.
- LOIs are simple and free. LOIs are incredibly straight-forward. They are short (1-3 pages in length), do not need to be drafted by an attorney, and can be written up at no cost to the prospective buyer/tenant. Moreover, they do not require any earnest money to be put down like a PSA would, which is another reason why they can be used liberally when shopping around for properties.
- Effective form of communication. LOIs spell out the general terms of the agreement, which removes any ambiguity that might exist if these same conversations were happening by phone or via a hand-shake agreement. Letters of intent are therefore a highly effective way to communicate intent to the property owner.
What is Included in a Letter of Intent for Leased Commercial Property?
Letters of intent are often used by businesses looking to lease office, retail, industrial and other commercial property. Regardless of how the property will be used, an LOI for leased commercial space will generally include the following:
- Date the LOI is being submitted
- Landlord and/or Broker and their contact information
- Tenant name and contact information
- Cover letter or paragraph indicating that this is an LOI for a specific property
- Property address, including unit number (if any) and description of that premises
- Description of permitted use (how the property will be used, e.g., for corporate office)
- Proposed lease term (including start and expiration dates) and whether that includes any options to renew
- Proposed rent, by year and on a square foot basis (including proposed rent escalations). This should include whether any period of rent abatement is proposed (e.g., 3 months free rent)
- Whether the lease will be a net lease vs. a gross lease. In a NNN lease situation, the tenant should estimate what the NNN charges will be on a per square foot basis (e.g., $5.50/sf) which will help both parties budget accordingly
- Whether any security deposit and/or any prepaid rental fees will be paid
- Taxes, insurance and common area maintenance (CAM) obligations (spells out who is responsible for each under proposed lease agreement)
- Utilities (will usually be the responsibility of the tenant, but important to acknowledge)
- Overview of who is responsible for property maintenance, including what types of maintenance (e.g., tenant responsible for walls-in maintenance; landlord responsible for walls-out)
- Expectations around construction and tenant fit-outs. This will specify whether the landlord will be expected to do any construction to the shell of the building prior to the tenant moving in, including what specifically those improvements will entail. Alternatively, the LOI might stipulate a tenant improvement allowance (expressed as a certain dollar per SF) that the tenant can spend to make those improvements to the space
- First right of refusal, a clause that would give the tenant the first chance to lease adjacent space if and when it becomes available to rent (something that tends to be important to businesses with long-term expansion plans)
- What type of signage will be used and allowed (if any) both inside and on the exterior of the building
- Whether any broker commissions will need to be paid and if so, by whom
- Confidentiality clause. Although LOIs are non-binding, most people will include a confidentiality agreement to protect their interests (even if not enforceable in court)
- Whether the business is willing to share financial documents and if so, what those include
- Signature lines for both parties to accept the LOI
While there is a minimum set of expectations around what should be included in an LOI for leased commercial property, there is no maximum. LOIs are generally simple, but if a tenant feels that there are more details that need to be discussed, it is acceptable to include those terms in the LOI as well.
How do you Write a Letter of Intent for a Commercial Real Estate Purchase?
Letters of intent are equally as common among real estate investors and developers looking to purchase commercial property. The LOI will outline, at a high-level, how the seller plans to acquire the property and under what terms. This is an important precursor to the sale of a commercial asset given how complicated and nuanced commercial real estate PSAs tend to be. An LOI can save the buyer and seller significant time if they’re able to come to general terms in advance of moving forward to a full-blown PSA. The PSA can then be used to resolve the finer points of the transaction.
At a minimum, these are the basic things that will be included in an LOI to purchase commercial property:
- Date that the LOI is being submitted
- The names and contact information for both parties involved (buyer and seller) as well as the broker(s) if either party is being represented by same
- Description of the property for sale, including building address and general square footage
- Proposed purchase price
- Proposed deposit amount, if any, and whether that will be held in escrow, for how long, and under what conditions
- Due diligence period, if any (essentially, the period of time that a buyer wants to conduct more robust due diligence on a property – usually expressed as a certain number of days ranging from 30-90 days)
- How the buyer plans to finance the transaction (e.g., whether they will buy for all-cash or will be using some combination of debt and equity; this might outline where the debt and equity is expected to come from as well, something referred to as “capital sources”)
- Expected closing conditions (this will usually include a list of items)
- Confidentiality clause
- Whether the agreement is binding or non-binding. While LOIs are generally considered to be non-binding, the LOI may include language that stipulates specific sections of the LOI are binding between the two parties
- LOI expiration date (letters of intent are time sensitive and intended to motivate the parties; they usually expire after a certain number of days)
- Signature lines for both parties to agree and accept to the terms outlined above
This list is not exhaustive, but these are the common terms that are generally described in an LOI to purchase commercial real estate. It serves as a roadmap for the buyer and seller as they contemplate whether to move forward. The LOI should be in writing and signed by both parties.
Again, an LOI is not necessarily required but both sellers and their brokers will usually expect a prospective buyer to submit an LOI before moving forward with negotiations. In short, use of LOIs have become an industry standard.
Before shopping around for a commercial property to lease or buy, it is worth drafting a “template” LOI designed to meet your specific needs. Then, before submitting that LOI to any owner, have your broker or attorney review the template language to make sure your interests have been sufficiently protected. While LOIs are non-binding, they help to set the stage for further negotiations. Assuming the owner accepts and signs your LOI, you want to be sure certain items have been sufficiently addressed prior to moving into the due diligence and formal PSA stage. Once the LOI has been blessed by your attorney, you can use that template to pursue various commercial properties.
Are you interested in purchasing commercial property? Contact us today to learn more about our co-investment opportunities at Feldman Equities.
Sign up to learn more about how to invest in office buildings and to get early access to our next investment opportunity.