Experienced commercial real estate investors and tenants always use a LOI when entering into a potential transaction or buy, sell, or lease office space. Although LOIs are frequently used to buy or lease commercial real estate, parties sometimes make critical mistakes that could easily be avoided.
In this article we’ll describe how to structure and write an LOI, and explain why a LOI is one of the most important documents in commercial real estate.
What is a LOI?
A LOI – or letter of intent – is a written non-binding document between two parties that serves as the basis for a proposed future action or agreement. In some markets an LOI may be called a Letter of Understanding, a Memorandum of Agreement, or a Memorandum of Understanding.
The LOI is used to:
- Outline the key aspects of a proposed transaction that the parties agree on
- Signify that the parties are committed to moving forward on a deal
- Serve as a guiding document for drafting a formal binding contract
Although a LOI is non-binding overall, the parties may mutually agree that some sections of the LOI are binding, such as the purchase price or financing structure used to acquire a property.
Related: Ultimate Checklist for Buying Commercial Real Estate
When is a LOI Used in Commercial Real Estate?
A LOI is used in commercial real estate to put the major points of a proposed purchase or lease into writing. The party presenting the letter of intent should research and tour available properties on the market before submitting a LOI to the owner or landlord.
Normally a letter of intent will be drafted by the commercial real estate broker representing the buyer or tenant after touring the property and conducting informal discussions with the owner. The LOI will outline key deal points such as price, due diligence period, financing, and close of escrow or date of possession.
Even though a letter of intent is non-binding, providing one demonstrates the buyer or tenant is committed to moving forward on a deal and intends to proceed in good faith. Of course, sometimes a party may change the terms of the initial LOI or withdraw from the deal entirely based on new information when conducting due diligence and verifying information provided by the parties.
Related: Understanding Your Time Horizon in Commercial Real Estate
Why is a LOI needed?
An LOI—an abbreviation for “letter of intent”—is used in the commercial real estate space as a non-binding agreement between two parties that are in the process of closing a deal. While the letter of intent is not legally binding, it demonstrates a basic level of commitment that can help negotiations, without the need to focus on minor details that can be ironed out later.
The letter helps confirm that all parties are in “general agreement”, which can help significantly accelerate the process of creating the contract. The letter also serves as a basic reference point for future negotiations—individuals in both parties can point to the letter and legitimately claim, “this is what we initially discussed and agreed upon”, which can be helpful in the event that any conflicts emerge.
Why is a LOI One of the Most Important Documents in Commercial Real Estate?
Buying, selling, and leasing commercial real estate can be time-consuming, complex, and expensive, even for the most experienced investors and tenants. A LOI helps to ensure that both parties have a “meeting of the minds” before getting too deeply involved in a transaction.
A letter of intent serves as a middle step between initial discussions with the property owner and drawing up a legally binding sales contract that could easily run 20 pages or more. The LOI provides a quick and easy way to memorialize the basic terms of the proposed transaction before negotiating other terms of the contract and paying a real estate attorney to draft or review the sales contract or lease agreement.
LOIs are also a good way for a seller or landlord to determine how serious a prospective buyer or tenant is. Because an LOI is free to make and non-binding, some prospects present as many letters of intent as possible in the hope that one is accepted. If the terms proposed in an LOI are significantly different from a property owner’s Offering Memorandum, that could be a sign that the party presenting the LOI may not be serious about completing the transaction.
Would you like to learn more about the ins and outs of commercial real estate investing but don’t know where to get started? Check out Feldman Equities to learn more or reach out to 813-221-6699 today to discover what they can do for you.
WHO sends an LOI?
The letter of intent can be sent by any party that might be involved in the contract negotiations—these letters are non-binding and can have various initial points of origin. An LOI will often be issued in response to a request for proposal (RFP); in these situations, an interested party has declared an interest in a particular type of property and the LOI can serve as a bridge to more formal negotiations.
What is Included in an LOI?
An LOI should include the following items:
- Name of seller, buyer or tenant
- Address and contact information
- Responsible parties authorized to execute a final sales or lease agreement
o Address and suite number of a lease is being negotiated
o Building description including lot size and square footage
o Amount of parking and signage
o Property gross income, operating expenses, and NOI based on seller’s representations
o Type of rent such as FSG or NNN, including any CAM charges, if the LOI is for a lease
- Purchase price including earnest money and terms of financing
- Due diligence period and general description of documents seller or landlord will provide
- Lease terms including rent and annual increases, rent abatements or tenant improvements (TIs), length of lease, occupancy, and rights to sublease
- Target date for signing the purchase contract or lease agreement
- Expiration date of the LOI, usually between 5-10 business days after being presented to the seller or landlord
- Name of any commercial real estate brokers involved in the transaction
- Disclosure of which party each broker represents
- Sales commission or leasing fee paid to each broker if the transaction closes
- Notice that the LOI is non-binding
- Pre-conditions to signing a purchase contract or lease, such as approval by shareholders in a partnership or city permit approval
How to Write an LOI
An LOI is normally 2-3 pages in length with a typical structure consisting of:
- Introductory paragraph describing the purpose of the LOI, such as interest in purchase the property or leasing available space.
- Parties to the proposed transaction including the entities involved, legal name and home state, and type of entity such as an LLC to reduce the risk of the wrong information being used in the final purchase contract or lease agreement.
- Key deal points such as property description, offer terms, disclosure of any commercial real estate brokers involved in the transaction and which party they represent, and any other key terms and conditions specific to the proposed transaction.
- Closing paragraph including whether or not certain parts of the LOI are binding, a non-disclosure agreement or confidentiality clause, remedies for breaching the binding provisions of the LOI, and a request that the party receiving the LOI sign and return a copy prior to the expiration date of the LOI.
Related: Hard Costs vs. Soft Costs in Real Estate Development
Final Thoughts on LOIs
A LOI is quick and easy to draw up and present, doesn’t require an earnest money deposit and is a document that can be presented to lenders or business partners to describe a proposed transaction.
Although a letter of intent generally is not legally binding, a LOI should be presented in good faith and both parties should work to maintain credibility throughout the negotiation process. If there are terms that need to be re-negotiated, explain to the other party why, such as new information discovered or a significant change in circumstances.
Would you like to step into the world of commercial real estate investing but aren’t sure where or how to get started? Take a look at Feldman Equities to learn more or reach out to 813-221-6699 today to discover what they can do for you.
Sign up to learn more about how to invest in office buildings and to get early access to our next investment opportunity.