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.
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:
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.
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.
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.
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An LOI should include the following items:
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
An LOI is normally 2-3 pages in length with a typical structure consisting of:
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.
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