You are an owner or manger and you’ve been tasked with finding a new location for your business. You hear brokers using a lot of real estate terms, one of which is Letter of Intent or LOI. What exactly is an LOI and why would I use one?
As the name implies, a Letter of Intent (LOI) is a document used by the parties – whether a lease transaction between a Landlord and Tenant or a potential purchase transaction between a Buyer and Seller – to put the major points of the proposed transaction into writing. This step gives both parties time to evaluate each other – kick the tires if you will – and see if they will be able to come to mutually agreeable terms for an agreement. Why this step first? Whether you are the Buyer/Tenant or the Seller/Landlord, you want to know if there is a real chance to put a deal together before you spend significant money or time on outside professionals such as lawyers, architects, contractors, etc.
Can we agree on the basic business points of the transactions? Does one of the parties have unrealistic expectations? By using the LOI, you can quickly sort through the basic deal points and find out if there is common agreement between the parties. For example, if a shopping center Landlord is quoting $35.00 dollars per square foot in rent and a seven-year lease term, and the Tenant says I can’t pay more than $25.00 per square foot and sign a lease longer than three years, then you can quickly determine that the probability of putting together a lease is very slim. The same principles follow suit with a sales transaction. If a Seller is listing the property at $1,000,000 dollars and the Buyer say there is no way they will pay more than $750,000, then the likelihood of sale is remote. In both of these examples, neither party will want to incur outside cost because the probability of success is very low. Conversely, if the parties are in agreement with the business terms, then both sides will be willing to invest resources, time and capital to make the transaction happen.
What should be in the LOI? It really depends on the complexity of the transaction. For most transactions you will want to keep it to the basic business points. For a lease agreement, the basic business points are length of the lease term, rent and any increases over the term, property operating expenses and who pays them (the tenant or the landlord), who manages the property, who is responsible for the property maintenance, the Use clause for which the tenant can operate in the property, defining the premises and determining what improvements, if any, will be done to the space. The majority of the other terms in a lease agreement are more legal in nature and can be negotiated as part of the lease agreement.
For a sale, the LOI will usually consist of price, earnest money, the amount of time for a property inspection, the period of time for the property to close after the inspection period and who will pay for the closing cost. As with a lease, the other matters related to a sale can be negotiated as part of the purchase agreement. While these are the basic points, if the complexity and type of transaction dictates that more details should be included in the LOI, then absolutely include them. What you don’t want to do is overload the LOI with business or legal points that are more appropriate to be discussed as part of the final document, whether that is a lease or purchase agreement. When this happens, it tends to slow the process down; and as we all know, time kills deals. The last item of note to consider is, does the LOI create a binding obligation or commitment on either party? Usually, the answer is no. While an LOI can create some type of obligation if the transaction does not happen, they are far and few in between. By far, the majority of the LOI’s have a phrase similar to “this Letter of Intent is for discussion purposes only, and is not binding on either party until such time that a lease agreement (or purchase agreement as the case may be) has been negotiated, signed and delivered by the parties.” A lot of times there will be an additional sentence that says either party can withdraw from the negotiations, with or without notice, and have no further obligations to the other.
In summary, LOI’s are a great way to kick the tires and evaluate several leases and/or sales proposals. When used correctly, you will find that the LOI will save you significant time, money, frustration, and most importantly help you find the perfect location for your business.