10/08/2024
LETTER OF INTENT (REAL ESTATE): 11 THINGS (2024) YOU MUST KNOW
If you’re preparing to enter into a major business transaction, you may be considering a letter of intent to make an offer on a property.
A letter of intent (LOI) is a document that declares the preliminary commitment of one party to do business with another and outlines the chief terms of a prospective deal.
We’ll discuss what a letter of intent is, how to use it properly, and whether this type of document is legally binding.
Here’s what you should know!
1. WHAT IS A LETTER OF INTENT IN REAL ESTATE?
A real estate letter of intent (LOI) is a non-binding agreement that outlines the sale or lease terms and conditions.
It is intended to start as a draft agreement and become a finalized contract later.
This legally binding contract is often in the form of a purchase agreement or lease agreement.
2. WHEN IS A LETTER OF INTENT USED IN COMMERCIAL PROPERTY?
A letter of intent is used by a serious prospective buyer or representing broker in a commercial real estate transaction.
It serves as an initial offer, and it’s prepared based on preliminary information that was provided by the seller or selling broker and on initial due diligence of the property.
After the initial letter of intent has been delivered, negotiations and formal due diligence begin.
Essentially, an LOI is used before a formal purchase agreement is entered into.
In some cases, letters of intent will be submitted and agreed upon, but circumstances will change.
If the terms change, the initial offer may be withdrawn altogether, and this is okay because letters of intent can be non-binding (depending on what the parties have agreed upon).
Often, letters of intent are subject to verification and further due diligence.
They can be amended or changed at any time.
3. WHAT ARE THE TWO MAIN WAYS TO MAKE OFFERS ON A PROPERTY?
There are two primary ways to make offers on a property.
The first is a typical sales contract or a purchase and sales agreement.
The second is a letter of intent (LOI).
4. HOW DO YOU USE A LETTER OF INTENT EFFECTIVELY?
A letter of intent is intended to be a bridge between your intent to purchase the property and a legal sales contract.
It’s a way of making an offer and getting simple terms out on the table for the seller.
The LOI is also used to get the seller to come to an agreement with you in basic terms.
This way, you can negotiate with all other terms in the sales contract.
5. IS A LETTER OF INTENT BINDING?
No, a letter of intent is typically not legally binding.
That said, the parties can determine to make an LOI binding between themselves.
Once the parties determine this, the document includes the binding status in written form.
This is because it would be far more challenging to enforce the validity of the LOI in court, and the case would likely be dismissed due to the uncertainty of the letter’s intent.
6. HOW WOULD THE COURT DETERMINE IF A LETTER OF INTENT WAS LEGALLY BINDING?
It’s not unheard of for a letter of intent to be declared legally binding and treated as a binding contract in court.
Courts may determine what parties intended based on the following:
- The conduct of parties
- The language used in the letter of intent
- The context of negotiations (ex: parol evidence may be introduced that oral promises were made and relied upon)
- Other custom additions
Keep in mind that there are four elements of an enforceable contract:
- The parties are legally capable of entering into a contract
- The parties reached a mutual agreement
- The subject of their agreement is not illegal
- Each party receives consideration
If an LOI contains all of these elements, then it creates a binding contract for the parties to do (or not do) a certain thing.
Additionally, you should note that even if an LOI is not binding to buy or sell property, it may be treated as such if it was negotiated in good faith.
If this happened, then both parties would be prohibited from renouncing the deal, abandoning negotiations, and insisting on terms inconsistent with those contained in the LOI.
7. HOW DOES A LETTER OF INTENT WORK?
Here’s an overview of how the letter of intent process works.
- Step 1: Buyer/tenant views the property
The first step is when the buyer or tenant visits the property to evaluate the premises.
This visit will determine if the space suits their real estate needs.
It is always recommended that a buyer complete a thorough walkthrough before purchasing.
This allows them to test appliances, plumbing, window quality, and heating.
During this time, the buyer or tenant will also be able to check if any visible material and structural defects are present.
- Step 2: The parties negotiate
After the walkthrough, the buyer or tenant will decide if they want to proceed with the transaction.
If they do, they should immediately complete a letter of intent and present it to the owner for review.
This letter offers a general description of the proposed real estate transaction, and it may include information like the desired financial terms and completion dates.
Following this submission, negotiations between the two parties will continue, especially if the owner is not satisfied with the initial offer.
- Step 3: A binding agreement is made
When the real estate conditions have been negotiated successfully, the binding contract should be drafted and reviewed by each party.
The document used will either be a purchase agreement or a lease depending on the nature of the relationship between the parties.
If you’re moving forward with a purchase agreement, you may consider having a lawyer examine the contract before entering an officially binding contract.
For leases, the transaction will be finalized once the parties sign.
- Step 4: The inspection period occurs
This inspection period occurs only for purchase agreements as they usually contain a clause that grants the buyer a specified amount of time during which they can perform a proper inspection of the premises.
This inspection should be completed by a qualified professional as they can more easily spot issues that might affect the value of the property moving forward.
If the inspection occurs and the property fails to meet the buyer’s standards, then they can normally back out of the agreement or negotiate new terms with the owner.
However, if the buyer is satisfied with the inspection results (or no inspection is performed), then the buyer’s offer will be accepted.
The property will then be transferred to their name following the closing period.
- Step 5: The closing occurs
Again, this step occurs only if a purchase agreement is utilized.
The closing date will be predetermined, at which point the ownership of the property is transferred to the buyer.
In order to complete the transaction, the parties may need to meet together with various entities such as a notary, escrow company, and title insurance agent.
This will largely depend on the terms previously negotiated.
Otherwise, the parties may be able to conclude the process separately.
8. HOW DO YOU WRITE A LETTER OF INTENT IN COMMERCIAL REAL ESTATE?
The content of a letter of intent may be changed based on who is writing it.
It’s often only 1 to 3 pages; although, it can be longer depending on the complexity of the deal.
Regardless of length, it should contain the following:
- An introduction paragraph
- A brief sentence or two stating the letter’s purpose
- Involved parties, including the buyer’s and seller’s names and contact information
- A property description, including the address and possibly the legal description
- The purchase price of the property as well as the terms for financing or loan contingency (if applicable)
- Escrow, including the escrow agent and sum to be paid as an escrow deposit
- Due diligence, including the length and time allotted to the buyer to conduct due diligence and specific documents or items that need to be produced by the seller during this period
- The closing date
- Closing costs
- The inspection period, including how long the buyer has to conduct inspections, the specific inspections that will be completed, and terms to exit the agreement if the inspections don’t meet the buyer’s criteria
- Whether the offer is subject to additional clauses or terms outside of the clauses above (i.e., 1031 exchange, broker’s commission, or covenants)
- Date of acceptance of the letter of intent, which could be a specific date or the date the final party signs the LOI
- A closing statement, which typically includes a sentence or two about how the LOI is not a contract and is nonbinding (unless agreed upon by the two parties)
- Signatures from both parties
Note: Non-disclosure agreements (NDAs) and no-solicitation provisions are often included in letters of intent as well.
9. WHAT DOES A SAMPLE LOOK LIKE?
If you are interested in creating your own letter of intent, then you may need to see a sample and how it is formatted.
Visit here and scroll to the bottom of the page to see how a sample LOI appears.
10. WHAT ARE THE ADVANTAGES OF USING A LETTER OF INTENT IN REAL ESTATE?
A letter of intent makes it easy to make offers because it is only 1 to 3 pages long.
They are also free and easily accessible.
Plus, you should not fear using one to make offers because LOIs are typically not legally binding.
11. HOW DETAILED SHOULD A REAL ESTATE LETTER OF INTENT BE?
A letter of intent is known for being short.
They’re only between 1 to 3 pages long.
Yet, this is still quite a range and can leave questions about how detailed you make your LOI.
Letters of intent often follow one of two models: detailed or bare bones.
- Detailed -
If you have leverage as a buyer, then you may want to create a comprehensive and detailed letter of intent that avoids future discussions about settled issues.
Most lawyers respect the fact that issues specifically addressed in a letter of intent are not subject to renegotiation, and as a result, a detailed LOI will limit the issues that are negotiated by the parties in the future.
As a result, even if the market shifts and the other party happens to gain leverage before the contract is signed, you will have an upper hand on the issues that were addressed in your detailed LOI.
Another benefit of going the detailed route is that it separates the business from the legal issues.
Parties must carefully contemplate and resolve most business issues before their attorneys spend time posturing, negotiating, and drafting legal issues.
Thus, an LOI serves as a roadmap to follow in drafting the purchase/sales agreement.
With the advantages, however, a detailed LOI also carries risks.
A letter of intent is more likely to be treated as a binding contract than a bare-bones LOI.
Courts can disregard well-drafted disclaimers by allowing parol evidence that contradicts the LOI.
Courts look at the facts and circumstances surrounding the negotiations and the parties’ subsequent actions in addition to the LOI.
As such, clients should be cautioned against making any promises or taking any actions that are inconsistent with the LOI.
- Bare Bones -
A bare-bones letter of intent may work in your favor if you have less leverage during early negotiations.
This is because the bare-bones LOI allows you to renegotiate later when the leverage may shift.
The timing element of a bare-bones LOI is also advantageous as parties can put one together fairly quickly and keep the deal moving forward toward closing.
However, keep in mind that bare-bones LOI can increase the stakes.
This is because using a short and undetailed LOI requires more time and money be expended during the negotiating phase.
Once parties invest this effort, they can’t afford not to close the deal.
FINAL THOUGHTS
A letter of intent aims to name key points of a deal that must be negotiated, protect the parties involved in the deal, and announce the nature of the deal.
By addressing all these issues, parties have an opportunity to come to a true understanding prior to the initiation of due diligence and the drafting of the definitive agreements.
When you follow the letter of intent process, you increase the likelihood that the transaction will be completed successfully and minimize the chances of misunderstandings and renegotiations.
