A Letter of Intent is very important in real estate private equity transactions.
In fact, whenever two or more parties are discussing potential REPE transaction syndications, or any other business transaction for that matter, it’s important to be very clear about the primary terms and conditions being discussed. This can help form the bases of understanding for moving forward to consummate a transaction but also, hopefully, to avoid any potential misunderstandings.
Accordingly, one way to ensure clarity is to record the key points in writing by way of a so-called “Letter of Intent” (“LOI”), which is not to be confused with an .Offering Memorandum.
What is a Letter of Intent?
An LOI is a document which outlines the key terms of a prospective deal and declares the preliminary commitment of one party to do business with another
It is a written, generally, non-binding document between two parties that serves as the basis for a proposed future series of actions or agreements. An LOI may also be called a “Letter of Understanding” (“LOU”), a “Memorandum of Agreement” (“MOA”) or a “Memorandum of Understanding” (“MOU”). Term sheets are similar in content to a Letter of Intent but, whilst LOIs are presented in letter format, term sheets tend to be a list of key items.
Why is a Letter of Intent needed?
An LOI is commonly used in commercial real estate to demonstrate a basic level of commitment between two intending parties which can be record of key or the head terms which have been or are being negotiated, leaving the more minor or finer details of the transaction to be worked out later.
The Letter of Intent usually confirms that all parties are in “general agreement” and, subject to further due diligence or compliance with any conditions imposed in the LOI, are prepared to move forward to the execution of a formal contract.
In addition, the LOI provides basic reference points for future negotiations so that all parties involved can refer to the Letter of Intent as a record of the broader issues which have/had been discussed and agreed upon, and in case there are any discrepancies in later viewpoints to recollections.
LOIs may also be conditional upon subsequent events such as the securing of financing by one or both parties, or might even have a so-called “lapse” date by which the that a deal will not proceed if the formal documents have not been signed by such a date, ie the Letter of Intent has lapsed or expired.
Who are the parties to a Letter of Intent and how is it originated?
The LOI can be prepared and sent by any party involved in the negotiations for the contract for a property, ie the buyer or seller. It may be issued in response to a “Request for Proposal” (“RFP”) so that the key terms a party is prepared to agree can be clearly set out.
Even though an LOI is generally non-binding, providing one helps to demonstrate that the buyer or seller is committed to moving forward on a deal and intends to proceed in good faith. Notwithstanding this, the terms of the initial Letter of Intent may be changed, or either party withdraw from the deal as a result of obtaining new information following due diligence or after receiving supplemental information from the other party.
Therefore, LOIs can be said to be iterative in nature, being a necessary step along the way towards consummating a REPE transaction, but subject to change and amendment as the deal process evolves.
As mentioned, a LOI is generally considered as non-binding overall, however, the parties may mutually agree that some sections of the Letter of Intent are binding, such as the purchase price or financing structure used to acquire a property.
Some of objectives of a Letter of Intent
In advance for formal contractual resolution an LOI can hope to achieve a framework for the final transaction; as such it will:
- outline the key terms and conditions of a proposed transaction which the parties intend to pursue;
- show intent that the concerned parties are committed to moving forward to conclude the deal;
- provide the framework for the subsequent drafting a formal binding contract;
- identify which key of the points and conditions of the proposed deal still need to be of be negotiated or resolved;
- serve as a record of what has been agreed and protect all parties involved in the transaction.
Who drafts the Letter of Intent and when is it presented?
Normally, an LOI will be drafted by the real estate broker representing the buyer or proposed occupier after inspecting the property and commencing discussions with the owner.
Once it has been drafted, it can be signed whilst negotiations between parties are underway, although after due diligence has commenced or is substantially complete—although it is still possible to vary the terms of the LOI as the negotiations progress or if new or additional relevant information comes to light.
Many LOIs include “Non-disclosure agreements” (“NDA”), which stipulate that the parties agree to keep the terms and conditions, even the discussions, confidential.
Typical contents of an Letter of Intent
Whilst there is no standard format for an LOI, such document will contain a mixture of factual information about the parties, the physical property and its operating performance, as well as any pre- or post- basic agreement conditions which need to be met before a formal contract can be executed, plus a lapse or validity date.
Contents may include:
- Introductory paragraph
- describing the purpose of the LOI, such as the wish to purchase the property;
- names of seller and, buyer or tenant; parties to the proposed transaction including the entities involved, legal name and state in which it is registered;
- addresses and contact information such as email or mobile phones;
- parties authorised to execute a final sales or lease agreement.
- The property
- full address of property;
- description of building(s) including plot size and square footage or metres;
- details of common areas such as car parking;
- annual gross income from the property, operating expenses and NOI based on seller’s representations;
- type of passing rents such as FSG or NNN if commercial property
- The offer or basic agreed terms
- purchase price including earnest money (but not payable at this stage);
- basic terms of financing;
- due diligence period and summary of documents seller or landlord will provide
- close of escrow or date of possession;
- pre-conditions to signing a purchase contract, such as approval by shareholders in a partnership, city permit or funding approval;
- expiration date of the LOI (usually between 5-10 business days after being presented to the seller or landlord, although this may be longer for larger transactions);
- name of any commercial real estate brokers involved in the transaction;
- disclosure of which party each broker represents;
- sales commission paid to each broker or other fees if the transaction closes.
- Summary concluding paragraph
This may include information such as:
- 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
- request that the party receiving the LOI sign and return a copy prior to the expiration date of the LOI.
Why is a Letter of Intent one of the most important documents in REPE investment?
Buying and selling commercial real estate can be complex, time consuming and expensive, for most investors. Having a LOI in place helps to ensure that both parties have a broad agreement on the most important terms before the parties spend too much time and become too deeply involved in a transaction.
It can be said to be an important middle stage between the parties having initial discussions and drawing up a legally binding sales contract which will take time and involve expense to prepare and can easily exceed 20-30 pages Therefore, the Letter of Intent provides a quick and relatively easy way to memorialise the key terms of the proposed transaction before getting into detailed negotiations about the other terms of the contract. At this stage there is also no need to engage and pay a real estate attorney to draft or review the sales contract or lease agreement.
Indeed, LOIs are also a very good way for a seller to ascertain how serious a prospective buyer is.
CPI Capital works with Letters of Intent with sellers regularly. As our goals include being efficient and effective in all of our business dealing and trying to secure the best terms for our passive investors, we are very selective about which properties we issue LOIs for.
We believe that, even though they are generally not legally binding, a Letter of Intent should be presented in good faith and both parties should work to maintain credibility throughout the negotiation process. If there are terms which subsequently need to be re-negotiated once new information discovered or a significant change in circumstances, this should be done with transparency.
There is a danger of issuing too many LOIs as this can damage the buyer’s credibility and seriousness, especially If the terms proposed in a Letter of Intent are significantly different from a property owner’s Offering Memorandum. This may well be a sign that the party presenting the Letter of Intent may not be serious about completing the transaction, but this is not the way we conduct business!
CSO, COO, Co-Founder CPI Capital