This article is a primer on Letters of Intent (LOIs) that are primarily used in the US to acquire multifamily and commercial real estate. We will also cover what LOIs are and how they are used.
A Letter of Intent is typically a non-binding document that outlines a framework for an understanding between two or more parties. This document also implies that the parties will work together to formalize a legally binding agreement in a real estate transaction.
Letters of Intent are used in the acquisition of properties, the leasing of properties, and also with the financing of properties. The purpose of a letter of intent is to get a meeting of the minds between the parties that will be transacting, which could mean a seller and a buyer of property, a landlord and a lessee, or even a lender and a borrower.
Assuming that a particular deal is in line with your investment thesis and that the returns meet your return expectations, you may decide to write a Letter of Intent, but I would like to show how to draft a thorough Letter of Intent.
A Letter of Intent is fundamentally just a business letter. At a basic level, you want to include your contact information, the date, and the person to whom the letter is addressed. The addressee is most likely the Seller directly or the broker.
Another thing that you should include is the address of the property with a brief description of the property including the name of the property and the address.
The next thing that you should include is your intended purchase price, the amount of your earnest deposit, and your due diligence timeframes. This would also be the area to include your contingencies, which are the due diligence and/or financing factors that would allow you to cancel the agreement without any penalty. The following are some areas that we outline that become contingencies:
- Title Review
- Building Inspection
- Rent Roll Review
- Lease Analysis
- Tenant Interviews
- Historical Operating Statement Review
- Copies of Property Tax Statements
- Environmental Analysis
Due Diligence items that are identified in the LOI will get translated to the Purchase Agreement. It is a way for the Buyer to let the Seller know that these are items that you want to review and to do analysis on prior to making a determination about whether the property and property related documents are sufficient to proceed as a Buyer.
There are a number of property level documents that you will want to evaluate. You will want to see operating statements, financials, tax statements, utility bills, and development costs (for a newly built property). You may want to see any communications that the Seller has had with the city and/or the municipality. You should also ask for copies of any third party reports that they have, which include environmental reports, engineering reports, mechanical reports, roofing reports, and any reports related to floods or seismic especially if the property is in a flood or a seismic zone. And if you can, it would be good to get a certificate of occupancy.
And in some cases depending on the property location and title requirements, you want to get any surveys that were done on the property. You don’t always need surveys with the title report, but it is important to try and get as much of this due diligence as possible.
During due diligence, you also should look at any employment agreements, service contracts, or maintenance contracts that may survive closing. And you want the Sellers to provide these reports in order to review them. You will likely also do new reports that will be addressed to you or your lender to rely on.
One of the most important things after detailing what due diligence you plan to complete is to let the Seller know your timeframe to complete the due diligence. I personally try to get 30 days of due diligence including physical inspeaction in my LOIs. An important differential in my LOIs is that I try to have due diligence start on the date that I receive all of the due diligence documents – not from the date that the PSA is signed, because many of the due diligence documents are time sensitive. I want to receive all the documents and then have my due diligence clock start thereafter.
Another thing that I do concurrently is start determining which lender partner to work with on the financing. For financing contingencies, I work hard to get 60-day financing contingencies, and the reason for doing so is that this has been a time period where lenders are moving more slowly due to being backlogged. The same is true for all the different vendors and all the different report providers. The financing process is taking time, and since I want to be confident that my financing is in place, I work hard to get longer financing contingencies with a reasonable time period to close. Once you feel like you can remove your financing contingency, I put in my LOI that I can close no later than 15 days thereafter.
If things are taking longer, Sellers will often times work with you to provide extensions, but I try and do the best that I can for myself and investors from a timing standpoint while also being reasonable with the seller.
In the LOI, I also address how the closing costs are paid, which is usually just customary for the county and the state in which the property is located.
In addition to all this, my Letter of Intent includes an expiration date. Often times, I have my Letter of Intent expire in 3-5 days. Assuming the Seller agrees, I also add a clause that the Seller won’t negotiate with anyone else for 14 calendar days because, at that point, I will be expending time, energy, and resource to put a Purchase and Sale Agreement together.
I also like to acknowledge whether the Buyer or Seller will draft the Purchase and Sale Agreement. Generally, I prefer to at least do the initial draft of the PSA.
A Letter of Intent addresses the main points that will be used to draft a purchase and sale agreement. Guardrail Finance has an example of a non-binding Letter of Intent that we use that is also available to members of the Passive Real Estate Investor Wealth Club, and you can access the LOI as part of your bonus materials when you become a member.