Letter of Interest – Key Elements You Need to Get Your Offer Accepted
Finding good deals in commercial real estate is paramount to a real estate investor’s success. Regardless of what some people think, a property’s financial success is not determined when the property is sold, but really when it is purchased. You do not want to overpay for a property. Hence, when you find one that you think fits the mold of your criteria, you need to act fast.
Unlike residential real estate where a buyer submits an offer via the purchase and sale agreement, the first step in the commercial world is to typically provide the buyer with a Letter of Interest (LOI). This document, also known as a Letter of Intent, is used to indicate your interest in a property. We use LOI’s all the time when we want to buy a multi-family property. It is a quick and effective way to tie up the property. These documents need to be clear, concise, and fair.
The Letter of Interest identifies the key elements of your offer to purchase the asset. It’s really a good faith effort to outline your terms & conditions prior to submitting a Purchase and Sale Agreement (PSA), which is the contract for the sale of the property. It is usually much shorter that a PSA and tends to not have the formal and legal language of a contract. Plus it doesn’t have the cost attached to it if you do need a lawyer to create or review your Contact. You don’t want to sink money into legal fees before you know you can strike a deal with the seller.
Think of an LOI like a resume. When you apply for a job you highlight on your resume your best qualities and experience to show you can do the job well. A Letter of Interest is no different. You want to highlight the key aspects that you think will get the owner excited to accept your offer. Anything you can identify that will give them confidence that you can close on time, goes a long way in them accepting your LOI.
This is especially important as most LOIs are not contractually binding. This means the seller can accept letters from other parties and can change his/her mind on our LOI. As a result, it’s important to put your best efforts forward, especially when suspect there is a lot of competition. Always remember though, no matter how badly you want a property, you cannot let your emotions dictate your offer!! You never want to pay more for the property than it is worth. If you run your financials properly, you will know what the maximum strike price is for the property. If the numbers don’t work, walk away. There will be other deals.
One advantage of a letter of Interest is it lets the buyer keep their earnest money deposit until they know a deal will work for them and the seller. The earnest deposit then only needs to be submitted when the PSA is signed and accepted. Depending on the size of the property, the deposit can be substantial, so you don’t want to provide funds earlier than necessary.
A LOI is a good place to start with a seller as it is essentially a preliminary agreement that is established before negotiations begin. Then, if both parties agree to the terms in the letter, as a seller you have more confidence that you can close the deal at a price that you can accept.
Following that, the next step is to submit a purchase and sale agreement which is a legally binding contract.
There is one key thing I’d like to point out here. Just because both parties agreed to a purchase price, doesn’t mean it will necessarily be the final price. With Multi-family real estate, the real negotiations begin after the PSA is signed. Should your investigation of the property’s physical and financial health during due diligence require you to lower your offer, then you have every right to request a lower price if you can provide sufficient justification. Many people don’t realize that that you can negotiate the price after a contract is signed.
You may have noticed that above I stated that most LOIs are non-binding. I say most because that is the usual intent these letters. It really depends on your strategy. It all comes down to what language you put into the letter. If you wish there to be contractually binding elements in the Letter of Interest you can do so. If both parties want the document to be binding; it can be. For example, the letter could blatantly state….” The parties intend this letter agreement to be binding and enforceable.”
Knowing this, when a Letter of Interest is executed it’s very important to pay close attention to the language to see whether there is an intent to bind you to something before the PSA. Most times both parties do not want to be bound until certain conditions are met, such as an inspection or financing are met. Due diligence discoveries and financing are usually the two key things that can kill a deal. Sometimes potential buyers will back out of a deal if they don’t like the results of their physical and financial inspection of the property. Also, a potential buyer could love what they see after their due diligence, but if they can’t get the financing necessary to close the deal, it won’t happen.
Let’s take a look at the main components of a Letter of Interest that should be included if you want to get it accepted.
- Transaction description; The address(es) of property & legal land description(s). Sometimes, properties are bundled or made up of multiple buildings; hence it’s important for buyers to ensure all addresses are included.
- Purchase price. How much you are willing to offer for the property. Usually your offer is based on selective information provided by the seller such as income and expense.
- Financing Terms: How long you need to secure financing for the purchase (30 days, 60 days etc. It’s important to give yourself enough time. This is especially important if you do not have your financing in place. It can take 30+ days for lenders to underwrite the deal and let you know if they will or won’t finance your deal.
- Deposit (earnest money deposit): The amount of money you will submit as a deposit on the property after the Contract is signed. It is a good faith exercise. If you close on the property the deposit goes towards the purchase price. Should you wish to back out of the purchase, the deposit is returned to you as long as you request it back before the earnest money deposit goes hard which is usually the last day of your due diligence period.
- Inspection Period (due diligence): Amount of time you need to perform your physical and financial due diligence on the property. Depending on the size and condition of the property due diligence can range from 30 -90 days. Due diligence is an intensive process. The more units in the property, the more in-depth inspection you need to perform and the more financial data you need to review (rent rolls, expense reports, etc.). It is Important for potential buyers to ensure they ask for enough time for them to be comfortable with their due diligence efforts. Yet not too long to annoy the seller, who, many times is probably eager to sell quickly. They don’t want the property to be tied up for too long.
- Purchase and sale Agreement deadline: PSA to be approved in X number of days of execution of the LOI. It identified how fast the contract needs to be completed once LOI is accepted.
- Closing date: When you expect to close after financing has been secured or when your due diligence period has expired.
- Commissions/Brokers fees: Where you advise the seller whether or not you are represented by a broker. If so, identify how commissions will be handled.
- Signature blocks for seller and buyer: This is pretty self-explanatory. Just get it signed!
The Letter of Interest is a great tool that potential buyers can use to help acquire a property. Regardless of what it contains, it needs to be clear.
If you want to learn more about a letter of interest or how real estate investing can benefit YOU, then contact us.
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