This article is part of our guide on passive investing in multifamily via syndication, available here.
A typical real estate transaction involves a lot of paperwork and contracts. Many buyers tend to be hesitant until they have everything checked out, but a seller wants to gauge your intent on purchasing their property. At the same time, they may not be willing to walk away from the deal.
This is where an LOI comes in. This document shows the commitment of one party to do business deals with another and establishes the terms of the deal.
So, what does LOI stand for? Who initiates it, and what does it contain? We’ll talk about that and more in this article.
What Does LOI Stand For?
LOI is an acronym for Letter of Intent. An LOI could also be referred to as a memorandum of understanding (MoU), heads of agreement or statement of intent.
So, what does LOI mean?
What does LOI mean?
A letter of intent is a preliminary document where two parties agree to do business with one another. These legal documents state the primary terms of the expected deal. The terms include the deal points as well as the introductory economics.
In commercial real estate, LOIs are negotiated between buyers and sellers. Each party outlines its requirements in the document so that the other party can decide whether they want to proceed with the formal contract.
Many investors think letters of intent are synonymous with term sheets. While both are similar in content, LOIs are written in letter formats. On the other hand, a term sheet is presented in a listicle format and is not legally binding.
Is letter of intent legally binding?
A letter of intent is naturally a non-binding agreement. However, some clauses or provisions in the agreement may be binding. The agreement should state which sections are binding while indicating that it’s not a definitive contract.
In short, a Letter of Intent can be binding depending on its contents and how it’s drafted. While it’s not binding, it does show commitment from the parties involved and the terms they should abide by.
The main idea behind a Letter of Intent is to have the involved parties reach a mutual agreement before the details have been worked out. Once the details have been worked out, the parties sign a formal contract, which becomes binding.
Good Read: What is a T-3 in Real Estate Investing?
Who initiates a letter of intent?
Different parties can initiate the Letter of Intent for various purposes. However, in most cases, buyers initiate the agreement. Whoever initiates an LOI has the upper hand since they can decide:
- What terms will be addressed in the agreement
- What clauses are binding
- How detailed the letter will be
For example, if the buyer initiates the agreement, it can give them the “right of first refusal”. Meaning the seller isn’t allowed to enter into a formal contract with another buyer if they’re yet to reach an agreement with the primary buyer.
Besides setting a foundation for a possible final agreement, the LOI also gives the buyer a little more leeway to start conducting preliminary due diligence on the property to assess the deal further.
If the buyer wants the property off the market but is not yet ready to put down the earnest money, they can initiate an LOI. It may serve them well since there may be a provision for the seller to stop all other negotiations and wait for the buyer to make a step ahead. In this case, however, the buyer should know that the agreement locks them into making a move.
The property seller or landlord can also initiate a letter of intent to show the potential buyer or tenant that they are ready to sell or lease the property. They may require the prospective tenant to hand in their financial statements so they can verify whether the tenant is financially capable.
What happens if you break a letter of intent?
While a Letter of Intent may be non-binding, it’s essential to tread carefully. If you break a letter of intent, you may expose yourself to liability. Depending on the terms stated in the LOI, the other party may sue you if you breach the agreement.
So, how do courts interpret letters of intent?
There are mainly two factors that courts consider when determining whether the agreement is binding:
- The terms stated in the LOI and the demonstrative actions both parties take after the agreement is signed. If both parties consider the agreement a contract, it’s ruled binding.
- If the buyer and seller have signed an obscure agreement but have previously had non-binding agreements, the court might rule that the recent one is also non-binding.
Frequently Asked Questions About the LOI Abbreviation
Yes, a letter of intent must be signed by both parties. This means that the whole process may involve a couple of revisions for both parties to be satisfied. A third party, preferably your real estate broker or attorney, should also witness the signing.
The broker, buyer, or attorney can draft a commercial real estate LOI. Typically the buyer would draft the LOI and submit it to the seller of the prospective property.
What Does LOI Mean - Conclusion
A letter of intent is an agreement between a buyer and seller or a landlord and a tenant. It’s used to show commitment to a deal and includes the core items each party needs to adhere to before proceeding to a formal contract.
While an LOI is primarily a non-binding agreement, it can be binding depending on the terms and how it’s drafted. If it’s intended to be non-binding, the parties should include disclaimers stating such. Mostly, LOIs are initiated by buyers to get the commercial property off the market. However, a landlord or seller can also initiate the agreement to show that they’re ready to lease or sell the property.
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- Investopedia, “Letter of Intent”
- Investopedia, “How Legally Binding Is a Letter of Intent?”
- The Balance Small Business, “What Is a Letter of Intent?”
- CARR, “What Is an LOI? | What Does a Letter of Intent Mean?”
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