Good intentions | Working through a detailed letter of intent early can increase the chances the final contract will be signed
Do we have a deal or not? So many real estate negotiations start off with good intentions and the makings of a deal, only to get crushed by egos, disagreement about business terms, miscommunication or petty differences that add up to big issues. There are too many ways to kill a deal, so I won’t bother to list them all here. I’ll save that list for my memoirs. Instead, let’s discuss how to keep a deal intact and bring parties together to consummate a transaction. â&Copy;
For the purposes of this discussion, we will focus on a lease transaction. One of the most important ways to unite a landlord and a tenant on a commercial transaction is a letter of intent, or LOI. In fact, a non-binding LOI laying out the details of the agreement before it is finalized can often mean the difference between smooth or tumultuous lease negotiations. If all of the parties (brokers, tenants and landlords) spend more time upfront with a detailed LOI addressing important transaction points, the entire process becomes easier and less likely to crash and burn at the 11th hour. So how do you craft an effective letter? Here are some key points to consider:â&Copy;
Even the most basic LOI will address the most important element — the price. If the price is good, everything else is good, right? Not quite. Let’s take an office building, for example. Let’s say a 20,000-square-foot space is available in a 60,000-square-foot, multi-tenanted building. The rest of the building is full, but this available space is on the top floor and it is the nicest spot in the building. The prospective tenant, a preeminent architecture firm in the area with excellent credit, knows this landlord wants a quality anchor to fill this large vacancy. The architecture firm’s occupancy needs fit the building and the location is good. When they make an offer using an LOI, they address the primary business points — price, total square footage, length of term, start date, build-out requirements, number of options to renew and parking requirements. These are certainly the big-ticket items, but it still leaves a host of issues unresolved. The firm should also address lease guarantees, the tenant’s financial capacity and an agreement on determining renewal rate structure. If work will need to be done on the space, the LOI should include a floor plan with a description of related costs to the tenant and landlord, a date of completion of work and a contingency plan if work is not completed. Addressing details like these early is critical.â&Copy;
Letters are for landlords, tooâ&Copy;
Similarly, the landlord needs to fully understand the deal he or she is signing up for. I often see landlords insert language in the build-out paragraph like “subject to confirmation of costs,” or “build-out to be provided as described herein with a cap on the landlord allowance of up to X dollars.” Another very common point to address is the allocation of costs for operating expenses. An LOI should very clearly spell out who is paying for utilities, real estate taxes, insurance, landscaping, maintenance, snow removal, management fees, etc. The description of how these costs are allocated also comes up in the calculation of a tenant’s square footage costs and what percentage of the building it occupies. Determining these guidelines up-front causes less confusion and disagreement during lease negotiations when both parties are spending legal fees.â&Copy;
A final word of caution on LOI — be sure the letter is clearly worded to reflect future intentions. A critical part of differentiating between a binding contract and a non-binding letter of intent is the utilization of the future tense and language such as, “the parties will seek to reach agreement on” instead of language you’d see in a binding contract, like, “the parties hereby agree to.” Another important feature of the LOI is a well-crafted disclaimer at the end of the letter that confirms it is a non-binding document and is subject to negotiation and terms to be agreed upon in a lease that will be a binding document between the parties. I have seen language in the last paragraph of an LOI to the effect of, “This letter of intent represents the preliminary understanding of the parties with respect to the proposed lease. This letter is not intended to constitute a binding or enforceable contract, nor does it constitute a legal obligation on either party. Further, the basic terms set forth are subject to both parties entering into a mutually agreeable written lease agreement to be fully executed by both landlord and tenant.” â&Copy;
It may seem that a closing paragraph such as this negates all of the other terms in the letter, but in my experience both parties tend to gravitate back to the “preliminary understanding” of the deal when they are in the midst of lease negotiations, and it becomes a guide for finalizing a lease. Neither party is under obligation to the other, but there is typically buy-in once both parties have signed an overview of the terms. It’s still no guarantee of avoiding deal-killer pitfalls, but a strong letter of intent does go a long way. â&Copy;
Drew Sigfridson is a commercial real estate broker with CB Richard Ellis/The Boulos Co. in Portland. He can be reached at editorial@mainebiz.biz.
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