Commercial real estate investing is an entirely different animal than residential. Not only are the needs of both buyer and seller different from a standard single-family property purchase, but the requirements from your lender may be entirely new for you. One of these requirements may be what’s known as a Letter of Intent or LOI. If you’re new to this, you may be wondering, “What is an LOI, and what does it have to do with commercial real estate purchases?”
A Letter of Intent, also known as an LOI, lays out the terms of a loan before a mortgage is drawn or any due diligence is done. It is a working document drafted by a real estate buyer and their lender. Because of the high cost that comes along with commercial real estate, LOIs were created to ensure both buyer and lender are working in good faith.
I’ve found that real estate investors who are new to commercial property buying can get intimidated by the gravity behind a Letter of Intent. The truth is, LOIs protect you as much as your lender. In my opinion, it’s crucial that you understand what to expect ahead of time so that you’re equipped to negotiate terms that work for your business. So let’s first cover what commercial real estate even is, what you should expect to see in an LOI, and a few things I think you should keep an eye out for in your first LOI draft. Let’s dive in.
What is Commercial Real Estate?
First, I want to make sure we’re all on the same page regarding what “commercial real estate” means. You, as a real estate investor, might be interested in buying a single-family home to either fix & flip or rent out as a business, so it would make sense that this purchase is seen as “commercial.”
While it’s true that you’re using a house you intend to fix & flip for business (and, to some extent, commercial) reasons, your single-family home is not considered commercial property.
Commercial properties are pieces of real estate that are zoned for commercial, retail, or industrial use. Warehouses, office parks, storefronts are all considered commercial. Commercial real estate can also be designated as “industrial” property too, though not always. It depends on how your municipality zones buildings are meant for industrial or manufacturing use. Still, we’ll just consider industrial and commercial to be the same for the sake of this article.
I just mentioned that single-family homes are not considered commercial, even if they’re used for businesses. Houses generally fall under “residential” zoning (though there can be some mixed-use zoning, but that’s another topic for another day), as well as duplexes and triplexes.
Anything above a 4-plex is no longer considered residential but is instead categorized as commercial. If this is making your head spin, you’re not alone. Basically, consider anything that will house five or more families as “commercial.” However, it’s best to double check with your township or real estate agent ahead of time. That way, you’ll know what your investment will be zoned as so that you don’t get caught in any zoning issues that cost you money down the line.
What is a Letter of Intent?
Commercial properties typically come with some hefty price tags, so there’s a different process that comes along with getting a loan for commercial space than you’d have for residential.
One of these additional steps is getting what’s known as a “Letter of Intent” or LOI. A letter of intent basically says that your potential lender has received your proposal and is interested in working with you to acquire the property.
On your end, the LOI says that you as the buyer are interested in moving forward with your lender. It’s like a real estate version of “going steady” (do kids even say that any more?); you and your lender are both committing to putting in the work that will make this deal happen.
LOIs are pretty boilerplate, but it’s important that you and your attorney review the doc as thoroughly as possible. Your Letter should include:
- Address of the property
- Projected loan amount
- Amount the borrower is responsible for giving as a down payment
- Duration of loan. This can run anywhere from 1 to 30 years, so feel free to negotiate this as there’s no standard rate.
- Interest rate of mortgage
- Prepayment penalties
- Fine print. It’s absolutely critical you don’t skim over the actual terms and conditions listed in the “fine print.” Glossing over this could be detrimental to the success of your business so don’t take it lightly. Ask questions and keep asking until you have a thorough explanation of your rights and obligations.
Sometimes there may be a Letter of Intent for a residential property, but this is really only for high-ticket real estate transactions.
A Few Things You Should Know About Commercial Real Estate LOIs
Real estate Letters of Intent are a serious step you’ll take before closing on a property. That said, you shouldn’t be put off entirely from investing in commercial real estate because of these extra steps. Here are a few caveats you should be aware of before signing your LOI as they’ll work in your favor to protect you should something happen.
- LOIs are working documents – Terms may change based on new discoveries about the property, negotiations, or other reasons. Nothing is set in stone until you move forward with the lending process.
- LOIs are non-binding – If you feel the terms aren’t in your favor, then you’re within your rights to walk away from the table and go elsewhere. There may be fees associated with this, as it can vary based on your lender. This is why reading the fine print is so important.
- Your lender will not move forward with the loan process without one – Don’t think that your lender will be willing to skip this step and start the due diligence process. It takes a lot of work for them to fund million-dollar deals, so they’ll want their bases covered as much as possible. Once the LOI is agreed to, your lender will move onto the next steps, including appraisals, verification of details, documentation of issues, inspections, etc.
Letters of Intent with commercial real estate help protect everyone involved. It takes a lot of work on both ends to get a commercial property purchased, so having an LOI drafted ensures that all parties are coming to the closing in good faith. Don’t feel intimidated or insulted if your lender requires an LOI before moving ahead with your mortgage; it’s in everyone’s best interest to have the terms agreed upon ahead of time. Keep an eye out for the things I’ve mentioned above, and always feel free to ask for clarification before signing on the dotted line.
What things do you think other investors need to know about a Letter of Intent? Leave a comment and let us know.