After 18 years in commercial real estate, I’ve seen countless deals where confusion between a letter of intent and a purchase agreement has cost clients time, money, and sometimes entire transactions. Whether you’re a seasoned investor or new to CRE deals, understanding the fundamental differences between these two critical documents can make or break your next commercial real estate transaction.
Key Takeaways
• Letters of intent are typically non-binding preliminary agreements that outline basic terms and allow parties to negotiate in good faith before committing significant time and resources into drafting a formal purchase agreement
• Purchase and sale agreements are legally binding contracts that include detailed terms and conditions, contingencies, and enforceable obligations for both buyer and seller in commercial real estate transactions
• Understanding when to use each document can save you time, money, and potential legal complications while providing the appropriate level of commitment for different stages of your CRE deal
What is a Letter of Intent in Commercial Real Estate?
A letter of intent (LOI) in commercial real estate serves as a roadmap for potential transactions between buyer and seller. Think of it as a preliminary agreement that outlines the key terms of a proposed deal without creating the full legal obligations of a binding contract.
The LOI helps parties agree upon basic terms before investing significant time and resources into drafting a comprehensive purchase and sale agreement. Most importantly, LOIs are typically non-binding, meaning either party can walk away without legal consequences during the negotiation process.
Key Components of a Commercial Real Estate LOI
When I draft an LOI for clients, it typically includes:
Purchase Price and Terms: The proposed purchase price and basic financing structure, though these can be adjusted during due diligence
Property Description: Clear identification of the real property being considered for purchase or lease
Due Diligence Period: Timeframe for the buyer to inspect the condition of the property and review important details
Exclusivity Period: Period during which the seller agrees not to negotiate with other potential buyers
Contingency Clauses: Basic conditions that must be met for the deal to proceed
Closing Timeline: Proposed closing date and key milestones
The beauty of an LOI is that it allows both parties to test the waters. The buyer can outline their intentions without full commitment, while the seller gets a sense of serious interest and deal terms.
What is a Purchase Agreement in CRE?
A purchase and sale agreement (PSA) is the formal, legally binding contract that governs a commercial real estate transaction. Unlike the preliminary nature of an LOI, a purchase agreement creates enforceable obligations for both parties and serves as the definitive legal document for the real estate purchase.
When parties sign a binding purchase agreement, they’re committing to specific terms and conditions with real legal and financial consequences. This binding contract typically comes after successful LOI negotiations and initial due diligence.
Essential Elements of a CRE Purchase Agreement
A comprehensive purchase and sale agreement includes detailed provisions covering:
Detailed Property Description: Precise legal description of the real property, including all fixtures and improvements
Purchase Price and Payment Terms: Final agreed-upon price, earnest money requirements, and payment structure
Closing Procedures: Specific closing date, location, and required documentation
Title and Survey Requirements: Title insurance, survey conditions, and resolution of any title issues
Environmental and Inspection Contingencies: Detailed inspection procedures and environmental assessment requirements
Default and Remedy Provisions: What happens if either party fails to meet their obligations
1031 Exchange Accommodations: Special provisions if the transaction involves like-kind exchanges
Lease Assignment: For income-producing properties, detailed lease assignment procedures
Key Differences Between LOI and Purchase Agreement
Understanding the fundamental differences between these documents is crucial for any successful commercial real estate transaction.
Binding Nature and Legal Enforceability
The most significant difference lies in their legal enforceability. While an LOI may contain some binding provisions (like confidentiality or exclusivity), the core deal terms are typically non-binding. A purchase agreement, however, creates fully enforceable legal obligations.
I always advise clients that once you sign a binding purchase agreement, you’re legally committed to the transaction under the agreed terms and conditions. Breaking a purchase agreement can result in loss of earnest money, legal action, or other significant financial consequences.
Level of Detail and Specificity
LOIs outline basic terms in broad strokes, while purchase agreements dive deep into every aspect of the transaction. An LOI might simply state “subject to satisfactory due diligence,” while a purchase agreement will specify exactly what inspections are required, who pays for them, and what constitutes satisfactory results.
The contrast is like the difference between a sketch and a detailed blueprint. Both serve important purposes, but at different stages of the process.
Time and Resource Investment
Drafting an LOI typically takes days, while negotiating and finalizing a purchase agreement can take weeks or months. The LOI allows parties to determine if they’re in the same ballpark before investing significant time and resources into comprehensive legal documentation.
This efficiency is particularly valuable in competitive markets where speed matters, or when dealing with complex transactions involving multiple parties or special considerations like mergers and acquisitions structures.
Flexibility and Negotiation
LOIs provide maximum flexibility for ongoing negotiations. Since the core terms are non-binding, parties can adjust deal terms based on due diligence findings or changing market conditions. Once you have a binding purchase agreement, modifications require formal amendments agreed upon by both parties.
When to Use Each Document in Your CRE Deal
Start with an LOI When:
Testing Market Interest: You want to gauge seller motivation and willingness to negotiate without full commitment
Complex Transactions: The deal involves multiple properties, special financing, or merger and acquisition elements
Competitive Situations: You need to establish exclusivity quickly while working out details
Early Stage Negotiations: You’re still determining feasibility and need time for preliminary due diligence
Build Relationships: You’re establishing a business relationship with a new counterparty
Move to Purchase Agreement When:
Terms are Settled: You’ve agreed on all major business terms through LOI negotiations
Due Diligence is Complete: You’ve completed initial property inspections and are ready to commit
Financing is Secured: You have loan pre-approval or confirmed funding sources
Timeline is Critical: You need enforceable deadlines and obligations to ensure closing
Legal Protection is Essential: You need full legal recourse if the other party defaults
Common Mistakes to Avoid
In my experience, these are the most costly mistakes I see in CRE transactions:
Making LOIs Too Binding
Some buyers and sellers try to make LOIs overly detailed and binding, which defeats their purpose. An overly complex LOI can be as time-consuming as a purchase agreement without providing the same legal protections.
Skipping the LOI Process
Jumping straight to a purchase agreement without an LOI can lead to wasted time and legal fees if fundamental deal terms aren’t aligned. The LOI serves as an important testing ground for compatibility.
Inadequate Legal Counsel
Both LOIs and purchase agreements should be reviewed by experienced legal counsel familiar with commercial real estate transactions. What seems like standard language can have significant implications.
Misunderstanding Exclusivity Periods
Sellers sometimes grant excessively long exclusivity periods in LOIs, while buyers may not request adequate time for proper due diligence. Finding the right balance protects both parties.
Ignoring Market Conditions
In hot markets, sellers may prefer to skip LOIs and go straight to binding offers. In slower markets, LOIs become more valuable for testing interest and negotiating better terms.
FAQs
Can an LOI become legally binding even if it’s labeled non-binding?
Yes, courts can sometimes enforce LOI terms if the language and party conduct suggest intent to be bound, regardless of a “non-binding” label. This is why clear, unambiguous language is crucial in any LOI.
How long should an exclusivity period be in a commercial real estate LOI?
Exclusivity periods typically range from 30-90 days, depending on transaction complexity and due diligence requirements. Simple transactions might need only 30-45 days, while complex deals involving environmental assessments or zoning changes may require 60-90 days.
What happens if property conditions change between LOI and purchase agreement?
This depends on how the LOI is structured. Well-drafted LOIs include provisions allowing for price adjustments or contract termination based on material changes in property condition or market circumstances discovered during due diligence.
Should earnest money be required at the LOI stage?
Generally, no. Earnest money deposits are typically made when signing the binding purchase agreement. However, some LOIs may require good faith deposits, especially in competitive situations or when requesting extended exclusivity periods.
Can I use the same attorney for both LOI and purchase agreement drafting?
Absolutely. Using the same legal counsel for both documents ensures consistency and can be more cost-effective. Your attorney will understand the transaction history and can efficiently transition from LOI terms to comprehensive purchase agreement language.
Conclusion
Understanding the differences between LOI vs purchase agreement CRE documents is fundamental to successful commercial real estate investing. While LOIs provide flexibility and protection during early negotiations, purchase agreements create the binding commitments necessary to complete transactions.
Ready to navigate your next commercial real estate transaction with confidence? Tolj Commercial would be happy to discuss how these documents can work best for your specific situation and investment goals. Schedule a consultation to explore how Tolj Commercial can help you achieve your real estate objectives.
