A properly written letter of intent, or better known simply as an LOI, can prove to be invaluable in negotiating lease terms with a tenant. Not only does it save time, but it avoids costly mistakes or misunderstandings later on when the final lease is drafted. The clearer the negotiations are from the beginning the more effective you can be as a building owner, and ultimately, secure a lease that may last for many years to come.
An LOI is not a binding agreement, but instead, it's a tool used to negotiate terms without the fear of committing yourself before all of the information is made available. Unless a lease is signed, both parties can walk away without owing any damages to each other. Also, you don't want to find yourself drafting an entire lease only to find out later that the tenant didn't agree to terms or their financials came back with less than favorable results. Then it's back to the drawing board and dealing with this hefty document.
Another point to keep in mind is that an LOI can come from either the landlord's side or tenant. Typically, when a tenant is being represented by a Realtor, the Realtor will submit the LOI on behalf of the tenant. Usually, an LOI submitted by a Realtor will have all or most of the information you need for a successful negotiation. And of course, anything missing could be added by hand and used as part of the negotiation.
However, if you find yourself negotiating with a tenant directly, chances are that the tenant is not well versed in putting together a proper LOI. Information will be missing, specific legal language ensuring that the letter is not binding won't be found, and a number of details that are crucial for an effective negotiation may simply be omitted. So, it's best to have your LOI ready ahead of time for this very likely event.
Let's start with the body and closing of the LOI. There must be language stating that the agreement is not binding and that it is only being used as a tool for negotiation. This is very important and can not be overlooked. Although I will go over the basic components of what is necessary to negotiate terms, be it rental rate, lease term, renewals, etc. you will need to have an attorney draft the language necessary that will be found in the main introductory body of the LOI and summary paragraph.
This being said, let's look at the underlying key negotiation terms that every well constructed LOI should have. These items will be the same whether it's an LOI from a tenant or from a landlord.
An LOI is not a binding agreement, but instead, it's a tool used to negotiate terms without the fear of committing yourself before all of the information is made available. Unless a lease is signed, both parties can walk away without owing any damages to each other. Also, you don't want to find yourself drafting an entire lease only to find out later that the tenant didn't agree to terms or their financials came back with less than favorable results. Then it's back to the drawing board and dealing with this hefty document.
Another point to keep in mind is that an LOI can come from either the landlord's side or tenant. Typically, when a tenant is being represented by a Realtor, the Realtor will submit the LOI on behalf of the tenant. Usually, an LOI submitted by a Realtor will have all or most of the information you need for a successful negotiation. And of course, anything missing could be added by hand and used as part of the negotiation.
However, if you find yourself negotiating with a tenant directly, chances are that the tenant is not well versed in putting together a proper LOI. Information will be missing, specific legal language ensuring that the letter is not binding won't be found, and a number of details that are crucial for an effective negotiation may simply be omitted. So, it's best to have your LOI ready ahead of time for this very likely event.
Let's start with the body and closing of the LOI. There must be language stating that the agreement is not binding and that it is only being used as a tool for negotiation. This is very important and can not be overlooked. Although I will go over the basic components of what is necessary to negotiate terms, be it rental rate, lease term, renewals, etc. you will need to have an attorney draft the language necessary that will be found in the main introductory body of the LOI and summary paragraph.
This being said, let's look at the underlying key negotiation terms that every well constructed LOI should have. These items will be the same whether it's an LOI from a tenant or from a landlord.
- Landlord and Tenant names: As they would appear on the final lease.
- Property and unit address: Make sure to include suite numbers and or specific address for the space being rented. Some units have their own specific address rather than one address for the whole building separated by suite or unit numbers. If several models were submitted to a tenant to choose from, this helps in ensuring the correct property is being negotiated.
- Lease term: Be specific on the length of the lease and periodic rental increases. Be sure to specify if the lease increases based on a fixed percentage or the CPI index.
- Renewal Options: If your goal is to have the tenant long term, it's a good idea to include a renewal option to the lease. All options should be initiated through written notice preferably by certified mail within 90 but no more than 60 days before the least end date. The exact terms of the renewal can be negotiated at the time of the lease. The option should also include language with a time limit to accept an offer from the landlord with the new terms.
- Base Rent: This is the rent due before any other charges are applied including possible pass through expenses such as Property Taxes, Insurance, and Common area Maintenance. Be sure to make a note that the base rent is subject to applicable sales taxes.
- NNN Cam Expenses (Triple Net): As mentioned on item 5, these are the pass through expenses for the property. Depending on the type of lease these expenses will vary. This could include property taxes, insurance, and common area maintenance expenses or a combination thereof. It is possible that there are no expenses charged separately so in this case you would just write N/A and leave it as is. This is typical with Gross leases as the landlord assumes all of the expenses with a given base rent.
- Advance Rent / Security Deposit: Any advance rents or security deposits should be detailed as well as specifying for which term these deposits are being applied.
- Utilities: Here you would specify which party is responsible for utility expenses for the particular unit they are renting. Some scenarios may call for the landlord to pay a portion of utilities. This is most common in office buildings with a common area bathroom, and shared A/C expenses. With retail, utility expenses are normally the responsibility of the tenant.
- Delivery Condition: In most cases the space will be delivered as-is. There are however instances where a landlord will make improvements to the space prior to delivering possession. This is most commonly found in office buildings and improvements usually include new carpet, painted walls, and minor buildout arrangements.
- Tenant's work: A tenant may want to modify the space for their specific use. It's important to describe at least a general description of what the tenant plans on doing to ensure the expectations of both parties are met.
- Maintenance & Repair: Specify what maintenance items should be performed by the tenant. If the tenant is responsible for the maintenance and repair of the A/C unit, this is the time to disclose and get this matter out of the way. Although there will be mention of this in the lease, it's always good to get this matter resolved way ahead of the game and not when you have a lease and time spent qualifying a tenant, only to find out that they have an issue with this particular item. It's not uncommon for the tenant to take care of maintenance and to some degree repairs, but it's the replacement that becomes an issue. And with a new A/C unit easily costing over $3,500, you want to be clear from the get go how this will be handled once it happens.
- Insurance: Tenants need to carry liability insurance for their business. If someone walks into the space and hurts themselves, it could result in a lawsuit against the landlord. And if the tenant does't have insurance, chances are that the insurance company will not cover the landlord because tenant insurance coverage is usually a pre-requisite to any investment property. Make sure the tenant knows ahead of time what type of insurance and policy minimum coverage are needed to qualify on your rental.
- Assignment and Subletting: Specify whether the tenant may be allowed to sublease or assign the lease to another party. Perhaps the tenant is in the business of starting businesses then selling them. Or, the tenant may have financial hardship in the future and the only out is to sublease until the lease term runs out or sell the business and assign the lease to another party.
- Permitted Use: Every lease has to specify the uses allowed by the tenant. This is very important for a number of reasons. You need to have control of what business activities are being run in your building. If a tenant starts with one business and then goes on to another business model all together because the first idea wan't working out to well for them, it could pose a problem with the local zoning authorities, neighboring tenants, and possibly code enforcement. Be specific and keep it limited. If working with a franchise, the franchisee may have an addendum or rider to the contract that would expand or clarify this area in more detail. Make sure to make a note of this and request a copy well in advance.
- Exclusive Use: This is most commonly found in retail use. Tenants will usually require that their use be the only one allowed in the shopping center to alleviate some competition. Some landlords don't allow exclusivity so it's good practice to disclose this at this stage of negotiations.
- Tenant's signage: One area that is usually missed is signage criteria. This is another area that is very important to clarify ahead of time. Most tenant are unaware of building codes and perhaps restrictions imposed by landlords to ensure that all of the signs meet a certain criteria. This would include the type of sign, color, font, location, and even as to how and when a sign can be or should be installed.
- Operations: Aside from the use restrictions, it's important to know what type of operations the tenant will be running. Sometimes the use can have different meanings in different scenarios so it's best to be more specific and describe in general what the business will be doing. For example, you can have a use for a Dry Cleaner, however, this could either by a pick up and drop off location or they could be cleaning the clothes on site. Depending on restrictions imposed by the local municipalities, this could greatly affect a tenant's ability to open his doors to the public.
- Tenant financials: Describe exactly what you will need to qualify the tenant. This could be a number of things or just one item. Some landlords require financial statements, credit reports, bank statements, rental history, and a number of other items they feel may be necessary to approve the tenant's application. Specify which of these items you will need for a quick and expedient approval.
- Expiration: The LOI must have an expiration date. The terms negotiated or potentially negotiated can not stay open indefinitely. This also gives the tenant a sense of urgency to review and respond to the LOI in a timely manner.
- Brokers: The tenant may be represented by a broker and they will be due a commission. It's always good practice to name any brokers in the transaction to avoid problems later. The lease should also make reference to this and disclose if there are any renewal fees owed to the brokers.
- Lease Form: The landlord will provide the lease form. A simple "Landlord's lease form" will be sufficient. As a landlord you should always use a lease drafted by your own attorney with terms in your favor. At the very least the tenant will know that this is not something they will need to be concerned with and it establishes the lease procedure early on.
- I hope this breakdown of a Letter of Intent has proven helpful and will be a good start in your negotiations with future tenants or landlords. I can not stress enough how important it is to establish the proper communication from the beginning. Putting it all in writing is essential for an effective and less stressful negotiation and ultimately a well drafted lease. This system has served me well on numerous negotiations throughout the years and I'm sure it will help you as well.
www.allrealtymanagement.com
written by: Victor A. Abreu