In this video, we dive deep into the intricacies of property acquisition in real estate syndication. Tune in as we uncover the crucial role of the Letter of Intent (LOI) in the initial stages of property purchase. Learn why crafting a meticulously detailed LOI that aligns with the Purchase and Sale Agreement (PSA) terms is paramount for a successful transaction and the significance of understanding seller representations, prorations, fees, and the intricacies of earnest money.
HOST: Welcome to the “Syndication Closer”. I’m James Frazee. I’m here with Dugan Kelley, principal partner of Kelley Clarke, PC, We’ve been talking about what a new syndicator or a new real estate investor can expect when they come through our doors, focusing on the security side. Today on this episode, I want to focus a little more on the acquisition side. We often have clients who come through our doors with a similar situation: they have a letter of intent, they’ve found a property they want to buy, but now, what do they do?
Submitting a Properly Crafted Letter of Intent
DUGAN: Love it. So this is what we would call the beauty contest portion of the transaction. Often, when you’re looking to buy a property, there are other people trying to buy the same property. You’re trying to secure the property by submitting what we call an LOI or letter of intent. Often, it is non-binding, describing the terms you hope to see as a buyer in the upcoming purchase and sale agreement or PSA. We constantly help clients navigate this beauty contest phase of the transaction. Before you sell securities, you need to get the property accepted, and your LOI has to be accepted by the seller. Sometimes the seller won’t countersign your LOI, but it’s essential for the buyer to understand how vital a properly crafted LOI is. It allows you to describe the material terms you expect to see in the PSA. Not every term will be in the LOI, as they are often short and concise, typically one to two pages, serving as headings for what you hope to see.
Entering Negotiation: Customized Purchase and Sale Agreement
DUGAN: Assuming you succeed in the beauty contest, and your LOI is accepted, the next step is entering a negotiation mode. Your lawyers should assist in drafting, counter-drafting, making changes, and showing you the various changes between the PSA drafts, ultimately reaching a PSA that you’d want to sign as a potential buyer.
HOST: That’s a very important point you bring up. We’ve had clients come to us in the past who tried to handle the PSA negotiation process themselves, with mixed results.
DUGAN: Indeed, it’s not straightforward. When you’re buying large assets, like raw land, self-storage facilities, mobile home parks, apartment buildings, or properties costing millions of dollars, you’re dealing with a customized negotiated contract—the PSA process. Sometimes people use generic contracts or pre-fabricated forms they find online, which often lack essential components that both buyers and sellers want to see in their contracts. It’s crucial not to gloss over the negotiation process because even in seemingly smooth deals, issues can arise. I’ve never seen a deal in my 20+ years of practice that was perfectly smooth, without any questions, hurdles, or challenges. That’s why it’s crucial to ensure that your PSA can defend and back up your position as a buyer or seller. You shouldn’t rely solely on pre-fabricated forms; customization is often necessary, even if you have to use them initially.
What are Key Focus Areas of the PSA?
HOST: Let’s discuss some of the pain points in the negotiation of the final PSA. What should a prospective buyer be looking for?
DUGAN: That’s a great question. Clients often ask us what sections they should focus on in the PSA, which can be quite dense, ranging from 20 to 40 pages on average, sometimes longer depending on the property’s size and the parties involved. The key terms buyers should focus on include ensuring that the material terms in the LOI match the PSA. Surprisingly, the first draft of the PSA we receive from the opposing counsel often doesn’t align with the terms initially included in the LOI. These terms encompass aspects like the purchase price, closing timeline, document exchange, due diligence access, and more. It’s crucial to ensure that these terms align.
Additionally, buyers should pay close attention to the representations and warranties the seller is making regarding the property, due diligence documents, financial performance, and overall property status. In most cases, transactions are “as-is,” meaning the seller doesn’t make specific representations about the property unless explicitly stated in the PSA’s representations and warranties. Negotiating these terms helps establish clear expectations.
Other essential points include prorations for taxes, utilities, costs, delinquent rents, income, and expense allocation. Buyers should also consider fees, such as those related to title and survey, and who is responsible for paying the real estate broker, if applicable. These details are crucial, and even if a prefabricated form is used, buyers can negotiate and add necessary provisions via addendums.
Terms and Conditions of Earnest Money
HOST: Let’s discuss earnest money, a significant amount put at stake. Can you elaborate on the terms and conditions surrounding earnest money?
DUGAN: Absolutely, earnest money is a substantial amount in most transactions, often ranging from hundreds of thousands to over a million dollars. It’s typically held in escrow by a title company or escrow officer, depending on the property’s location. Understanding the refundability and triggering events for earnest money is crucial. Sometimes, disagreements arise between parties regarding when earnest money should be refunded. Title companies or escrow officers are neutral observers and cannot release earnest money over one party’s objection, even if it may appear to be in bad faith or erroneous. Legal mechanisms may be necessary to resolve such disputes.
It’s essential for buyers to have a clear understanding of earnest money terms and conditions, whether it’s refundable, and how to utilize these terms in the PSA. Don’t wait until issues arise; reach out beforehand to address potential roadblocks.
Schedule a consult if you’d like help with your LOI and PSA. Here to help you with all of your real estate syndication needs.