Commercial real estate transactions are often complex, involving large financial commitments, extended timelines, and professional advisors. Because of this complexity, parties frequently rely on preliminary agreements to structure negotiations before committing to a full purchase agreement. Among the most common tools used in these situations are letters of intent, option agreements, and rights of first refusal. Each serves a distinct role in managing risk, timing, and expectations, and understanding how they function can help parties approach commercial real estate transactions more effectively.
Before any document is drafted, it is important to understand the objectives driving the transaction. Although it may seem simple that a seller would want the highest price and a buyer would want the lowest price, commercial real estate transactions are usually more nuanced. In some situations, a seller may prioritize certainty and speed over maximizing price, preferring a quicker closing with fewer contingencies rather than a longer negotiation that could introduce additional risk. Buyers may also have different motivations depending on the strategic value of the property. Some acquisitions represent one of several potential opportunities and can be abandoned if negotiations become unfavorable. In other cases, a property may be uniquely valuable due to its location, development potential, or proximity to existing operations. In those situations, securing the property may be more important than eliminating every possible risk.
In many commercial real estate transactions, negotiations begin with a letter of intent, commonly called an LOI. An LOI is typically a short document outlining the key terms of a proposed transaction. Instead of immediately negotiating a lengthy purchase agreement filled with extensive legal terms, parties use an LOI to confirm they are aligned on the fundamental structure of the deal. An LOI generally identifies the parties, describes the property, states the proposed purchase price, and outlines the anticipated timeline for due diligence and closing. Because the document focuses on these core terms, it is usually much easier and faster to negotiate than a full purchase agreement.
The primary advantage of an LOI is efficiency. By agreeing on the key terms early, parties can avoid spending significant time and legal expense negotiating a detailed contract if they are not aligned on the structure of the deal. Once the main terms are settled, the formal purchase agreement can be drafted with greater clarity and fewer surprises.
Despite these advantages, LOIs also present risks. One of the most important considerations is whether the LOI is intended to be binding or nonbinding. Many parties assume that an LOI simply reflects preliminary discussions, but that assumption can lead to unintended consequences. If the document includes clear offer and acceptance language and does not explicitly state that it is nonbinding, it may be interpreted as an enforceable agreement. For that reason, the document should clearly define its intended legal effect. Another potential issue is that parties sometimes focus on the primary terms while overlooking unique aspects of the transaction that later become points of disagreement. Addressing unusual requirements or deal-specific concerns during the LOI stage can help prevent delays and complications later in negotiations.
In some situations, parties may not be ready to move forward with an immediate sale but still want to preserve the possibility of a future transaction. In these circumstances, an option agreement may provide a practical solution. An option grants a potential buyer the right, but not the obligation, to purchase a property within a specified period of time. In exchange for this right, the buyer usually pays the seller an option fee. This arrangement allows the buyer to secure the opportunity to purchase the property while completing other steps necessary for the transaction.
Developers often use options when additional time is required to obtain zoning approvals, secure financing, or finalize development plans before committing to a purchase. For sellers, the option fee can provide immediate income while preserving the possibility of a future sale. Because option agreements can last for extended periods, they must be structured carefully. The parties must decide how the purchase price will be determined, whether it will remain fixed or increase over time, and what conditions must be satisfied before the option can be exercised. They must also consider how changes in market conditions or unexpected events could affect the property’s value during the option period. Clear drafting helps ensure both sides understand their rights and obligations if the option is exercised.
Another contractual tool frequently used in commercial real estate transactions is the right of first refusal. A right of first refusal gives a specific party the opportunity to purchase a property before it can be sold to someone else. The right is usually triggered when the owner receives a bona fide offer from a third party. When that occurs, the holder of the right of first refusal has a limited period to decide whether to purchase the property on the same terms offered by the third party. Rights of first refusal often arise in broader business relationships, such as leases, development partnerships, or agreements between neighboring property owners interested in future land assembly.
Although rights of first refusal can provide meaningful protection, they can also complicate the sales process. Potential buyers may hesitate to negotiate an offer if another party has the ability to step in and match the terms of the deal. This dynamic can reduce competition and make it more difficult for the owner to market the property effectively. In addition, the holder of the right must accept the exact terms of the third-party offer, which may include provisions that were not specifically negotiated with that party. Careful drafting is therefore important to address issues such as the time allowed to exercise the right and whether the holder will have another opportunity if the third-party offer later changes.
Letters of intent, option agreements, and rights of first refusal each play a distinct role in commercial real estate transactions. Letters of intent help establish the framework for negotiating major deal terms, option agreements provide flexibility when additional time is needed before a purchase can occur, and rights of first refusal create opportunities to acquire property if it becomes available in the future. When these tools are carefully structured and clearly drafted, they help manage risk, structure negotiations more efficiently, and allow complex commercial real estate transactions to proceed with greater predictability.
Joseph Heck is an attorney at Fryberger Law Firm. He can be reached at Fryberger’s Cloquet office at (218) 879-3363.
The material in this article is for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem.
Fryberger, Buchanan, Smith & Frederick P.A.
