When an investor receives an initial request to finance a project and agrees to consider the proposal, sometimes the individual making the proposal mistakes initial interest with a firm commitment, especially those who are relatively new in real estate development and rehabilitation. In this article, we’ll letter of intent and commitment letterdiscuss the differences between a pre-qualification, a Letter of Intent and a Commitment Letter.

The initial conversation typically starts with a phone call between the developer and the investor where the project is generally described. This is the prequalification stage where the investor determines whether or not the project matches the investor’s internal guidelines. Private investors can lend on most anything but will have minimum requirements. Primarily the proposal needs to make sense, the investor is familiar with such projects and there is a clear exit strategy presented.

If the proposal makes it past the prequalification stage, the investor will ask for an application, financials and a written business proposal. From this, the investor prepares a Letter of Intent, sometimes referred to as a Letter of Interest. This letter identifies both parties involved and spells out what needs to take place and the expectations of the investor for the project. This is where initial confusion comes into play. A letter of intent is not a legally binding document, it is simply a formal expression of interest and spells out the investor’s expectations and understanding of the project. During this time, it is expected of the developer to halt solicitation of third parties for funding.

Finally, if both parties agree, the investor will compose a Letter of Commitment. This letter is in fact a legal document spelling out how and when the investor will finance the project. This is completed after a thorough review and an underwriting of the project and typically only falls through if there are newly-discovered inspection issues, the property fails to appraise or there are issues with title that cannot be cleared prior to closing. The next and final step is funding where the investor wires the funds and the project begins.