Showing posts with label international real estate fraud. Show all posts
Showing posts with label international real estate fraud. Show all posts

Thursday, August 7, 2014

Shelf corporations in international real estate transactions


Grand Cayman's famous Ugland House, the address of 19,000 corporations






Most readers know what shell companies are. Many offshore locations, such as British Virgin Islands, Cayman Islands, and Cyprus are known for harboring shell companies because of their privacy laws, and shell companies are sometimes used for illicit purposes, tax evasion and money laundering.

But wait! This Wyoming office building houses 60,000 corporations.






A “shelf corporation” is an aged shell company that has a multiyear history of being in business and may also have a credit history and bank account, but no other assets or income. Shelf corporations are created by third party vendors to sell to buyers seeking a misleading history of credit and longevity for their own new enterprises. These shelf corporations are offered for sale on the Internet. Just do a Google search of “shelf corporation for sale” and you will find many shelf corporations that are legally created in the U.S., in states such as Nevada, Wyoming and Delaware, which promise privacy, secrecy, and protection from litigation. Named directors of these corporations are often down-on-their-luck individuals who consented to sell their names just like they would sell their blood to blood banks.

There are legitimate uses for shelf corporations, too, such as the ability to rapidly start up a business in a state that has a lot of red tape for start-ups.

Since most of my work is for lenders, though, I see the seamier side of this business. If the lender has made a loan to a shell or shelf corporation, and the loan defaults, the lender ends up trying to recover their money from a corporation which has no assets, no income and no accounts receivable.

I am sometimes confronted with purchase contracts in which the seller or buyer, or both, are LLCs, shell corporations or shelf corporations, leaving me unable to judge whether the purchase is an arm’s length transaction (a sale to unrelated parties). As an appraiser, however, I can only estimate a value supported by market data, and if the transaction is not arm’s length, it will become obvious. Many other appraisers will try to “hit the purchase price”, any way, with strange selection of or adjustment to comparable sales.

Every state in the U.S. has either a Secretary of State office or Department of Corporations office from which one can obtain names of the principals of LLCs and corporations, and it is helpful in determining whether a purchase transaction is arm’s length (different names on each side of the transaction), unless those entities are located in Nevada, Wyoming or Delaware.

Working in the United Kingdom last year, I was thrilled with the functionality of the UK Companies House web site – one web site for all of the corporations in the UK, so much easier than working in the U.S. It provided addresses, directors’ names, and dates for and changes of company names or directors. It also allowed me to easily establish that the sale contract I was looking at was for the sale of the property from one shelf corporation to another shelf corporation sharing the same directors — in other words, a completely bogus transaction.

The ICIJ, International Consortium of Investigative Journalists, has been documenting known offshore shell companies and their addresses. If in doubt about an address, one can check it out on their web site, https://offshoreleaks.icij.org/ They also have a list of the nations having the most offshore shell companies, which is helpful in its own right. For instance, a few weeks ago I was looking at a deal in Mexico in which the developer was a company in Cyprus. Red flag. Cyprus is not known for its real estate developers, just its reputation as a haven for shell companies.

Clues that you’re dealing with a shell or shelf corporation include:

1. No web site.
2. The principals of the organization have only hotmail, gmail or yahoo e-mail addresses.
3. The web site is “Under construction”. Sometimes there is verbiage about “amazing things to happen”.
4. No present location for company staff.

For example, in a situation I encountered in 2012, in which a piece of raw desert land was being purchased for $1.6 million above the price it had been listed at for two years, the buyer claimed to be looking for a location to build a 100,000 square foot corporate headquarters building for an unknown high-tech company. They had a web site under construction with the words:

“Company is in stealth mode while we develop the team, the infrastructure and the technology. Details to follow in Fall 2011.”

The corporation had no current location. A search of LinkedIn showed about 4 employees scattered all over the country, hardly enough for a 100,000 square foot building. No plans, specifications or blueprints were presented for the building, only artists’ renderings.

When he was unable to show established business operations, the CEO then talked about “secret government contracts”. Suspecting that my client had not performed due diligence on this loan applicant, I ordered a simple $25 on-line background check on the CEO and found:

1. Two criminal convictions, one for check fraud
2. Two bankruptcies
3. Two legal judgments against him
4. No background in high technology, but a bachelor’s degree in political science.

I could go on and on, but I quickly came to the conclusion that his company did not exist and his lack of recent accomplishments suggested that he may have been the kind of person typically recruited as a “straw buyer” in a fake purchase scam. If you participate in certain LinkedIn real estate groups, for instance, you may sometimes see offers of up to $50,000 to participate as a front man in a commercial real estate purchase. This is called “nominee fraud” by the FBI.

Monday, November 25, 2013

ACFE Asia Pacific Fraud Conference and Observed Patterns of International Real Estate Fraud

I have been a member of the Association of Certified Fraud Examiners for 11 years now, and last week I attended their annual Asia Pacific Fraud Conference for the second time. I found it surprising that this year’s conference was held at the Marina Bay Sands casino hotel in Singapore, considering that gambling is a popular form of money laundering in Asia, but perhaps ACFE wanted us to see it firsthand.

I received useful knowledge from this conference, even if it did not directly relate to real estate. To this purpose, I thought I would summarize here the types of fraud and attempted fraud I have been encountering in my own international real estate work.

One of the things I learned early in my career at Jones Lang Wootton was that the dodgiest deals often had to travel the farthest in securing investors or financiers, so one must consider that international real estate transactions already present an elevated risk for fraud. Here are the types of fraud or misrepresentations I have personally witnessed:

Common scams:

1. Puffery regarding the quality of the distant real estate assets. “Resort land” is often no more than a sugar plantation or a mangrove swamp with or without development approvals. What is represented as “next door” to a prime area is often more distant than represented. Leaseholds about to expire have no value without documented proof of renewal in place. “Rental yields” often fail to stand up to scrutiny. “Substantially sold out projects” sometimes hang by a thread in the form of a minimal 5% deposit from would-be buyers (which buyers are willing to forfeit if the value of their lot declines by more than that). In this line of work, I am sometimes placed in the uncomfortable position of asking myself “they made me fly thousands of miles to see this?”

2. Bait and switch. One property is advertised or being pledged as collateral for a loan, but documents submitted to me are for another property. One particular ploy to watch for in Latin America is when documents refer to “Lote S/N”, which is an abbreviation for “Lote Sin Numero”, or “Lot without a number”. It may not be the same property, and professionals will need to be consulted to establish its proper identity.

3. No valid purchase contract. A foreign loan applicant must submit a valid, executed contract to purchase a property he does not yet own in order to receive purchase money financing. The purchase contracts I often receive are often submitted as a draft document in MSWord, with many blank fields, without proper signatories, and sometimes the seller is not the same party as the present property owner. These flaws do not allow me to consider the purchase contract to be valid, and they only arouse suspicion instead. Think about it -- how did you close on the purchase of your first home without a binding purchase and sale agreement? Yet these foreign buyers will tell me of impending purchase closing deadlines without even having ratified agreements in place.

There are two different scenarios in which I’ve seen this done:

a. There is another real purchase contract for a lesser amount of money, or

b. There is no proof that the legitimate owner of the property consented to sell the property or even knows about the phony purchase contract. This latter scam seems to be increasing.

4. Misrepresentation of ownership (similar scam to 3b). Foreign loan applicants sometimes attempt to pledge other people’s properties as collateral for a loan. One common ploy is when they present excuses as to why I cannot contact the rightful owner, such as “he is a high government official who is hiding his assets”. These scams quickly fall apart when the borrower cannot produce documents that an owner would be expected to have, such as a property tax bill or the actual development plan that has been officially approved. Government officials’ secrets are safe with me, any way; my job is to perform due diligence on a particular piece of real estate, not judge the integrity of government officials or violate principles of confidentiality. My job is completely apolitical.

5. Compromising the property inspection. Yes, I like to ride helicopters, but the proffered helicopter ride is often done to prevent me from discovering true ground conditions. Mangrove swamps can appear to be solid ground from the air, for instance, and rugged terrain can sometimes resemble terrain than it is flatter than it really is. In Fiji, I rented a hotel room a quarter mile’s walk up the beach from the subject property so that I could walk to the property that I was only allowed to see from a helicopter. It turned out to be a mangrove swamp. Likewise, after insisting in Belize that I be taken to the property’s edge, only then did I find out that the property could not even be reached by 4-wheel drive vehicle. I would have had to rent a tractor.

6. Tricking the appraiser by showing him or her the wrong property. I have seen MAIs from famous international real estate firms fall for this trick, which should not happen to any appraiser or valuer who has the ability to identify a property on a map or the ability to read a legal description. When will this skill be taught in real estate valuation courses?

7. Attempting to influence the lender or appraiser with biased feasibility or valuation reports from “experts”. Despite what is sometimes a long list of credentials of the expert, the biases are usually evident in the reports themselves, which are often revealed through disclaimers or “extraordinary assumptions”. I hesitate to be convinced by an expert who is being paid to be an advocate for a particular real estate transaction, especially if they are being paid to meet me or travel with me or pretend to be my new best friend.

Even scientific and engineering reports from other countries can be biased. I remember one environmental report that conveniently removed one legally protected mangrove location in between the first and second editions of their report, thereby reducing the number of mangrove locations from 3 to 2. Luckily, I saved a photo of the problematic mangrove location.

I used to be challenged by clients for rejecting reports from famous firms, but the reports from these firms provide all the ammunition I need to discredit them, such as disclosures of pre-existing conflicts of interest, mandatory indemnification agreements in the valuation of questionable projects, and other disclosures indicating a lack of due diligence or verification of borrower-submitted data.


Friday, November 30, 2012

Real Estate Purchase Contract Scams



The appraisal textbooks don’t mention these, so I will.  Real estate purchase contracts are often constructed to mislead lenders and appraisers.  Various ruses are used to inflate stated purchase prices above market value, with the hope of tricking an appraiser into valuing a property at above market value and tricking a lender into offering a loan at an unsafe loan-to-value ratio. Many borrowers don't want to inject cash equity into a deal if they have the ability to purchase with "no money down". Heads, the purchaser makes money; tails, the bank takes back the property with no loss of money to the buyer.


What the buyer and seller are counting on is a phenomenon known as “anchor bias”, the tendency of appraisers to offer an appraised value identical to the purchase price. Various academic studies have indicated that this happens about 86 to 87% of the time, but I notice that some appraisers have been getting wiser lately.


Some ruses that I have recently seen include the following:


1. The “soft second” mortgage loan – forgivable seller financing used to inflate the contract purchase price.


My last appraisal assignment presented such a possibility.  It was an $8 million purchase contract which was contingent upon $4 million in first mortgage financing, supplemented by seller financing of $4 million.  The buyer would have no equity in the property, a situation that presents a high risk for loan default.


I suspected that the seller financing was a “soft second”, a seller concession disguised as a fake loan.  My suspicion was well supported by a contract purchase price which was $1.6 million above the listing price for a property that had been marketed for almost 3 years on LoopNet and updated only 8 days before.


Normally, the term “soft second” in the real estate industry refers to a legitimate second mortgage loan made at a below-market rate, perhaps subsidized by a government agency or a nonprofit entity.  In some cases, though, the seller financing is not meant to be paid back.  It is a price concession in disguise, meant to inflate a contract purchase price.


An appraiser cannot be sure the second mortgage is real or fake, so he must look for clues, the most obvious of which is that the purchase price is not supported by comparable sales or the purchase price is above the asking price.  The lack of equity contributed by the buyer should also make lenders and appraisers think twice. Nothing casts more suspicion on a real estate purchase than that the price cannot be supported by comparable sales.


One would think that some government agency or appraiser association would issue an “all points bulletin” on this deception, but this scam continues to this day.


2. Unsigned purchase agreements in draft form.


I have seen a proliferation of this trick in the last 2 years, and am currently witnessing it happen on a transaction in Puerto Rico.  The buyer just says that the purchase contract has not yet been finalized and submits his own version, usually in MSWord, with a different price.  Very simple, but these deceivers are counting on appraisers or lenders who will believe anything. 


Normally, an application for a purchase mortgage loan comes with an already-signed purchase agreement with contingencies for financing. Why and how could there be a closing without a definitive purchase agreement? An agreement that is not written is not worth the paper it is written on. There is no reason for an appraiser to accept an unsigned, draft purchase agreement as a reliable indication of value.


3. The double escrow


This is when there are two purchase contracts for the same property.  The first purchase contract is the legitimate one, and once closed, the buyer can then sell at a higher price to an entity he controls in a different purchase contract that he will submit to lenders and appraisers.  The latter transaction, however, is a sham "pocket-to-pocket" transaction.

4. Secret partnerships and "transaction facilitators"


In one instance I met with the owners/sellers of swampland intended for development of a marina residential community. The buyer and sellers were old friends, but none had development experience. I was presented with three conflicting purchase contracts, and whenever the story keeps on changing, that is a good sign of deception. After four hours I asked Mr. Seller, who lived in a trailer on the property, where he would be moving to. He seemed surprised and responded, "I'm staying here, of courseI've got a lot of work to do!" which made it clear that he was part of the development team and this was not an arm's length transaction. I looked at his wife, whose facial expression said "How can my husband be so stupid?"


I discovered one company in Arizona that advertised "transaction facilitation" services. Step 1 is that the buyer forms a joint venture partnership with the transaction facilitator in buying the property in the guise of an LLC or Limited Partnership. Step 2 is the shell company (the LLC or LP) sells to the buyer again at a higher price in a sham transaction designed to trick a lender and maximize financing.
I encountered this company in a purchase loan application with a contract price which was twice market value.


Another type of "transaction facilitation" is those services which "rent" cash down payment money overnight to buyers while the purchase price is inflated to cover the amount of the phony down payment.  Law enforcement has been shutting down such operations in the United States. Read my post: https://www.internationalappraiser.com/search?q=down+payment+fraud



5. The missing addendum

Sometimes the purchase contract has a dangling reference to an addendum that suspiciously gets separated from the contract. I am looking right now at a purchase contract with an asterisk by the stated sales price. Below the asterisk is the explanation: “*Sales Price is subject to adjustment based on Special Provision Addendum”. When I requested the missing Special Provision Addendum, it stated that the purchase price could be adjusted to 50% of my appraised value. Knowing that a property will be sold at half my appraised value – now that is a sobering thought.

6. The straw buyer

I recently appraised a parcel of raw land for a purchase money loan to a prospective developer of a hyperscale supercomputing facility along the NLR (National LambdaRail).  The purchase application indicated that the buyer, who supposedly owned a hyperscale computing company, was putting no cash into the transaction; seller financing would fill the funding gap.  At the same time, there was no discernible relationship with the sellers.  The appraisal failed to hit the purchase price, but rather than trying to negotiate the purchase price down, the buyer spent two months arguing that the property should be appraised higher.  Finally, a background check indicated that this man was no computer expert but had a history of legal judgments, bankruptcies, aliases, criminal convictions -- and a degree in political science.  It appeared that he may have been hired to be a fake buyer to bail the sellers out. These types of arrangements are sometimes found offered on LinkedIn.

Straw buyers are more common than you would think.  As I drive around L.A., for instance, I see simple signs stapled to telephone poles advertising "Real Estate Investment Partners Wanted".  What happens when one calls the number is that a fee will be offered to someone with good credit to sign a mortgage loan for someone with impaired credit.  The fee might be $5000 or $10,000 for a residential mortgage, but I've seen a fee of $50,000 offered to sign a commercial mortgage.  In each instance, the real estate partner will be guaranteed to have his name released from the mortgage lien after funding of the loan, but it often does not work out this way, as what starts as mortgage fraud (use of a straw buyer with a high credit score) often continues as a mortgage fraud; the real estate "partner" is not released from the mortgage lien and ends up being pursued by a lender for the full amount of a delinquent mortgage loan. The organizer of the scam has already left town with the funds. Moreover, the "real estate partner" with the high credit score cannot report this fraud to law enforcement because he has already become an accomplice to mortgage fraud.

Other purchase contract deceptions

It is risky, any way, for an appraiser to automatically assume that a contract purchase price is identical to market value.  I have seen fake purchase contracts and purchase contracts which disguise the fact that the buyer and seller are one and the same. I have seen purchase prices inflated by real estate syndicators who are compensated as a percentage of the transaction price.

Many appraisers are so convinced that the purchase price is real that they make the mistake of making unconventional adjustments to sales data to support the stated purchase price. They may choose much newer properties or much smaller properties as comparable sales and fail to make adjustments for age or size.

Questions to ask

The first thing I do in analyzing the purchase transaction is to peruse the Internet to try to find the property listed for sale. LoopNet and realtor.com are good sources, but sometimes if you just google the address of the property, you can find a more obscure listing. When I find the property listed at a price below the contract purchase price, and the property has already spent a substantial time on the market, that is cause for suspicion.

The next question I ask the buyer and the seller, separately if possible, is "who were the listing broker and the buyer's broker on this transaction?" The reason why I ask is that I see so many purchase loan applications which are not represented by a broker, begging the question of how the buyer and seller found each other in a market with so many properties listed for sale. 

If there was no broker, there was most likely no listing or advertising, meaning the buyer already knew the seller, increasing the odds that the purchase transaction is not arm's length or could even be a "pocket-to-pocket" transaction with the owner buying the property from himself with my client's financing. Past experience has shown me that this is a way to make the lender the unintentional buyer of a hard-to-sell property.

One tell-tale sign of a fraudulent purchase is when the buyer complains that the value is too low. In legitimate purchases, the buyer often uses a low appraisal to negotiate a better price, and they sometimes even thank me for saving them money, but when a buyer starts making phony excuses as to why the appraised value should be higher, it is a signal to me that the buyer is either already affiliated with the seller, a straw buyer, or else the buyer and seller have negotiated a separate purchase agreement and the contract I was given was phony.

Recent adverse publicity for the appraisal profession

The National Association of Realtors (U.S.) has recently unleashed their well-funded publicity machine to criticize appraisers for failing to "hit" purchase prices. They publicize sob stories of realtors whose purchase deals fell apart.  "I had a bona fide purchase contract and the incompetent appraiser appraised it too low!" Such things could be said about me, too, but nothing is being said about the epidemic of deceptive purchase contracts nowadays.

To appraisers who think they must "hit" the purchase price:

If it was really true that the market value of a property is always the same as the purchase price, there would be no need for appraisals, would there be? 

It doesn't help, though, that some lenders have policies of sanctioning appraisers who don't "hit the purchase price".

Next stop: Puerto Rico










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Monday, October 29, 2012

Central American Real Estate Horror Stories


I received another such phone call today. Today the offending country was Panama, but sometimes it is Costa Rica. I asked, “Did you get legal representation before you purchased the land?” The answer was “I didn’t know how to find an attorney down there, so I just went with the one recommended by the seller..” I asked, “Did you get title insurance?” The answer was “No. The title company thought it was a scam.” I’m short on time today, so let me just present 3 “musts” for investing in foreign real estate:

1. Get title insurance. It has become available in many countries where it did not exist before. If the title insurer won’t insure, that is Red Flag no. 1.

Get to know this "scent" before investing in Latin American real estate














2. Get independent legal representation. This means never use an attorney recommended by the seller. That is Red Flag no. 2.

3. Keep your property secure from squatters. If you do not plan to occupy your property, make sure that someone is there to keep the squatters off. Whether it is Latin America or Africa, once they’re living there, you will have a hard time removing them. Recall my previous post linking to a YouTube video of a desperate British investor who has fought for 14 years to remove squatters from his property in Costa Rica. My advice: If you’re just buying a vacation home, buy in a gated community.


Friday, October 14, 2011

The Appraisal Institute has published my new book


Soft cover, 122 pages

ISBN: 978-1-935328-22-3

Stock Number:0751M
Fraud Prevention for Commercial Real Estate Valuation
Vernon Martin, CFE
Appraisal Institute
Price: $45.00
Member Price: $35.00
Plus shipping and handling

Direct link to Appraisal Institute book ordering web site: http://www.appraisalinstitute.org/store/p-283-fraud-prevention-for-commercial-real-estate-valuation.aspx

This is the Institute's description of the book:

"Mortgage and investment fraud are at an all-time high and there are serious consequences for appraisers who become involved in suspicious transactions. This book describes common methods of deception used in fraudulent schemes involving commercial properties and land. It presents various situations and conflicts of interest that have the potential to exploit the appraisal process for dishonest purposes.

Appraisers who can detect fraud can protect themselves from relying on inaccurate information that could compromise the valuation analysis. By thinking critically and challenging assumptions, commercial appraisers can keep out of trouble, whether it is trouble for themselves or for others who rely on their work.

Order now and arm yourself against real estate fraud!
"

A note to my most faithful readers:

My previous book, "Lessons from Losses in Commercial Real Estate", is being retired due to my new venture with the Appraisal Institute. Although the overlap between the two books is small, the Appraisal Institute does not want me to compete with them with another book, and that is fair.

Sunday, August 7, 2011

Costa Rican Teak Farms for Gringo Investors

I’ve been preparing for an upcoming tree farm appraisal assignment in Costa Rica, but learned late that what was thought to be a teak farm is actually a tree farm with lesser tree species. Nevertheless, something should be said about the teak farm market in Costa Rica.

In the late 1980s Costa Rican President Oscar Arias declared a state of emergency concerning the depletion of the nation’s forests, much of which had been felled for timber harvesting or cattle ranching. Generous tax exemptions were put in place to encourage commercial reforestation projects. Capitalism quickly and enthusiastically addressed the problem, and some of those who observed the flow of international capital into Costa Rican forestry investments figured out that perhaps there was more money to be made by selling forestry investments than in actually growing, harvesting and processing the trees.

As with any market for investment properties, distortions are created when properties are developed in response to investor demand rather than consumer demand. For instance, great surpluses of “rental homes” were developed in Arizona, Las Vegas and Kissimmee, Florida, not in response to a shortage of housing in those areas, but to sell to out-of-state investors. Costa Rican tree farms are now repeating the same concept all over again.

Teak became the preferred tree farm crop because of its high value. There were no restrictions on the creation of new supply in Costa Rica, so many entrepreneurs got into the teak plantation business and European “investment funds” (syndications) were organized to develop teak plantations for small investors, charging high mark-ups. Many teak plantations were subdivided into smaller parcels for purchase by small, absentee investors in North America and Europe.

Misleading data crowding out objective data

The Costa Rican timber market is fragmented and lacking in price information, which has led to the crowding out of objective information by hyperbole crafted by investment promoters, many of who claim historical investment returns in the timber industry of greater than 13% per year. This is not based on Costa Rican data, however.

The most recent price survey among the Costa Rican members of OLAT (the Latin American Teak Organization) indicates prices between $120 and $595 per cubic meter for standing teak trees, depending upon diameter, but prices appear to have decreased since February of this year. For instance, standing teak trees of 50 to 59 centimeters in diameter were priced at an average of $220 per cubic meter then but are now priced at $175 per cubic meter, a drop of 20% in the last six months. Mature trees above 30 years in age have much greater value per cubic meter than immature (“short rotation”) trees, as they can be more efficiently processed into large pieces of sawn wood.

Investment promoters, however, are misleading investors with pro forma cash flow projections based on price increases of 5 to 10% per year, despite the increasing supply of Costa Rican teak, and unrealistically shortened maturity times of 20 to 25 years. OLAT’s data is based on reported prices for mature 30-to-50-year-old trees (the older, the more valuable) and describes 20 to 25-year old plantations as “young plantations” for which there is insufficient market price data, and also commenting that Latin America will supply an important part of the teak market, but is not properly geared to marketing short rotation material. This will change in the coming years, with the knowledge that producers are not getting the best price, the market being controlled by buyers.” In Asia, teak trees are often not harvested until 60 years.

As for the balance between teak supply and demand in Costa Rica, OLAT states “With all the money that was invested by forestry funds over the years in Latin America many plantations were enthusiastically created and the know-how has been improving steadily. Lacking, to some extent, are the sales aspects of plantation products.”

Investment Promoters and Scam Artists
Some investment promoters are not even selling land to investors, just the trees themselves. It is important to know that titled ownership in Costa Rica extends to real estate only; there are no tree titles, and the idea of tree titles in a nation with so many more trees than people would be an administrative nightmare, even if it was tried.  How does one prove ownership of trees that are situated on someone else’s land? Any contract in English is not valid or enforceable in Costa Rican courts, either.

Many investors claim to be victims of scams in which plantation owners sell tree ownership and then charge a fee to manage the tree investment; Tropical American Tree Farms seems to have attracted the most complaints. Most of the alleged fraudsters are gringos themselves, including Eric Heckler, who was a fugitive from mortgage fraud charges in Florida when found selling Costa Rican teak trees that weren't his before being extradited back to the U.S. in 2009.

In the numerous listings of teak plantations for sale in Costa Rica, a sizeable discount per tree is apparent for the larger plantations, indicating an insufficient demand for the quantities of teak they are producing, with prices as low as $167 per standing tree for 20-year-old trees, which translates to about $244 per cubic meter (based on an average of 0.8639 cubic meters per 20-year-old teak tree), or 58 cents per board-foot, quite a bit lower than even the OLAT-published prices.

Next stop: Tepotzotlan, Mexico
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Monday, August 1, 2011

Why Fraud is Attracted to International Real Estate Transactions



Several of my previous blogs refer to the possibility of fraud in international real estate transactions. It stands to reason that a property owner or developer who cannot find buyers or financiers in his own country will seek them out in other countries, perhaps taking advantage of the foreigners' lack of local knowledge. Why, for instance, must Spanish hotels be marketed in the U.S.? Could they not attract European investors?

I do not wish to seem overly critical of Chinese or Central American property owners. A predilection to commit fraud is a fault of human nature and knows no nationality or ethnicity, as I’ve seen plenty of it in the U.S. Fraud tends to flow to those areas where:

1. The controls are weakest,
2. The opacity is greatest,
3. The penalties for fraud are the least severe or least likely to be enforced, and
4. The story sounds the most sensational.

Let me provide an example:

Imagine a nation which has experienced average annual economic growth of 5% after inflation for the last 14 years and real estate prices are rapidly increasing [the story]. Real estate transaction prices are not disclosed due to privacy concerns [opacity]. The culture is very pro-business and real estate regulation is non-existent except for the licensing of real estate sales agents [weak controls]. Prosecution against white collar fraud is unheard of [lack of penalties and enforcement].

Are you ready to invest?

Well, you’re too late, because the place I just described was my home state of Texas in the year 1985. What happened next was an economic disaster. Much of the Texas economic miracle had been based on real estate construction, adding far more supply than could be absorbed at even robust growth levels. Any new development could get 100% financing from a Texas bank, and developers were allowed to order their own valuations from their favorite appraisers. As new buildings stood empty, bank loans could not be repaid. Property prices plummeted. Almost every Texas-domiciled bank and thrift institution failed. Construction workers, realtors, appraisers and bankers lost their livelihoods. The unemployment rate was 12% in Houston when I lost my job there and moved to Los Angeles in 1987.

From 1984 to 1987 I was working in the Houston office of Jones Lang Wootton. My colleagues were busy acquiring and managing investment properties for British, German and Saudi investors who were excited by the Texas story. This all changed rather quickly.

Travel ahead 25 years in time and is China or Costa Rica that much different?

Wednesday, July 27, 2011

The Rights of Foreign Victims of U.S. Real Estate or Mortgage-Backed Securities Scams

A few previous blogs touched on the subject of real estate fraud that crosses national boundaries, and how difficult it can be for American victims to seek redress in foreign courts. I might have sounded xenophobic by focusing on scammers in Latin America, Canada and China, but international real estate fraud works both ways. There are also foreign victims of U.S.-based frauds.

Ethical standards in the U.S. should not be considered different from ethical standards elsewhere. It is not the nationality that matters, but the type of people the real estate industry attracts – people who want to make lots of money. If the real estate industry instead attracted saints, perhaps Mother Theresa herself would have devoted her life to selling condos to foreigners.

Prestige and fame matter little, too, in protection from fraud, as this blog will focus on extensive litigation against Goldman Sachs, an institution once so hallowed that our last three U.S. presidents have selected Goldman executives to become U.S. Secretary of the Treasury, including the present one.

U.S. Securities Laws are not Extra-Territorial

An overseas investor might also be surprised to find that U.S. securities laws do not apply to U.S. real estate investment securities marketed overseas, which includes mortgage-backed securities and real estate syndications.

For instance, Australian hedge fund Basis Yield Alpha recently lost its lawsuit against Goldman Sachs for a $78 million loss on its investment in a Goldman-sponsored CDO (collateralized debt obligation) known as Timberwolf 2007-1, which specialized in subprime mortgage loans. Goldman profited by betting against this CDO, as they have been known to do, even letting John Paulson design another CDO in which he was able to pick the nonprime packages that were “most likely to fail” and then invest in credit default swaps. The U.S. Securities and Exchange Commission sued Goldman and settled for $550 million one year ago this month.

Goldman, for this reason, faces other investor lawsuits from domestic investors, but Judge Barbara Jones dismissed the Australian lawsuit solely because U.S. securities law only governs securities sold within the United States. (As you may recall, This jurisdictional exception was upheld by the U.S. Supreme Court last year in the landmark case, Morrison v. National Australia Bank Ltd. This decision serves to bar the extraterritorial application of the U.S. Securities Exchange Act of 1934. In that case, although the lead plaintiff, Morrison, was American, the remaining plaintiffs were Australian and were victims of NAB’s (National Australia Bank) inaccurate accounting for its American mortgage servicing subsidiary, HomeSide Lending. The plaintiffs argued that the overvaluation of mortgage assets occurred in Florida, where the subsidiary was located, and U.S. securities laws should therefore apply, but the Court found that the securities were sold in Australia, by Australians, to Australians, and therefore U.S. law did not apply. Morrison, the American, could not prove damages, either.

Korean insurer Heunkuk Life Insurance is similarly affected in its lawsuit against Goldman Sachs.

These recent Federal court decisions do not preclude plaintiffs from suing in state courts or foreign courts.

Monday, July 4, 2011

"Independent Valuation" Problems in Chinese Equity Offerings

One notable scandal this last month was the public accusation that Sino-Forest, a Chinese forestry resources company traded on the Toronto Exchange (TRE.TO), is no more than a Ponzi scheme. The accusation was made by Hong Kong equity research firm Muddy Waters, LLC, in a 40-page research report reminiscent of Harry Markopolos’s expose of the Madoff Ponzi scheme.

I will not comment on the merits of the accusation other than to say that there is enough fraud coming out of China that I don’t see a reason for an analyst to make up false stories. On U.S. exchanges alone, eleven Chinese companies have had their securities registrations revoked by the SEC (Securities and Exchange Commission) and 24 more have been forced to address accounting irregularities or auditor resignations, and of the 19 most recent filings of class action securities lawsuits in the U.S., at least 5 have been against Chinese companies. The simple observation that Sino-Forest has produced no free cash flow or dividends in 16 years in spite of escalating revenues is cause for suspicion. John Paulson dumped his shares right away after the MW report.

Some of you may wonder about the CFE initials in my by-line. They stand for "Certified Fraud Examiner", a credential awarded by the Association of Certified Fraud Examiners. One thing we were taught in our educational program is that fraud is a crime of opportunity. It will move to areas where the controls are weakest, opacity is greatest, and greed and a miraculous story get in the way of due diligence and reason. This makes China an ideal place to commit fraud, just as Florida and Las Vegas were 5 years ago.

Foreign investors are wowed by China's reported 10% annual GDP growth rate and accept Chinese financial reporting with the assumption that auditors and valuers know everything going on within a Chinese company. Many Chinese companies create a labyrinth of offshore entities in the British Virgin Islands and Cayman Islands to hide transactions or owners from view. Sino-Forest and Hui Xian have both done that.

As for Sino-Forest, Muddy Waters specifically addressed the reliability of the "independent valuation" report, as follows:

"TRE provides fraudulent data to Poyry, which
produces reports that do nothing to ensure that TRE is
legitimate."

and

"TRE became more sophisticated – engaging Jakko Poyry to write valuation reports, all the while giving Poyry manipulated data and restricting its scope of work. Thus more and more investors are drawn into TRE’s fraud every year as it falsifies timber investments and manipulates Poyry further."

One common theme of the Muddy Waters analysis and my own blogs about Perennial China Retail Trust and Hui Xian REIT is the use and abuse of so-called “independent valuation reports” from respected firms with valuers possessing respected credentials. In each case, the sponsors that hired the valuers restricted the scope of work or imposed assignment conditions which impaired the reliability of the reports. Each example is explained as follows:

Independent valuation of Sino-Forest (TRE.TO)

As Muddy Waters describes, the independent valuation firm Jaakko Poyry couched its valuation opinion with multiple disclaimers such as follows:

• “Poyry has not viewed any of the contracts relating to forest land-use rights, cutting rights, or forest asset purchases.”

• “It is important to understand that this is not a confirmation of forest ownership, but rather a verification of the mapped and recorded areas of stocker forest
.”

These types of disclaimers naturally arouse suspicion, as in Shakespeare’s famous phrase, “The lady doth protest too much, methinks.” Why would the valuer feel the need to make such statements unless he knew something was wrong?


Independent valuation of Perennial China Retail Trust (N9LU.SI)

Here’s a situation in which the annual base fee to the Sponsor is established by independent valuation, but the “independent valuer” was asked to assume that all five properties had been acquired and developed and leased to full occupancy, when only one of five properties had been built and two only existed as purchase options. The inflated appraised value of about $1.1 billion SGD is 54% above market capitalization at the close of markets on July 4th. The $1.1 billion SGD appraised value translates to an annual base fee of $3,850,000.

The valuation firm also performed limited due diligence, as they explained as follows in the valuation report that was included in the IPO prospectus:

Whilst CB Richard Ellis has endeavoured to assure the accuracy of the factual information, it has not independently verified all information provided by the Trustee-Manager (primarily copies of leases and financial information with respect to the Properties as well as reports by independent consultants engaged by the Trustee-Manager).

CB Richard Ellis has relied upon property data supplied by the Trustee-Manager which we assume to be true and accurate. CB Richard Ellis takes no responsibility for inaccurate client supplied data and subsequent conclusions related to such data.

This confidential document is for the sole use of persons directly provided with it by CB Richard Ellis (Pte) Ltd. Use by, or reliance upon this document by anyone other than Perennial China Retail Trust Management Pte. Ltd. (as Trustee-Manager of Perennial China Retail Trust) is not authorised by CB Richard Ellis and CB Richard Ellis is not liable for any loss arising from such unauthorised use or reliance. This document should not be reproduced without our prior written authority.”


Independent valuation of Beijing Oriental Plaza (Hui Xian REIT)

The owners had been receiving valuations of its only property, Beijing Oriental Plaza, from DTZ Debenham Tie Leung Limited on an annual basis. The valuation was RMB 11.2 billion at the end of 2009 and RMB 20 billion as of October 31, 2010, based on a decline in market capitalization rates and an increase in rents of 2% for offices and 6.7% for retail tenants.

Nevertheless, for the purposes of the IPO and the estimation of a “revaluation surplus” distribution to the previous owners, a different valuer was chosen – American Appraisal China Limited -- who estimated market value to be RMB31.4 billion as of January 31, 2011, just three months after the DTZ valuation of RMB 20 billion, a further increase in value of 57%. Despite this new valuation, though, the IPO sponsors priced the entire offering at between RMB 26.2 billion and 27.9 billion, 11 to 17% below appraised value. Why would the Sponsors price below appraised value unless they didn’t believe the appraised value of AAC? Why did they switch valuation firms? As of July 5th, market capitalization has dropped to RMB 23.45 billion, which is only 75% of appraised value.

More specific concerns about the valuation report are presented in my Hui Xian blog.

The appraised value of RMB 31.4 billion was used to establish a “revaluation surplus” of RMB 7.775 billion payable to the previous owners, although the market capitalization of the entire REIT was never that high, and current market capitalization suggests that no such surplus value exists. The amount of “revaluation surplus” was based on subtracting net book value of RMB 23.635 billion from the appraised value of RMB 31.41 billion, but current market capitalization of RMB 23.45 billion suggests that no revaluation surplus is warranted, and that the RMB 7.775 billion is money that has been taken from investors through a dishonest scheme.

The new valuers also performed limited due diligence, as they explained as follows:

We have not carried out on-site measurements to verify the areas of the Property and assume the areas contained in the documents provided to us are correct. We have no reason to doubt the truth and accuracy of the information as provided to us by BOP and Commerce and Finance Law Offices on PRC law. We have also been advised by BOP that no material facts have been omitted from the information so supplied. We consider we have been provided with sufficient information to reach an informed view.”


Conclusion

Allowing IPO and subsequent offering sponsors to order “independent valuations” is a blatant conflict of interest, although this is a problem that is not unique to China. Moreover, an "independent valuation" that refuses or is not permitted to perform verification of factual information, such as ownership, financial operations, or property size, is useless and misleading to investors.

Investors should understand that valuers typically put disclaimers and limiting conditions in their valuation reports to prevent liability for passing on fraudulent data. They basically assume that everything the property owner states is true. This does nothing to ensure that valuers rely on accurate data, but deceives investors into thinking that the valuation reports are thorough and accurate.

Disclosure: I do not have any short or long positions in these stocks.

Wednesday, June 8, 2011

Fraud in International Real Estate Transactons

Ecological preserve represented as potential residential subdivision


Working for Jones Lang Wootton back in the 1980s, I sometimes received phone calls from our foreign offices, usually in Asia, inquiring about some Houston property that was being marketed in their country. These were typically the hardest-to-sell properties, and seemed to fit a pattern operating in both directions, which is this:

1. The hardest-to-sell properties must be marketed the furthest distances to find buyers or lenders.
2. The best real estate opportunities tend to get picked off by local investors.
3. The riskiest or least desirable properties also need to search the furthest distance for financing.
4. The real estate business attracts charlatans, but it is difficult to spot charlatans from the other side of the world, which is why the charlatans seek out foreign investors and financiers.

Nowadays, the overseas properties I am sent by private lenders to appraise often turn out to be mangrove swamps or sugar cane plantations with dreams of being turned into 5-star resort developments — in other words, high risk deals that have already been passed over by other lenders.

Here are some of the misrepresentations I’ve seen in the last three years:

1. A Mexican property in which the owner substituted an uso de suelo (public document identifying the property and its permitted land use) for a superior property in place of the actual property. The actual property, which was intended for residential development, was an ecological preserve with protected species of mangroves and crocodiles.

2. A substantial portion of a property in Fiji was on a native land lease expiring in one year and the remainder was on another “crown” land lease. The owner also falsely claimed to have government permission to remove protected mangroves along the shoreline.

3. A phony purchase contract for an Australian nursing home.

4. A Canadian developer represented web site inquiries as pre-sales.

5. A Costa Rican development claimed to have full entitlements, but only the first of its three phases was approved.

6. Most transactions were supported by misleading appraisal reports, ordered by the borrower and often prepared by designated appraisers from some of the world’s best known appraisal companies.

7. Proposed developments were often supported by biased feasibility studies from some of the world’s best known consulting firms. What makes me consider the feasibility studies biased is when there are no pre-sales but the feasibility of the project is considered certain.

Seller-ordered appraisal and feasibility reports

Some words of advice for investors or lenders provided with unsolicited appraisal or valuation reports: If you did not order it or select the appraiser/valuer, do not trust the report, no matter how credentialed the appraiser or how famous the firm. One internationally famous real estate appraisal and brokerage firm, for instance, is facing over $24 billion in appraisal fraud-related lawsuits. Too many appraisers are whores, and circumstances in the last decade have elevated some of these appraisers and appraisal firms into the ranks of the world’s most widely used appraisers.

As for appraisal designations, I have never seen meaningful ethics enforcement by the conferring organizations. These appraisers may have had their U.S. appraisal licenses revoked by government agencies for their misconduct or may have been found guilty in malpractice lawsuits, but they always get to keep their memberships in the private organizations that have conferred their designations. One international organization even elected one such appraiser as their president while he was undergoing disciplinary proceedings in his home state. When I asked them how they could elect such a person, they told me that he had “voluntarily surrendered” his appraisal license, which somehow allowed the pretense of innocence.

The bottom line is: Order your own studies from your own trusted expert.

Pre-construction buying opportunities

Pre-construction discounts are often proportional to the riskiness of the development. Investors are often provided guarantees of refunds if the project does not commence and then find out that the guarantees are not honored or enforceable. The Florida courts are crowded with aggrieved investors trying to get their money back on Florida condos, and an investor should also seriously consider his chances of success in a foreign judicial system.

Be particularly wary of making substantial cash down payments on undeveloped lots in Latin America that are being sold with promises of roads and utilities to be installed in the future. It might be instructive for prospective investors in raw land to read the legal complaints filed against Paradise International Properties of Costa Rica, for instance, which pretty much explain everything that could go wrong in investing in raw land in Latin America. At the least, hire an independent attorney to find out if the land has even been legally subdivided.

Costa Rica and Mexico have recently been hotbeds of real estate fraud, and the fraudsters are often American, too. Consider that neither country requires real estate brokers to be licensed and that their fraud laws are less strict than U.S. fraud laws, as they are based on the Napoleonic system of justice of “No harm, no foul”, meaning that unless you physically injure somebody, you can pretty much conduct business as you want. Lawsuits in those countries can be futile.

U.S. properties marketed overseas

Any property having trouble being sold in the U.S. can sometimes find itself being marketed overseas.

Lately I have been getting offers through LinkedIn to market properties to the Chinese.

It is no accident, either, that on a Chinese web site marketing US residential investment opportunities, one finds ads from the most overbuilt vacation condo communities in the U.S., such as the Disney World market, which includes Orlando, Championsgate, Kissimmee and Davenport. The geographical area described as “just 3 exits from Disney World” encompasses thousands of vacant, bank-owned condos. Such an investment might make sense to a foreign investor genuinely wanting to own an inexpensive condo near Disney World, but some ads talk about “guaranteed rental income” and “guaranteed appreciation” as if such condos make good income property investments and the oversupply would end soon. I was sent by one client to appraise a package of 15 brand new rental condos in Kissimmee, for instance, and found only one occupied, which is not unusual for this extremely oversupplied market.

Also be suspicious of rental properties with guaranteed rental income for the first year or two, particularly in Arizona and Nevada. Such guarantees would not be made unless the rental income after the guarantee period was in doubt. The guaranteed income is often added to the sales price, any way, and these properties are often sold with spurious “management services”. Perform an Internet search of the management companies and you will often find a litany of investor complaints. If no information can be found, Google the principal of the company, and you may find a fraudster who has been moving around from state to state or country to country.

An overseas investor might also be surprised to find that U.S. securities laws do not apply to U.S. real estate investment securities marketed overseas. For instance, Australian hedge fund Basis Yield Alpha recently lost its lawsuit against Goldman Sachs for a $78 million loss in a Goldman-sponsored CDO (collateralized debt obligation) known as Timberwolf 2007-1. Goldman profited by betting against this CDO, as they have been known to do, and faces other investor lawsuits, but Judge Barbara Jones dismissed the Australian lawsuit solely because U.S. securities law only governs securities sold within the United States. This jurisdictional exception was upheld by the U.S. Supreme Court last year. Korean life insurer Heunkuk Life Insurance is similarly affected.

Why international real estate attracts fraud

Fraud is most effectively practiced where there is ignorance, and foreign real estate investors are often at a disadvantage in obtaining all information they need on an investment being made in another country. Sellers of real estate know how to exploit this information disadvantage. That is why one needs to proceed cautiously in investing in (or lending on) foreign real estate.