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?

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