Friday, November 29, 2013

Interview techniques for appraisers and valuers

Each ACFE (Association of Certified Fraud Examiners) Fraud Conference has an optional pre-conference seminar on a subject of special interest by a dynamic and authoritative speaker.  This year’s presentation was on Forensic Interview Techniques for Fraud Examiners and Auditors by Jonathan Davison, director of Forensic Interview Solutions Ltd of New Zealand.  These interview techniques are meant to solve fraud crimes, but part of the job of a diligent real estate appraiser is to prevent fraud, thereby ensuring a more accurate valuation, and these interview techniques can be useful to the appraiser who cares about his clients enough to protect them from fraud.

Jonathan Davison
Mr. Davison travels the world for the ACFE, studies the investigative interviewing methods of various countries and measures their effectiveness on various quantitative scales. He has made investigative interviewing into a science.

Most people’s perceptions of "investigative interviewing" are not based on reality, but on dramatic representations, particularly in American television media.  Davison made a statement to the effect of “Don’t be Starsky and Hutch, be Columbo”, which immediately resonated with me, because in my own book on real estate fraud prevention (see right-hand sidebar), I also lauded fictional LAPD Lieutenant Columbo as having a particularly effective interviewing technique.

Columbo never starts an interview with a suspect by telling him that he is a suspect, and he is humble, deferential, friendly, inquisitive and persistent enough to keep the suspect talking under a false sense of security, revealing valuable clues along the way. He is a modest man who dresses poorly, drives an old car, and is easily underestimated.  It's only at the end of several encounters that Columbo finally does his trademark "Just one more thing…” that takes the suspect by surprise when he provides proof of the suspect’s guilt, with the suspect often having been tricked into proving his or her own culpability. And throughout the whole process, Columbo never shows any disrespect for the suspect.

What does this all mean, though, to real estate appraisers, investors, or lenders, when a crime has not yet been committed?  The answer is fraud prevention.

When starting any valuation assignment or performing a property inspection, I assume that the representatives I interact with are honest, but I remain alert to clues that they may be otherwise.  This often starts with honesty-calibrating questions.  The attorneys I work with advise other lawyers to only ask questions in court that they already know the answers to, and I do this to a limited extent when I start the interview process.

An appraiser should have already done homework on the appraised property prior to his inspection.  One honesty-calibrating question I like to ask is “Who owns the property, when was it acquired, and for what price?” The reason it works so well in the USA, Canada, Australia, the UK and some other British Commonwealth countries is that it is usually public record. If the answer to this first question is a lie or exaggeration, I remain on guard for more lies to come. Like Lieutenant Columbo, pretending to be ignorant of certain facts lays the bait for spotting liars or exaggerators, and it never ceases to amaze me that property owners, brokers, or other stakeholders are willing to believe that appraisers are ignorant. 

Keeping the property owner talking, even if I already know the answers to the questions, often dislodges inconsistencies or details that may have otherwise remained hidden and can open up new lines of questioning.  Inconsistencies are often clues to misrepresentations, as the truth should not vary.  Spotting inconsistencies is the way how Columbo caught killers and is standard investigative interview technique.

For instance, in one loan application I received three almost-identical purchase contracts from stakeholders in a purchase and sale transaction, with the one difference being that the amount of acreage being sold differed significantly but the total purchase price was identical in each contract. Situations like this make me suspect that the purchase transaction is not real.

In a private moment with the seller, I had the following conversation:

Me:  So, where are you going next?

Seller:  What do you mean?

Me:  After the sale closes, what will you do next?  Where will you move to?

Seller:  We’re not going anywhere; we’re going to have a lot of work to do, developing this property.

Me:  Oh.  I thought you were selling the property.

As it turned out, the buyer and seller were partners and old military buddies, and the purchase contracts were sham documents.

In another instance, the owner could not get his story straight about the tenant improvement allowance he would be giving a new tenant, a state legislator. I called the state legislator and found that the landlord had forged her name on a lease and she had no plans on moving offices.

I also stay alert for seemingly innocuous but odd statements, as I try to discern a purpose for any unusual statement. For instance, one Puerto Rican land developer talked of using one particular escrow company for his purchases.  This is often done to steer business to a relative or a friend who owns an escrow company, which is of no particular concern to me, but it is also a common element in mortgage fraud, and a quick Internet search of this developer's name disclosed that he had been convicted of mortgage fraud a year earlier and was fined $1 million. The court should have jailed him so he wouldn't keep on repeating the same tricks.

Sequential ordering of questions

Mr. Davison advises starting interviews with non-threatening questions, and when inconsistencies are identified, ordering the questions from "least impactive to most impactive" to preserve the cordiality of the interview.  As for my own interviews, I save any controversial questions until after I have been driven back to my car, as I often appraise in remote areas.  In the Dominican Republic, I waited until after I had left the country, as the developer claimed to be a personal friend of the president.

The moral of the story is that when an appraiser starts getting unusual statements and different answers to the same question, a lot more questioning and digging is in order. Also see my recent blog post on "Critical Thinking Skills".

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.

Wednesday, November 13, 2013

Appraisal of Waterfront Lots in Bimini, The Bahamas


Several years ago, the real estate industry perceived a proliferation of “high net worth” individuals (HNWs) seeking second or third homes, and the development industry geared up to build 5-star vacation resorts with expensive villas or lots to prepare for the onslaught of the latest nouveau riche.
Then the Global Financial Crisis happened, creating the dual adverse effects of lessening the ranks and solvency of the nouveau riche and also leaving behind partially completed resorts that had no hopes of being completed according to their original scale because of a steep drop-off in sales.  Buyers became much more hesitant to provide cash down payments when they questioned whether the resort would not be completed or else completed without the promised amenities.
Tourism has been seriously affected by the crisis, too, which has resulted in less eyeballs exposed to these resorts under construction.
This situation has resulted in my traveling to many tourist destinations to appraise failed resorts in places such as Fiji, Mexico, Costa Rica, Puerto Rico, Brazil, and Barbados. 
Normally, when I see sales stop for a year or more, I never see a recovery.  New buyers are scared off, thinking that the resort might never be finished and they would be left holding overpriced raw land in a wilderness lacking services and amenities.
Against this backdrop I was sent to look at a waterfront lot sales program at a struggling resort in Bimini.  There were 41 lots sales initiated in 2012, but only one in 2013, although a previous phase of development produced a deepwater marina and over 350 condos and villas. These lots were typically sold as pairs, creating “sea-to-sea” parcels with a beachfront lot paired with a bayfront lot suitable for a dock. Sales prices were each over $1 million (USD or Bahamian dollars, which are equivalent).

Normally I would perceive the sudden drop-off in sales in 2013 as an indicator of another moribund resort, but these developers were able to find a savvy, deep-pocketed partner to bring back confidence and hope, and that partner was the Genting Group, the successful Malaysian casino and resort operator. For those unfamiliar with the Genting Group, their largest casino operation is their casino on Singapore’s Sentosa Island. Their Sentosa casino and the more visually prominent Marina Sands Casino Hotel are the two casinos that have catapulted Singapore into third place, behind Macau and the United States, in gaming revenues worldwide.  
They already built a casino in this resort and it is now operational.  Gamblers are ferried in from Miami (only 48 nautical miles west), where gambling starts on the boat when entering international waters and can proceed to the Bimini casino, which was built to showcase gorgeous views of the Caribbean rather than to shut out the outside world, as most casinos do.

There are many people who would not care to live near a casino, but the new casino is allowing the addition of more amenities, such as enhanced food and beverage operations, and a 300-room hotel which is currently under construction.  A tourist hotel can be a nuisance, but it can also offer management services for those who own high-end villas on their beach lots and need maintenance, security and domestic services while they are away.  A typical service might include the provision of fresh groceries and flowers in anticipation of the owner’s return.

Predicting the sale of these lots, and at what prices, is still a guessing game, but the shot in the arm by the Genting Group at least gave me hope that the lots could be sold as the number of visitors and amenities increase, and my assignment was to estimate a bulk sale value achievable within one year.  Without the fortunate game change for this resort, I might have had to value the remaining unsold lots as raw land, particularly since there were 106 more unsold lots that were not part of the collateral.

Monday, November 11, 2013

Critical Thinking Skills Needed for Real Estate Appraisers and Valuers

My posts on Scotland and Trinidad in September were critical of "chartered surveyors" who allowed false information to enter the valuation process with exculpatory phrases such as “the developer informs us that…” without verifying such information, even if it seemed preposterous. I did not intend to suggest that chartered surveyors were worse than valuers and appraisers elsewhere.  The same problem exists  throughout the world, including my home country of the USA.

Part of the problem is that “critical thinking” skills are not part of the valuer’s training in any nation where I have interacted with local valuers. 

In the English-speaking world, valuers are trained using “business school” methods.  Instructions in problem-solving start with set, unchallenged assumptions, and the question is not asked, “What if the information and assumptions are wrong?” or "What if the property owner is lying?" There is an intermediate step which is being neglected, the step that consists of verification, exemplified by such questions as "How do we know that the building measures 25,000 square feet?" Did we measure it? Did a government entity measure it?  Did we get the number off the rent roll? (Rentable areas are often inflated by landlords.) Or were we just "informed" by the owner?

Consider, for instance, that the larger the property, the less likely it is that the appraiser will measure it.  In a recent appraisal of a 44-structure industrial campus, the owner represented building area as 256,000 square feet, claiming the measurements to be from the county tax assessor's office. The assessor's measurements were 54% smaller.

In Latin America and some other nations, valuers enter the profession through the field of architecture or engineering, and their more scientific education is even more dependent upon problem-solving that starts with set, unchallenged assumptions. I find many of these architects and engineers overly rely on the Cost Approach and also lack skill in discerning current market conditions (which need to be known in adjusting the Cost Approach for “external obsolescence”, the loss in value due to unfavorable market conditions or external adverse influences).

Imagine if all appraisers and valuers verified the information about the subject property that they relied on.  The world would receive more accurate valuations.  Instead, trainers of valuers indoctrinate their students into providing multiple “Assumptions and Limiting Conditions” that merely serve as disclaimers that complete due diligence was not performed, and then they have the nerve to call this "good appraising"! Remember that "Assumptions and Limiting Conditions" serve to protect appraisers and valuers from liability and not to protect the client.  Take the following example:

In the Scotland post, (, I spoke of a former munitions site appraised as the site of a new, 5-star hotel, with the valuer stating the assumption that no environmental contamination was present (almost never the case with a munitions site), even with abundant metal scrap visibly leaching oxides into the soil, underneath signs warning persons to keep out due to ongoing asbestos removal. 
Making this assumption in the “Assumptions and Limiting Conditions” section of an appraisal is not good appraising; it is aiding and abetting fraud. Sure, a valuer is not professionally trained in measuring environmental contamination, but a valuer does not have to be an environmental expert to state visible evidence in his or her report.

Once I had a debate with another appraiser on an on-line appraisers' forum.  I mentioned that I had one client who insisted that I inspect the roof on every building that I appraised for them.  This other appraiser seemed angered by my remarks and insisted that roof inspections were outside the scope of an appraiser’s duties and it was dangerous to our profession to think otherwise. He even stated that it was even unethical to state my roof observations because it would infer that I was representing myself as a roofing expert. That had been what he was taught.

I remember a situation with a former Honeywell building in Minnesota in which missing or worn-out roof flashings resulted in rain and snow melt leaking down inside the exterior walls and destroying several hundred thousand dollars of computer equipment. Now which appraiser is more likely to get sued – the one who pointed out the obvious hazard, or the one who performed an incomplete property inspection and had the attitude of “That’s not my job”?

The truly concerned appraiser or valuer (who cares about his clients) needs to think about whatever may affect the market value of the property.  This includes being properly informed in matters of construction and design, environmental hazards, flood zones and protected wetlands, demographic analysis, and microeconomic analysis of the equilibrium between supply and demand.  Anything less could make the valuation a meaningless academic exercise and is an abdication of professional responsibility.  It can also hurt the client.

This also answers a question I occasionally get asked, which is why do I get sent overseas to perform valuations where local appraisers are available?  The answer is that I offer my clients extra due diligence that they have learned not to expect from other appraisers or valuers, who instead provide pages and pages of disclaimers and limiting conditions. When others say "That's not my job" I say "I will make it my job."

But let us take "critical thinking" to an even higher level.  Shouldn't we as appraisers and valuers also question valuation techniques that may be incomplete or unsound to begin with? 

The appraisal profession has been deficient in its use of discounted cash flow (DCF) analysis, for instance. Some appraisers and appraisal organizations teach that future expenses will grow no faster than future income, when in reality, a building is a deteriorating asset and expenses will almost always increase faster than the rate of price inflation. So many commercial loans have failed because reliance was placed on an unrealistic DCF analysis.

Appraisers have also been surprisingly resistant to the concept of looking at listings as comparable sales data. If listings are found indicating lower market values than most recent sales, this is the warning indicator to inform appraisers of a declining market. In that case, listings will indicate the new, reduced ceiling of value.

Some appraisers refuse to use comparable sales that are foreclosures or in foreclosure, even if the appraised property is also in foreclosure. Someone has taught them to do this. This can result in overvaluation.

Critical thinking can sometimes fly in the face of professional orthodoxy, which may not always hold up to logic. There is a status quo maintained by professional "Grand Poobahs" whose power is dependent upon a lack of change.  Professional orthodoxy is sometimes not that much different than a religion. Many years ago, religious leaders were asked the question, "What would you do if Science invalidates part of your religion?" (We all know that the Earth is not flat.) The answer that impressed me most was from the Dalai Lama. He said, "Then Buddhism would have to change." Likewise, the appraisal profession will also need to change with the times. 

PS:  For younger or foreign readers, the above illustration is of a television character named "Sergeant Schultz", an incompetent prison guard played by John Banner in the 1960s television sitcom "Hogan's Heroes". His stock phrase was "I know nothing, NOTHING!" even though he sometimes knew that his prisoners were up to no good, but could be persuaded to look away by a piece of chocolate.  

Thursday, November 7, 2013

Appraisal in Abaco, The Bahamas

The appraisal was for refinancing purposes, but the subject property was the largest on a cay with only 110 homes, a substantial number being second homes for wealthy foreigners. This was the former residential estate of a well-known American commercial family dynasty.

Complicating the situation is that 37 of these homes on this cay are currently listed for sale. Just as elsewhere in the Caribbean and Latin America, the supply of vacation homes for sale is currently greater than demand.

Also complicating the valuation was the high value of land as well as the high cost of construction in the Bahamas, which forces an appraiser to segregate each home sale into components of land value and improvement value. On the continental mainland, the abundance of land makes land values cheap, but on a cay which measures about 2 kilometers by 100 meters and is surrounded by the sea, the constrained land supply makes land much more valuable, similar to Manhattan and San Francisco, where natural barriers also constrain the supply of land, making real estate more expensive.

Likewise, labor and materials are usually brought in from other islands and sometimes other countries, such as Haiti, adding to construction costs in the Bahamas.

Rather than using a normal adjustment grid, I performed a multiple regression analysis based on nine sales. From a statistical point of view, the sample size is not good, but still better than the classical adjustment grid method of valuation. The two variables which proved to be statistically significant were land area and finished living area, and I also tested variables for lineal feet of beachfront, number of docks, number of bedrooms, and a dummy variable for presence of a protected harbor (useful during hurricane season).

For this particular cay, for instance, the coefficient for land value was shown to be $745,286 per acre, while the local appraiser had already been using $750,000 per acre in his adjustment grid. The results were remarkably similar.

PS:  A $5,170,000 loan was subsequently made by Kennedy Funding of Englewood Cliffs, New Jersey.