Warning about international real estate syndications and other crowdfunding ventures

Unsold Arizona condos are a favorite among Canadian syndicators.





What is a real estate syndication?

A real estate syndicator is one who organizes groups of investors (or “syndicates”) to acquire real estate investments. The syndicators are paid fees from investors for spotting and sharing profitable real estate investment opportunities with potential investors. The process is called "syndication", "TIC" (tenants-in-common), or "crowdfunding".

Real estate syndication achieved a bad reputation in U.S. in the 1970s and 1980s as an investment vehicle that enriched syndicators at the expense of investors. They reappeared in the last few years, now called "TICs" (tenants-in-common), and repeated the same abuses committed before, with the largest syndicators, such as DBSI and SCI, declaring bankruptcy in recent years, causing major losses for their 22,000 investors. Now that "TIC" is becoming a dirty word, the new term for syndication is "real estate crowdfunding".

Lately, I have seen such syndications go international. They may start in Canada, for example, and recruit Canadian or UK investors to invest in US real estate or Latin American real estate without involving a single US investor. They typically overpay for properties because they are compensated in proportion to acquisition prices. I am not implying that Canadians are any more dishonest than Americans, only that the dishonest ones are released from prison a lot sooner up there than down here in the U.S., if they serve time at all.

Take Canadian Ed Okun, for example. He had already had a civil judgment for fraud in Canada before coming to the U.S. to continue his ways.  He is now serving a 100 year sentence in US Federal prison. Here is his story:

Ever since he was a young man in Canada, Ed Okun dreamed of living a lifestyle of the rich and famous. His first wife described him as a con man who stole $150,000 from his father-in-law and raided his own family’s trust fund to buy a 53-foot yacht, Rolls-Royce, Aston Martin and Mercedes before fleeing to the United States to escape a civil judgment. Just prior to his arrest in the U.S. for embezzlement, he drew unfavorable attention to himself with a small dinner party in the Bahamas that cost more than $56,000, a fact eagerly disclosed to law enforcement by his second wife after he dumped her to marry a Brazilian call girl.

Ed Okun is perhaps an extreme example of the type of people the real estate syndication business attracts, but it is not a business that attracts saints. Otherwise, Mother Theresa herself would have been organizing real estate syndications.

Okun’s syndication scam

As a syndicator, Ed Okun claimed expertise in “identifying, acquiring and turning around distressed commercial real estate”. Okun, doing business as Investment Properties of America (IPofA), managed several such syndicates. Being a Certified Fraud Examiner, I was contacted by the lead investor of one such syndicate, composed of 20 senior citizens who lost all of their $13 million investment in Okun’s acquisition of the Park 100 Industrial Building in Indianapolis, the investment he arranged for them.

The Park 100 Industrial Building is an aging behemoth, a 459,000 square foot warehouse built in 1959, about the size of eight football fields. Unbeknownst to the syndicate, Okun already owned this building, for which he paid $3,300,000. As the manager of the syndicate, he then used his claimed investment expertise to have the investors pay him $12,650,000 for the building, earning him a 283% profit.

To justify such a high purchase price, he had to show that he was adding value, which he did by securing a tenant to pay almost $1 million per year in rent in addition to all operating expenses. The investors later found out that the tenant was a shill for Mr. Okun. The lease document between Okun and the tenant promised a $1 million incentive to be paid to the tenant “upon successful syndication of the property”. Thus, the tenant was chosen not to pay money but to consummate the syndication deal. The tenant occupied the property for about a year, but did not pay rent.

Also enabling the scam was Cushman & Wakefield Valuation and Advisory Services, which appraised the warehouse for $12,650,000 based on comparisons to 21st century warehouses. This same appraisal firm currently faces over $10 billion in class action lawsuits in connection with the Credit Suisse syndicated loan fiasco involving the Yellowstone Club and other prominent resorts.

The warehouse was foreclosed on and has traded since then, but since Indiana is a non-disclosure state (good states in which to commit real estate fraud), the subsequent prices are not known. The local tax assessor has assessed its market value to be $4,125,400.

This quite common type of syndication scheme involves the syndicator organizing investors to acquire a major property, such as a mall. The syndicator usually shares few of the risks of the venture by taking huge upfront fees and minimizing his own equity in the investment. He may have already bought the property through another business entity and then sold it to the syndicate or TIC for a profit. Through another company which he owns he may receive substantial fees for management services. The syndicator uses his superior knowledge to take unfair advantage of the investors. The reported “acquisition price” is typically above market value.

In one recent Texas syndication the syndicators purchased a piece of land from themselves, on behalf of the investors, at a $20 million profit after a one year holding period, in a market with a growing inventory of large land parcels for sale at much lower prices. In addition to the $20 million profit, the syndicator earned fees of about $3,300,000 in selling commissions, $500,000 in wholesaling fees, $800,000 in placement fees, $600,000 in reimbursement of offering costs, $350,000 in underwriting fees, and $5,200,000 in reimbursement of offering and organization expense fees. This represents over a $30 million profit on a property that probably lost value since its original purchase as the demand for residential land waned.

Syndicators are thus able to acquire real estate or sell their own real estate with other people’s money and charge those people again and again for the right to take their money. One Internet course on real estate syndication (syndicationsuccess.com) teaches 17 different ways to extract fees from investors. Not to be outdone, New York University (NYU) offers a course this spring entitled Real Estate Investment Syndication: Acquiring and Managing Real Estate Using Other People’s Money, also promising to teach “maximizing opportunities to generate revenue.”

Meanwhile, many syndications are falling apart. 12,000 syndicate investors lost money in the DBSI bankruptcy two years ago, and an estimated 10,000 investors are affected by the current SCI bankruptcy. Both DBSI and SCI were American syndicators, located respectively in Idaho and Los Angeles.

There needs to be a cleanup of this culture of predation on small investors by the real estate syndication industry. Perhaps NYU can offer a course on that, too.

Related articles

• Isn't "Crowdfunding" the old Syndication Game? Do Your Homework, BusinessWeek..
• Investors here left nursing big losses after London sale

Gibson v. Credit Suisse: The Mother of All Syndication Frauds?

Previous blog posts have discussed deceptive real estate syndications.  

The mother of all alleged syndication frauds is the Credit Suisse loan syndication program involving 14 U.S. resorts. A syndicated loan is a loan sold off to multiple investors. I became obliquely involved when I appraised the property of one of the resort developers as additional loan collateral. (I have no relationship with Credit Suisse or Cushman & Wakefield.)

The alleged loan fraud is described by Bankruptcy Court Judge Ralph Kirschner as follows:

“In 2005, Credit Suisse was offering a new product for sale. It was offering the owners [developers] of luxury second-home developments the opportunity to take their profits up front by mortgaging their development projects to the hilt. Credit Suisse would loan the money on a non-recourse basis, earn a substantial fee, and sell off most of the credit to loan participants. The development owners would take most of the money out as a profit dividend, leaving their developments saddled with enormous debt. Credit Suisse and the development owners would benefit, while their developments—and especially the creditors of their developments—bore all the risk of loss. This newly developed syndicated loan product enriched Credit Suisse, its employees and more than one luxury development owner, but it left the developments too thinly capitalized to survive. Numerous entities that received Credit Suisse’s syndicated loan product have failed financially, including Tamarack Resort, Promontory, Lake Las Vegas, Turtle Bay and Ginn [Sur Mer].”

What makes this alleged fraud interesting to the International Appraiser is that Credit Suisse is Switzerland’s second largest bank and allegedly created a fake Cayman Islands branch in order to get around U.S. banking laws, particularly FIRREA (Financial Institution Reform, Recovery and Enforcement Act of 1989).

Credit Suisse and Cushman & Wakefield Appraisal are currently co-defendants in three class actions lawsuits, claiming over $10 billion, over the loan defaults of all 14 resorts, as follows:

1. $8 billion alleged damages. Property owners v. lender and appraisal firm. Filed January 2010.
2. $2 billion alleged damages. Borrower v. lender, appraisal firm and appraiser. Filed February 2012.
3. $250 million alleged damages. . Hedge fund loan investors v. appraisal firm. Filed October 2011.

The plaintiffs in the first lawsuit contend that CS saddled the resorts with debts much higher than the underlying real estate values, thereby forcing bankruptcies that impaired the value of the real estate holdings of the individual residents. Such a loan is sometimes called a “predatory loan” and the scheme sometimes called “loan to own”. As a former banker, I find such a complaint to be hard to believe. Foreclosures are rarely profitable for banks.

Credit Suisse hired the appraisal firm Cushman & Wakefield to appraise each resort according to an unorthodox methodology named “Total Net Value,” which basically ignored the time value of money in estimating the present value of each of these resort developments. Such developments were going to take years to sell out, but future revenues were not discounted for time. The “total net value” (TNV) methodology was tantamount to creating discounted cash flow models with 0% discount rates. Its sole purpose seemed to be to inflate the appraised value and thus justify a higher loan amount.

The appraisal firm performed the appraisals according the Total Net Value methodology dictated to them by the lender and attempted to cover themselves with all the necessary disclosures and Assumptions and Limiting Conditions in their reports. Others mistakenly thought that the appraisals were market value appraisals, and it appears that CS wanted to create that illusion. Cushman even mailed the appraisal reports to the Cayman Islands address, ostensibly to circumvent U.S. appraisal laws.

All 14 syndicated loans failed and property owners at four failed resorts, Yellowstone Club, Tamarack Club in Idaho, Lake Las Vegas, and Ginn Sur Mer in the Bahamas, filed the first suit against CS and the appraisal firm, claiming that CS had defrauded them with a predatory “loan to own” scheme, that appraisers had used the total net value methodology to create misleading and deceptive appraisal reports that violate FIRREA, and that the defendants, knowing this, engaged in a conspiracy to circumvent FIRREA by creating a special purpose lending entity in the Cayman Islands and having the appraisal reports delivered there. The CS Cayman branch was alleged to be a post office box.

In its motion to dismiss, the appraisal firm claimed that the plaintiffs were aware that the appraisal reports properly disclosed that they were not based on market value. They also pointed out that there was no connection between the plaintiffs and the appraisers and thus no basis for privity (fiduciary responsibility). The motion to dismiss, interestingly enough, also states that the appraisals’ non-compliance with U.S. banking laws was irrelevant to any of the loans because the lender was from the Cayman Islands. How convenient.

The Yellowstone Club example illustrates the magnitude of appraised value inflation as a result of the TNV methodology. Yellowstone Club is a private vacation home community in Montana that includes such notable residents as Bill Gates and Dan Quayle. Prior to CS’s involvement, the same appraisal firm had appraised Yellowstone Club for $420 million. CS instructed the appraisers to revalue Yellowstone Club several months later using “total net value” methodology, and the appraised value shot up to $1,165,000,000, supporting a $375 million loan decision by Credit Suisse. The loan later went into default and foreclosure.

On July 17th, 2009, the foreclosed Yellowstone Club was sold for $115 million to Cross Harbor Capital Partners. The loan loss was therefore about $260 million.

Lessons to be learned

From the standpoint of international investors, there should be the fundamental realization that appraisal or valuation reports ordered by a syndication sponsor are not “independent valuation reports”, as they are often labeled. Allowing syndication sponsors to buy and pay for valuation reports is just placing foxes in charge of the hen house.

The U.S. certainly has laws against appraiser misconduct, but enforcement is rare, and was certainly not enough to prevent the greatest global financial crisis since the 1930s, which was due in large part to massive mortgage fraud enabled by appraisal fraud. What’s worse is that most other countries do not even have laws as strict as the U.S., which implemented tougher laws after the Savings and Loan Crisis of the 1980s.

Some appraisers may think that certain liberties can be taken in an appraisal report as long as they are disclosed in the report. Appraisers may agree among themselves on what these types of disclosures are, but those outside the appraisal profession may not understand disclosures when they see them. This particular case may test the limits of how far this possibly undue reliance on disclaimers can go.

The appraisal reports for CS were previously published on the Internet and contained standard disclosures, disclaimers and Assumptions and Limiting Conditions. The “intended use” was for loan underwriting and the “intended user” was CS. An appraiser reading these reports could reasonably infer that the appraised values were not labeled as or intended to represent market values. The first plaintiffs in this case would not normally be considered to have a claim based on privity [duty of care to the plaintiff], either. Nevertheless, the appraisal firm is still facing an $8 billion lawsuit after an unsuccessful motion to dismiss.

The current judge on the case has raised the question of whether the plaintiffs properly understood the reports or had such capability. This raises the questions of whether disclosures and Assumptions and Limiting Conditions are enough to prevent the public from being misled. Appraisers should consider that any number printed as “appraised value” is likely to be interpreted by others as an expression of market value. There are many persons, particularly investors, who may rely on an “appraised value” without reading the report and finding the disclosures. Some properties or projects are even marketed with representations of appraised value without ever allowing the public to see the supporting appraisal reports, as was the case with Credit Suisse.

Large firms, in this case an international brokerage and appraisal firm, have deep pockets that can serve as a target for lawsuits. It would be in such a firm’s best interest to avoid all situations allowing accusations of impropriety. In this case, the reason for the using Total Net Value methodology instead of market value was not explained, making it seem that TNV’s sole purpose was to inflate the appraised value. This may make the appraisers seem complicit in the alleged loan fraud by CS, which the appraisals enabled. It is questionable if the appraisers expected to be part of a syndicated loan fraud scheme, though, as the only benefit to them were the fees earned for the reports. Nevertheless, whistleblower Michael Miller at C&W has come forward with allegations and incriminating e-mail messages (such as “not in jail yet and continuing to write these appraisals”) indicating that his colleagues knew they were creating misleading reports.

Congratulations to Cushman are in order for their award of a large "Financial Advisory Valuation Services" contract by the FDIC. Who says that excellence does not go unrewarded?

Final suggestion

Here is a suggestion for investors: Order your own appraisal or at least hire an appraiser to review the “independent valuation.” American Property Research provides such a service.

GIC's Failed New York Real Estate Investment: An In-Depth Analysis

Stuyvesant Town. 

While recently in Singapore, I encountered lively debate about Singapore’s two sovereign wealth funds, the Government of Singapore Investment Corporation (known as “GIC”) and Temasek Holdings. Given Singapore’s reputation for clean government, some citizens grumbled about the lack of transparency with which these funds operate. I first became curious about GIC last year after learning of their $675 million + loss in the default of a New York apartment community known as Stuyvesant Town/Peter Cooper Village at the beginning of 2010.

The failure of Stuyvesant Town/Peter Cooper Village at the beginning of 2010 resulted in the largest real estate foreclosure [actually “deed in lieu of foreclosure”] in U.S. history. These two aging apartment communities, with a total of 11,250 apartments, were together purchased for $5.4 billion in 2006 in a syndication organized by Tishman Speyer and BlackRock; there was also $4.4 billion in first and mezzanine financing. The purchase price equated to $480,000 per apartment in two complexes that were built in the 1940s, equating to an annual gross rent multiplier of more than 30, unheard of for an American apartment property not headed for condo conversion (but perhaps common in Singapore).

73% of the apartments had rents restricted by New York’s Rent Stabilization Ordinance, and the average rent for a one-bedroom apartment was about $1300 per month at the time. At the time of purchase, market rents on one-bedroom apartments, once renovated, were estimated to be $3200 to $3500 per unit.

The loans were underwritten not according to present income but according to pro forma income expected in 2011, five years hence. Net operating income was forecasted to triple in five years! Tishman reportedly planned to more actively manage the property than previous owner MetLife, and thought rents could be raised through renovation and the eviction of or renegotiation with illegal tenants, estimated to occupy about 1000 units. MetLife previously also had a plan to convert the units into luxury apartments, but found itself legally confounded by tenant litigation. They basically tried the same strategy before and failed.

Enterprising New Yorkers sometimes pretend to keep possession of apartments with restricted rents while subletting to other unrelated parties. Tishman planned to aggressively raise rents on these illegal subletters. One problem, though, was that under the Rent Stabilization Ordinance, stabilized rents below $2000 per month are not eligible to be raised to market value, and most of the units were earning less than $2000 per month.

My personal observation is that New York is a very litigious city (I had an appraisal office there in the 1990s). I have been threatened with lawsuits just for calling up buyers or sellers and asking them what they paid for their properties. MetLife had already been stymied by tenant lawsuits, so Tishman should not have been surprised that its aggressive rental increase program would also attract a class action lawsuit on more than 4000 units. The courts judged $200 million in rental increases to be illegal and awarded $4000 to each renter.

Besides ruinous legal expenses, the financial industry meltdown had hit the New York apartment rental market hard, and market rents were falling. Asking rents on one bedroom apartments at Stuyvesant/Cooper had declined to $2255 per month at the time of foreclosure, not including a $500 move-in bonus.

The first mortgage loan was underwritten at a 1.7 debt coverage ratio based on pro forma Year 2011 NOI, but actual first year debt coverage in year 2006 was only .48! Having worked for America's largest multifamily lender in the 1990s, a deal like this would never have been done. Including the mezzanine debt, the 2011 DCR would have been only 1.2. Even more surprising was that there were two pieces of mezzanine debt, and GIC held the subordinate piece, $575 billion, which became worthless at the time of foreclosure. The superior mezzanine lien at least received $45 million.

What this meant for equity investors was years of red ink before the property could earn positive cash flow. When the projections became unattainable, there was no more reason for the investors to hold on to the properties, and the lenders took possession.

The most recent appraisal of this complex estimated market value at about $2.8 billion, meaning a potential loss of about $2.6 billion for the consortium of lenders which include Wachovia (now Wells Fargo), Merrill Lynch (now Bank of America), GIC and the other mezzanine lender.

When real estate scoundrels pretend to be saints

"As God is my witness, I can GET YOU FINANCED!"

Now that Andy Rooney has passed away, it’s my turn to talk about what annoys me most. In the commercial real estate industry, I am annoyed by real estate scumbags-turned-saints.

Now we all know that the real estate industry does not naturally attract saints. It may attract sincere people, but mostly people who just sincerely want to become rich.

Sometimes, when a convicted fraudster, perhaps a mortgage broker, is led from court in handcuffs, he or she may say, “But I was making the dream of homeownership a reality for underprivileged families!” in a tone of voice so sanctimonious as to make one wonder why Mother Theresa herself wasn’t a mortgage broker, too, until one considers that people with bad credit who lie about income and assets might not actually deserve homeownership.

Those people who must announce their integrity!

“The louder he proclaimed his honor, the faster we counted the spoons”--Ralph Waldo Emerson

Two weeks ago I received a comment on my Costa Rican tree farm scams post which basically said that my comments did not apply to a company named Ethical Forestry, which owns teak farms in Costa Rica and uses telemarketers to lure UK citizens to invest in trees.

If the proof of integrity is in the name of the company, this gives me an idea to create The Ethical Bridge Company. The company’s purpose will be to ethically sell the Brooklyn Bridge, not like all those other Brooklyn Bridge salesmen who give bridgeselling a bad name. 10% of your purchase money will be used to buy wheelchairs for crippled orphans.

It may be no coincidence, too, that the only client who ever cheated me out of my fee proclaimed his Christianity in every conversation we had. Have a blessed day in Hell, Mr. Scott.

Those ethics awards!

A developer once deceived my bank into making a $30 million land speculation loan at a 5% interest rate and 97% loan-to-value ratio. The loan was allegedly for the purpose of constructing a surface parking lot supposedly worth $65 million, according to their appraiser (but had just been bought for $24,375,000). When I raised doubts about the developer’s intentions, the loan officers dismissed them, pointing out that the developer had just received an “ethics award” from a realtors’ organization. Ethics awards from realtors? What could be next -- a humanitarian award from Osama bin Laden?

In any event, the Chief Lending Officer who rigged this deal is now being sued for $300 million by the FDIC (Federal Deposit Insurance Corporation).

Those philanthropists!

Eighteenth century philosopher Samuel Johnson once said “Patriotism is the last refuge of a scoundrel.” Let me update Johnson by adding the word “philanthropy” to the list. Some of the best known “robber barons” of the 19th Century (and at least one from the 20th) became philanthropists. My alma mater, the University of Chicago, was founded by one such philanthropist, John D. Rockefeller. Bernard Madoff was also a known philanthropist.

Take Richard Simring, for instance, a co-conspirator to Ed Okun, who I mentioned in my international real estate syndication fraud post. Before confessing his guilt, he was also serving as the Chairman of the Board of the Voices for Children Foundation, a charity that raised money to advocate for abused or neglected children, in addition to serving the Lighthouse for the Blind and serving on the board of directors of Educate Tomorrow, a foundation making education attainable to children in the third world nations of Niger and Miami, Florida.

Young Irish real estate mogul Darragh MacAnthony dropped out of college to sell timeshares in Spain and ended up founding MRI International, which took funds from UK and Irish investors to buy overseas vacation homes and furnishings. The company was headquartered in Spain and went into liquidation in 2009, and hundreds, if not thousands, lost their cash deposits, for which MacAnthony faces Spanish litigation for “theft by swindle and misappropriation of funds”. He is also chairman of the Helping Hands Group, a charity that provides free transport, training and physical therapy to brain-injured or learning-disabled adults, and chairman of the Peterborough United Football Club. What a nice man. Meanwhile, an “MRI Victim Support Group” of more than 800 members has protested in front of the UK Prime Minister’s House (10 Downing Street).

The real estate industry often accommodates such paradoxes. When I was in banking I sometimes had to present the unpleasant news that we had been deceived by a borrower, only to hear an admonishment such as “How dare you question his integrity! Don’t you know he’s chairman of the Pathetic Crippled Children’s Foundation?” Charity and honesty are not necessarily synonymous, and I hypothesize that the biggest crooks often turn to charitable giving to assuage the guilt they feel in receiving ill-gotten gains. Everyone wants to feel good about himself.

“Martin, before you call this man a liar, you should know that he’s chairman of the Pathetic Crippled Children’s Foundation.”
Cartoon art was purchased from CartoonStock and captions changed.