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Emerging fraud trends: Fraudulent investment property schemes

Investment property and 'investment club' arrangements are common in the industry, but they may be sometimes based on fraudulent origination and/or closing practices. Like potential property investors, those in the real estate and mortgage industries also need to be extremely vigilant about fraudulent investment property schemes.

How does an investment property scheme work?

  • Investment property schemes are usually spread by word of mouth and require individuals to invest large sums of money in investment properties. Most schemes promise either a large increase in the value of the property resulting in a large return on investment, or higher-than-market interest on contributed capital, or even both.
  • A property 'investment club' arrangement is a group of individuals pooling funds in order to make investments in real estate that individual club members would otherwise not be able to afford. A property 'investment club' is a legitimate practice when all representations regarding investment are true and accurate. However, when there are misrepresentations as to the property or the investment, this type of arrangement is fraudulent and may lead to devastating consequences.

An example: A fraudulent bicoastal investment property scheme

Below is an example of a fraudulent investment property scheme:

The set up

An individual who purchased properties in a metropolitan area in the Midwest moved the property titles to companies under his control. The individual had family members on the East Coast recruit prospective buyers from the town in which the family members lived. The borrowers were told that the loan applications which they signed served as their membership in a 'real estate buyer’s club' that would acquire properties, hold the properties for a period of time, and sell these properties in the future for a profit. The buyers/borrowers were promised that while the properties were being held for future sale, they would be rented out and maintained to ensure a cash flow for the 'real estate buyer’s club' mortgage payments.

The end result

  • The perpetrator of the investment scheme flipped the properties to the borrowers using inflated values.
  • To the lenders, it was represented that the borrowers were individually purchasing a number of investment properties – 8 to 10 properties per borrower, instead of a group purchase.
  • There was no property maintenance and there were no tenants.
  • The lenders ended up with non-performing loans that were upside down (owing more than the properties are worth) in equity because the original values were inflated and the borrowers never actually made the down payment as represented.

Common fraudulent investment property scheme 'red flags'

Common characteristics of fraudulent investment property schemes are multiple loan-level misrepresentations. Some 'red flags' to be aware of are:

  • The use of straw buyers
  • Inflated appraisals
  • Falsely stated income
  • Circumvention of purchase guidelines
  • Large number of properties purchased
  • The borrowers are located in several states. While these schemes have historically involved borrowers who geographically lived close to the subject properties, the trend today is for at least some of the borrowers to be located several states away.

Preventing fraudulent investment property schemes

Fraudulent investment property schemes can often be detected with thorough data analysis. Data on loans in a company’s portfolio can be analyzed to identify trends and common patterns. Here's an example of how data analysis can help detect fraudulent investment property schemes:

  • Pull data by category, such as investment purchases in Ohio, and search a particular LTV range.
  • Then manually search for common street addresses, subdivisions, or borrower names.
  • From this sample, other common elements may appear. For example, a lender may find that there are several properties within a condominium project all closing within a tight timeframe with very similar terms (100% LTV, stated income, etc.) or all from the same source. This is not in and of itself fraudulent, but it may suggest that the group of loans and the originating parties should be inspected more closely.

It is always critical to be mindful of fraud on the front-end, but examining existing portfolios and a targeted sample of closed loans can sometimes be very helpful, and can direct the front-end to watch more closely areas where the risk of fraud may be greater.

Important fraud prevention resources

Leverage the following resources that provide more information on dealing with fraud:

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