Wednesday, August 23, 2006

Real Estate Scams

Not all real estate scams are illegal.
Some people have simply discovered all kinds of ways to legally steal money from other people using real state. So it's a good idea to enter into any kind of real estate transaction with both eyes wide open and one hand on your wallet, and double-check everything before you make a move.
The real estate boom that happened in the recent economic recovery was not spawned by need, but by greed.
The only need-based reason that millions of homes should have been in such a huge desperate demand would have been if we suddenly had, say 10 million more people that needed housing.
But we didn't. There was no huge new influx of immigration. Therefore, the demand was created by people who already have homes here looking to make money by investing in extra real estate and flipping it over to someone else to make a huge profit.
That next person is doing the same thing and flipping it over AGAIN to someone else to also make a huge profit. Each time it flips, the profits made are more than the average person can save from an average job in a couple of decades. So it seems like winning a lottery. Except that at the end of the chain, someone is always left holding the bag. And you never know if you're the one at the end of the chain.

In the end, that person has some hugely overpriced house they can't hope to sell at the price they paid and so they take a loss - or they are forced to carry the payments for it for years until the market values finally rise to meet what they paid.

But these are not the people I feel most sorry for. These at least are people who did this with both eyes open, just looking for a free-ride by getting rich flipping real estate. They weren't cheated by anybody necessarily, they were just unwise enough to misjudge the boom trend and buy a property at it's peak. That's the chance they took, and it didn't pan out that time. So be it.

The people I really feel sorry for are the ones that are deliberately scammed by unscrupulous types trying to make money by misleading innocent people and taking their hard-earned money, or their homes. Let's look at some examples of how some of the scams work so you can learn and avoid these situations yourself. Remember, people in every position can get burned one way or another. Sometimes it's the seller getting burned. Sometimes the buyer. Sometimes the mortgage lender, the mortgage buyer, the mortgagee, the real estate salesperson, everybody involved has the opportunity to be cheated at some point by someone.

Buyer Scams
The Chinese Tease
Back in the late 1980's when I was in the real estate business myself, I used to see a lot of tricks that people were using to get some advantage over others. One trick I saw a few times I called the Chinese Tease, and was not uncommon among buyers coming in from Hong Kong to buy real estate in the Toronto area. Obviously, it's not restricted to only Chinese, it just happened that most of the ones I saw doing this at that time were Chinese from Hong Kong.

Here's how it worked: First, the people buying the house are not just a couple, but rather a large group of people. They pool their income and their money and assets in order to buy a series of properties as investments and to qualify for mortgage financing beyond what they normally would. And that is ironic, because that is contrary to the trick they used. The trick is this: They would offer to buy a house and pay a fair price, but with a relatively close closing date, perhaps in 30 days, explaining that they were coming in from Hong Kong and needed a place to live very quickly. The sellers would sell them the house with the normal 'conditional upon financing' clause in it, and allowing the buyers three weeks to arrange financing because they needed extra time to arrange the mortgage. But the buyers have no intention of getting a mortgage. Instead, they simply wait the three weeks and then rescind their offer - legally.

They simply claim that they did not qualify for the mortgage. However, since they thought they had sold their house already, the sellers had already gone to buy their next house with a firm offer. Now, they are stuck with two houses. They have to come up with another down payment for the new one without having the money from the sale of the old one, AND they have to arrange bridge financing to cover two homes at once. Something that is very very difficult - or impossible in an expensive housing city like that.

The alternative is to default on the new purchase and let that seller now sue them for hundreds of thousands of dollars, or sue for 'specific performance' to force them to buy the property anyway. After a few days, when the full depth of their problem sinks in, suddenly another Chinese buyer comes along. The sellers don't know it, but he is actually a member of the same buying group that did the original deal. He offers to buy the house at a drastically reduced price, but he can close on the original date - which is now only 5 or 6 days away.

This allows the seller to escape a lawsuit or having to carry both houses, but it is usually such a low offer that it strips away most of his equity in his house. Then, the buying group has acquired another house - and at bargain basement prices. They may get a $500,000 house for $300,000 this way, which they could simply turn around and resell again immediately and pull $200,000 profit out of. Cute trick, huh? If they do this 5 or 6 times, they could make over a million dollars per year this way.

The Brother From Barona
Another trick I saw many times was where someone would sign an offer to purchase a property, but they would put the words "(in trust)" beside their name. They said this was because they were actually buying the property for a brother coming from Italy (or wherever) and he would be there before closing, but he is not here now to do the offer. The idea is that just before closing, they transfer the agreement over to the brother who actually intends to buy and live in the house. Usually this is accompanied by a rather low deposit.

Then when closing time comes along, the buyer does not wish to close and instead uses the (in trust) clause, transfers the agreement to a numbered company that he owns which has no assets and so is unsuable and untraceable. This places the seller in the same position as the Chinese Tease described above, but it's worse because by then, the damage is done already. The seller is already stuck with two properties, and must dump one. He can then go in with a cheap offer to pick up one of them and then flip it for a profit. Or his brother does.

Straw Buyers
In some cases, a person will sell their land to an accomplice for an inflated price.
Then the mortgage company loans money to the buyer for the property to complete the transaction. Then the buyer defaults and the seller and buyer split the proceeds.


Seller Scams
I was once stung very badly by an unscrupulous seller. I bought a house with a long lot that was ideally situated for being subdivided and sold as three lots for a potential upcoming infill subdivision. I paid a premium price because it had that potential. More than it would sell for without it, but less than I would get for subdividing the other two lots and selling those. I bought the house in good faith from a seller who sold it in good faith. In fact he bought it in good faith years before from an honest man too. In fact, the real crook was the man who sold it 17 years before that in 1972. The house had changed hands 7 times since then.

When the subdivision plan was finally coming along, I had been living in the house for several years, but in 1991, suddenly one day there was a notice in the mailbox to say that a previous owner from 19 year prior to that was exercising his option to buy back the land behind my house for one dollar.

He was trying to STEAL my land!

Apparently, the way he did it was to have his daughter, who was a title searcher, go to the registrar's office and ask for the 40-year search. She then took the stack of original documents (not copies, mind you) over to a desk where she works unobserved. I assume it was here that she inserted a replacement page into the original Agreement of Purchase and Sale from 19 years previously when her father sold the land, and the new page includes the clause that allows him to buy back the rear 400 feet of land for one dollar anytime up until 20 years had passed. I had no idea who this guy was, but he had a reputation for unscrupulous and illegal activity in that town.

We refused. He sued. The civil court does not have jurisdiction over criminal issues such as fraud, so they had to take the documents at face value, despite the fact that the page headers and trailers did not match, despite the fact that it was written by a different typewriter than the other pages in the same document, and despite the fact that none of the other lawyers, including mine, had ever seen the clause or
noted it in all 7 transactions over 19 years.

Nevertheless, the court decided in his favor, and I lost my land, and my house. I lost everything I owned in that transaction. The legal fees alone were enough to bankrupt me. I managed to stay out of bankruptcy, but I had to sell my house to pay for them. I lost 8 years of my life in that debacle. I just had to walk away and start again with nothing. Which I did.

Mortgage Scams
Mortgage Flipping
Many mortgage lenders encourage you to keep refinancing your mortgage to get extra cash by taking it out of your equity, or to take advantage of a lower rate. The problem is that there are usually about $5,000 in fees to set up a mortgage. These fees may be added on to the principal so they are not as obvious when you do the original paperwork, but every time you change, you increase the overall debt by another $5,000.
In the long run, with compound interest rates over 30 years, each renewal costs you
3.5 times the original amount. In other words, if you renew your mortgage twice, that's about $10,000 is mortgage setup fees, which, amortized over thirty years comes to about $30,000 extra to pay off on TOP of the amount for the house. Just for the FEES for renewal.

Interest Only
Some interest only loans have a balloon payment of principal due at the end of a short term. Suddenly you find you need a huge amount of money which you don't have and cannot afford on top of your mortgage payments so you lose your house.

The Handyman Special
Some people ask a contractor for a quote for an addition or renovation on their home.
The contractor comes back with a quote but it's much higher than they thought. However he says he will arrange financing for them.

He starts the work and then comes back with paperwork for permission for him to get a homeowner's loan against their house that they have to pay. He will walk out and leave the job in a mess if they don't sign.
But the terms are bad. High interest rates, extra fees, penalties, etc. and the contractor was in a deal with the lender to get kickbacks on the loan. Once the loan is set up and he gets his money there is little incentive to ever come back and finish the job. But the homeowner is stuck with the new home improvement loan to pay
and they and the contractor already have their money.

Loan To Own
Here is another trick. This is one that my brother told me about. He has spent many years in the commercial real estate business and has been exposed to a lot of business dealings both clever and crooked and has probably seen it all by now. Or at least most of it. Here is one secret: if you want to own a shopping mall, you don't need to go to all the trouble of designing it, buying the land, doing the land studies, the market research, deal with the planning board for the zoning changes and planning permissions, hiring the builder to build it, dealing with all the cost overruns and construction problems, water problems, etc. etc. etc.

Instead, you can simply give a mortgage to a shopping mall that someone else is building, and then wait for a major tenant, or a few smaller tenants, to leave, then use a mortgage call to take over the whole mall. Of course he has never done this, but he's seen it happen several times.

It works like this: The mortgage, like a home mortgage, is based upon loaning an amount up to but not exceeding a certain percentage of the value of the property.
So, if the mall is worth say, 32 million dollars, and the mortgage is for 75% of the value, then the mortgage is for 24 million, and the developer that built the mall has to invest 8 million dollars into it.

However, unlike a house, the mall's value is not based merely on it's land value or the value of it's construction. It is also based in a large part on the signed leases it has with the retail tenants. If they leave, then the income potential of the mall is severely damaged and the mall is worth a LOT less money to investors. If the value drops to say 25 million because a large tenant has left or shut down, then the mortgage is now at more than the agreed upon 75% of the overall value, and so the developer has to give the mortgage company enough money to make up the difference.
In this case, the call might be for the difference of 18 million to 24 million, which is of course, 6 million dollars. It is unlikely that the developer has 6 million dollars to hand over just like that. Especially when there is no return for the investment, and ESPECIALLY since their income is drastically reduced due to the fact that their major tenant has shut down that store. So they are not in a position to pony up the cash, and they lose their mall, lock, stock and barrel.

Now, of course the mortgage company can go ahead and assume control and lease out the empty store and the value of the mall jumps back up to industry standard and they have just bought themselves a 32 million dollar mall for 24 million. No headaches of planning or construction.


Buyback Scams


Some people who are having troubles making the mortgage payments have been taken in by scams where a person offers to help them out by instead of giving a traditional mortgage, the owners actually sign over the deed to the property temporarily for the value of the mortgage. Then they have a reduced payment which is essentially rent they pay to continue living in the same house. They stay in this mode until they are financially on their feet again and then they buy the house back for the same price they sold it for.
However, there are usually fees, indexes to inflation, etc. that keep the house always just out of reach and they cannot afford to buy it back, of the mortgage company sells the property to someone else who now wants the house and has no such agreement with the people he considers 'renters'. Either way, they never get their house back.

Rent to Own Scams
Promises, Promises
Many people that rent have a decent income and some limited cash, but not quite enough to pay a full down payment and buy a house. There are those who prey upon these people too.
They offer a rent-to-own plan where they take a small down payment, such as $10,000, then charge $300 more than normal monthly rent, with the intention of having the renter buy the house after a couple of years.
Typically though, in 2 years, the financial situation for the renter has not changed much, and they still can't afford it. Part of that is because the value set in the contract is higher than what the place is worth at that time. Set high deliberately in order to get the down payment and extra rent every month. You can be sure that if the value of the house ever actually gets to where it's a fair deal and the renter is trying to exercise his option, the owner will be on the phone to his lawyer looking for a way to get out of it.

Renter Scams
Pacific Heights.
We are used to think that the owner is a scam artist and the poor person renting is the victim. But not always. Sometimes the renter is the scam artist. If you ever saw the movie Pacific Heights, you know how this can happen.

Well, that happened in real life to a couple I know very well. In fact, we're related.

They themselves rented a small, but clean and decent apartment in the city to live in while they put all their money into buying a farm. The farm was too far away to commute to everyday for work, so it was for an investment. But they put all their eggs into that one basket. The goal was to keep it for a few years and then sell it to a housing developer to subdivide and they should make their retirement nestegg.

Unfortunately, it didn't work out that way. They had to rent it out to cover the mortgage payments and other costs, and the woman they rented it to was a shyster. She ended up setting up a business for hosting exotic pets (Python snakes, large predator cats, etc.) and she found a way the trick the system so that she wouldn't ever have to pay rent, and could eventually even get the farm for free.

She started by taking a chicken and letting it go bad to develop some salmonella. Then she dunked that into some water and then took the water to some testing lab to be tested. The water came back with a lab report saying it was contaminated. She then opened up a lawsuit against the owners to say that this was the well water at the house, and she was refusing to pay the rent because of this issue. That meant that the rent was now formally considered 'in dispute' and so did not have to be paid until the court date. The court date was set 6 months in the future. Then she damaged an electrical panel and claimed it was a fire hazard and set up a separate law suit for that. Then she did the same with several other spurious lawsuits.

The judge decided that all the cases had to be heard at the same time, but it was going to be a large case now, and so would have to be rescheduled out to a more distant date. It was set out well after a year.

In the meantime, she was paying no rent. She continued to pile on lawsuit after lawsuit ridiculously, until it got to the point that she was suing for more than the property was worth. If they lost the lawsuits, then the older couple would lose their life savings. The case started to go her way because most people think that if there are that many claims - SOME of them have to be true! They can't ALL be made up can they??

As it happened, she had done this same trick in another city to several other people, and so they showed up to give evidence to the judge. They had been looking for her for some time.

When the judge saw that, the case turned around, and the people got their farm back, and the woman was charged. However, the whole nightmare took years to settle, and the chance to sell the property at a decent price had now passed. The recession had now begun and the property was worth less than they paid for it, so they sold it at a loss and got out.

Planning Scams
The Planner Who Plans Ahead
Another commercial one I once heard of was where a company bought a corner property in a major city. This is a commercial office building of perhaps 4 or 5 stories. They planned to use it as their headquarters, but because of a very specific zoning by-law, they had to apply for a slight zoning change to allow them to operate the business there. The change was minor. It was the equivalent of switching from
say a medical building to an insurance company. That type of thing.

Well, the planner looked at it and decided that they could have their zoning change but only if they could provide 12 more parking spaces than what were there already.
This was of course, impossible. The building was already built and had been standing for years. The only way to get more parking spaces would be to demolish the office building for which the parking spaces were ostensibly for. It was a huge problem. The company had paid millions of dollars for a building they could not use. So they asked for an alternative.

And, of course, there was one. The planner said that if they wished, they could instead donate $20,000 per parking space for each parking space that they didn't have (that he said they needed to have) into a local city fund that would be used to buy a local parking lot to be used for parking for the buildings in that area. So they did that. They paid the $240,000 into the fund.

Then, shortly thereafter, that planner himself had personally purchased an old abandoned gas station down the street and resold THAT to the city for the exact amount in the planning fund. Three million dollars. How nice.


Other Scams
The Boomerang Burger Bar
I saw this happen with pizza places before, but it's common all across the restaurant industry.

One guy has a small restaurant that he wants to sell. He put it together by going to buy up the remains of another restaurant that went broke, and buy his equipment and fixtures at 10 cents on the dollar as a liquidator.
For $250,000 worth of kitchen equipment and chairs, tables, etc. he pays maybe $25,000. Then he puts another $5K into signage, and strikes a deal with the owner of a small plaza with an empty store to sign a 6 year lease but with free leasehold improvements and the first 6 months rent-free to get the business started. He hires some local kids at minimum wage and opens the doors. He then IMMEDIATELY starts looking to sell it.

He wants to sell it before the rent payments kick in. So far, his total cost outlay is only less than $35k.

He finds some middle-aged corporate guy who is tired of the corporate rat race and dreams of owning his own business. Then he offers to sell him the business for $500K. The corporate guy thinks that he can make that up eventually because he doesn't know that more than 90 of all restaurant businesses go broke. Also, he doesn't really know how badly the books have been cooked to make it look like it was profitable when it was not. It's impossible to prove how much business was really going through a restaurant that has a large cash component of their sales, because you'll never get the credit card companies to give information about past years business, or suppliers, and even then, the supplies can be bought anywhere and multiple places at once.

The buyer tries to get a loan from a bank and they laugh at him for being so ridiculous. But the seller takes pity on him and gives him a mortgage on the business. "Give me $100K down, and put up your house and the business itself as collateral, and I'll give you the other $400K as a vendor mortgage." He KNOWS that the man is going to fail because he doesn't know the restaurant business, and because the books were faked, and usually the corporate guys never have enough money in the bankto keep paying the bills for month after month of running losses.

So the buyer quits his corporate job and starts working his little restaurant. Months go by.

The seller has his $100K - which itself was far more than what it cost him to set it up in the first place. And now he is also collecting the mortgage payments every month from the poor sap. Then, after 6 months of steady losses, the new owner starts to default on the loan. The seller gives him 2 months leeway and then forecloses.
Now he own the man's house, and his $100,000 in cash, and he took about 20,000 in mortgage payments, AND he got the original business back.

He just turns around, re-lists it on the market and waits for the next sucker to come along. He keeps selling it and it keeps coming back - just like a boomerang.

I bought a pizza place one time and saw this stuff happen. The money in the restaurant business is not in RUNNING the restaurant. It's in buying and selling them.

3 Comments:

At 8/24/2006 9:29 AM, Anonymous lauren said...

My dad and stepmom are both real estate agents. My dad was a music teacher for 30 years before that. Man they make a ton of money selling in NJ. It's SO expensive to live in NJ!

 
At 8/24/2006 4:03 PM, Blogger Val Serrie said...

In 1989, I had been working in the computer field for 11 years so far and I looked at my younger brother and he was making 3 times my income by working in real estate. And it required no education, there was no boss, no morning commute, the hours were whatever he wanted and it was easy work compared to what I was doing.
I decided to try it. Well, I was just in time to hit the recession. The whole industry and economy fell down. There were way too many real estate agents in the market and many just had to go. I lasted about 2 years, then figured that that was just not the life for me.
I didn't like being in a business where I could not effect my own success. Too much was dependent on the market and the economy, and the interest rates, and the stories in the news. If the whole industry was quiet, then there simply was no business to spread around - and too many to spread it around to.
In a strong push market, real estate agents can make a lot of money quickly, but in a bad slow market, they starve. And there is no such thing as unemployment payments for real estate agents. As long as you have your license, you are not eligible.
I left it after 2 years and went back into the corporate world and got a regular job. Even though it paid less than I had been making 2 years previously, and was a lower level position, still, I was glad to have it. Glad to have escaped Real estate intact. So many others had gone bankrupt or some even committed suicide.

 
At 8/24/2006 4:44 PM, Anonymous lauren said...

My dad retired from teaching and is doing this now. My step mom worked for companies like Leo Burnett and then had her own dot com for a long time. They are both business people through and through and do well. They're selling their own house now and it's on the market for 900k. It's a decent house but not a mansion or anything by ANY means. Yet in the burbs of IL here my boyfriend's mom has a large ranch house with a pool and hot tub INSIDE the house and it was listed at like 600k 2 years ago or so. Ha.

 

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