Caution When Investing In Real Estate
Real Estate Development Fraud
I have encountered numerous real estate development projects where there have been allegations of fraud, many of which were proven accurate.
Real estate developers often have total control over the construction company and the vendors used on a project. They determine the amount and timing of capital calls and distributions to and from investors and which vendors get paid when. With what is often total oversight, developers can engage in a variety of activities to maximize their profits to the detriment of outside investors. Some examples include:
Misapplication of funds where they use construction loans or investment funds from one development for a different project or for personal use.
Inflating charges for the services or materials he supplies on a project resulting in reduced returns for investors.
When working on numerous projects simultaneously allocating more expenses to a project in which they have a smaller ownership interest.
Creating fictitious invoices and receiving payment for work not performed or materials not used.
Oftentimes, developers, have poor accounting systems and commingle funds from multiple projects or investments, making it challenging for investors to track the sources and uses of funds for specific projects.
Enhanced data analytics allow forensic accountants to perform procedures that can uncover many of these schemes. Some examples include:
Compare pricing for similar products by vendor to identify if products were purchased at higher than average rates.
Analyze product costs per unit and compare them to industry standards.
Compare the total number of contracts by vendor to identify the presence of any bid-rotation activity.
Determine the average value of contracts awarded per vendor to identify if high-dollar contracts are awarded to related parties.
Examine for one-time vendors or vendors with expedited payments.
Compare names, addresses, and account information to vendor master files to identify potential conflicts of interest or hidden relationships.
Compare expense allocations in relation to the size and scope of multiple concurrent projects.
Compare sales prices by customer to identify if condo units were sold at lower than market prices.
Identify large expense reimbursements or cash withdrawals prior to requesting a capital call.
Analyze disbursements made after capital calls are incurred.
Analyze payments made for excessive travel, charitable donations, gifts, and entertainment.
Analyze the chart of accounts to identify vague or suspicious accounts where improper payments could be expensed.
Misuse of funds can have serious consequences for investors, lenders, vendors, and other parties involved in a project. It can result in financial losses, delays in project completion, and legal disputes. Investors and lenders should conduct thorough due diligence on the companies and individuals involved in a project before making any investments. They should establish the extent of internal controls and reporting mechanisms in place and make certain they have the ability to monitor the use of funds on an ongoing basis to avoid becoming victims of fraud.
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