Today I finished an appraisal of a golf course that had been bought out of lender receivership a year ago for $3.2 million. The new owners, seeking cash-out refinancing, were eager to show me the appraisal that had been done for the prior lender in 2004, before the property was placed in receivership. The prior appraised value had been $6.7 million. Not coincidently, so was the stated purchase price at that time. The previous lender made a $5 million loan based on a loan-to-value ratio understood to be 75% ($6,700,000 × 0.75 = $5,025,000).
The problem with that scenario was that the publicly recorded purchase at the time of the prior loan’s funding (in 2004) was for $4.7 million, not $6.7 million. The unintended loan-to-value ratio had actually been 106% and the previous owners’ lack of equity in the property had probably hastened the loan default, causing a loss to the lender.
The publicly recorded purchase price of this golf course in 2004 was $2 million less than the appraiser had been led to believe.
How could the purchase price have been misunderstood? Was the lender deceived? Was the appraiser deceived? Did the previous owners commit mortgage fraud? If so, what statutes might have been violated?
Was the prior appraiser, who was seasoned and respected, knowingly or unknowingly complicit in mortgage fraud? What are the possible legal consequences? Did the assumptions and limiting conditions of the report protect the appraiser from liability? If this was a case of mortgage fraud, what could the appraiser have done to prevent the fraud from occurring? What was the appraiser obligated to do? These questions and more will be addressed in this book.
This book has been written because mortgage fraud has reached an all-time high, yet the appraisal profession often finds itself unprepared to assist in detecting and preventing the frauds that recently almost brought down the global financial system. The Financial Crimes Enforcement Network (FinCEN) released an Advisory on Activities Potentially Related to Commercial Real Estate Fraud in March 2011 indicating that suspicious activity reports relating to commercial real estate fraud tripled between the years 2007 and 2010.1 Other areas of fraud will be discussed, too, such as investment and securities fraud as well as syndication fraud, which was rampant in the 1980s and appears to be returning once again.
Appraisal textbooks do not address the prospect of fraud compromising the accuracy of analysis, and neither do finance textbooks in general. Business education today emphasizes problem-solving skills at the expense of critical-thinking skills. The problem-solving exercises so often used by business schools and professional education providers start with explicitly stated assumptions by necessity, which works against cultivating a mindset that challenges assumptions. This book will take a step towards teaching critical thinking skills useful to the commercial appraiser who wishes to prevent fraud.
This book will focus on common methods of deception used in fraudulent schemes involving commercial properties and land. It will also explore various avenues of critical inquiry that may protect the appraiser from relying on inaccurate information. It will present the various conflicts of interest in our industry that have the potential to exploit the appraisal process for dishonest purposes.
This book will also disclose the legal consequences for appraisers who knowingly or unknowingly become complicit in fraud schemes. In discussing possible legal consequences for appraisers, the emphasis will not be on what is fair or unfair or legal or illegal. Instead, we will focus on what is happening or could happen to appraisers. Some of these consequences may be unfair, as the justice system is by its very nature a work in progress.
The goal of this book is to keep commercial appraisers out of trouble, whether it is trouble for themselves or for others who rely on their work. I will refrain from using “thou shalts” and “thou shalt nots” and instead make suggestions (“this could prevent trouble for both you and others”). I will also rely on examples from actual practice. Most cases have not been fully settled in court, so rules of confidentiality preclude greater specificity in some instances.
If the tone of this book sounds unduly negative, remember that this book is about fraud and the very nature of the subject will focus attention on the seamier sides of the commercial real estate industry. It is not my intention to label the whole commercial real estate industry as dishonest.
This book intends to go well beyond existing literature on methods of preventing commercial real estate fraud. If appraisers put this information to good use, perhaps the dreaded words real estate crisis will not have to be used again in our lifetime.
Vernon Martin
1. “FinCEN Releases Commercial Real Estate Fraud Analysis and Advisory,” www.FinCEN.gov, March 30, 2011.