Friday’s Fraud – Real Estate Investment Schemes: Watch Out for Traps

By Benjamin Stubbs, Spring 2014 Student Intern

trapFor some time it was thought that real estate was a near foolproof investment and that if you owned land you should never sell it. This notion was badly shaken when the real estate bubble burst in 2008. Not only are investments in real estate recognized as risky, but in the words of NASAA, real estate investments “are popular with con artists” as well.

Real estate investments came in second on NASAA’s list of most common investment frauds of 2013. Accordingly, NASAA warned investors of “schemes related to new real estate development projects or buying, renovating, flipping or pooling distressed properties . . .” and “non-traded real estate investment trusts (REITS), properties that are bank-owned, pending short-sale, or in foreclosure . . . .”

Types of Real Estate Investments

There are several ways to invest in real estate. Most of us have seen shows on TV where a person buys a house in bad shape, spends some money fixing up the house and then sells it for a large profit. This is known as flipping and is one way to invest in real estate. Other ways include buying property where the owner is highly motivated to sell, such as property owned by a bank, where the owner of the property needs to escape the mortgage on the property and property that is in foreclosure, so the current owner just wants to get rid of it. These investments can pay off if the timing is right, but, as with all investing, there are risks involved.

Another common way to invest is real estate is to pool properties together, which provides a type of diversification. This type of pooling of distressed assets played largely into the real estate crash in 2008. One of the problems with pooling properties is that investors may not know exactly what properties they are investing in or how risky their investment in those properties is.

Another common form of real estate investment is known as a REIT (real estate investment trust). According to the Securities Exchange Commission (SEC), a REIT as a company that generally owns and operates income-producing property or real estate-related assets. There are different types of REITs, specializing in different types of properties. For more information on REITs and their risks, see this information from the SEC and FINRA’s Public Non-Traded REIT Tip Sheet.

Additionally, REITs can be traded or non-traded. As FINRA explains in its alert on public non-traded REITs, non-traded REITs are often the riskiest real estate investment and are “rarely, if ever, suitable for short-term investors and even long-term investors must be willing to bear the risks of illiquidity.” For an explanation of why non-traded investments are riskier than publicly traded investments, see my post from last week on private offerings. For more information on REITs, see former student intern James Gallagher’s post here.

How to Protect Yourself Against Real Estate Scams

booksThough the people flipping houses on TV may make it look it easy, if you find the thought of flipping a home or buying foreclosed property a little daunting, or if you find REITs and pooled property confusing, you’re not alone.

As we’ve said many times before on our blog, to protect yourself, do your homework and don’t rush into anything that you’re uncomfortable with. In NASAA’s words, “careful vetting and due diligence [are] a must with real estate investments.” This includes investigating the person trying to sell you an investment in real estate. Make sure that he or she is properly registered to be selling you investments by asking him or her and running a BrokerCheck report on him or her.

If you’re considering purchasing a certain piece of property, make sure you understand the risks involved, including potentially being unable to sell the property for years or another crash in the housing market. You can find a lot of information regarding the property and past sales history on the tax assessor’s website of the county where the property is located. Finally, if you’re considering purchasing an interest in a REIT, make sure you know whether the REIT is publicly traded, and ask about the fees and redemption restrictions associated with the purchase. Additionally, investigate the specific REIT that you’re considering. REITs are required to file certain disclosures with the SEC, and you can find them here.

Conclusion

Just because property values have historically risen over time doesn’t mean that real estate is a safe investment, and it certainly doesn’t mean that real estate is the right investment for you. Think twice before you decide to flip a certain property or to invest in pooled properties. Do your research, on the seller and the specific property. If you think you’ve been scammed, you’re not alone, so consider contacting our Clinic to see if we can help. Remember to check back in next week to learn more about fraud to help you protect yourself and your future.