22nd February 2019 – (Hong Kong) We have all heard the term caveat emptor, Latin for let the buyer beware. All securities offerings come with lengthy legal jargon essentially informing the investor that past returns are no guarantee of future earnings. These rules, however, do not protect the investor from potential fraud. 

On the surface, the crowdfunding model is a great way to spread the risk of real estate deals for many rookie investors as crowdfunding platforms generally support smaller minimum bite-sized investments. Real estate crowdfunding has gained in importance, and many today consider it to be a superior alternative to REITs. However, REITs are less risky, more liquid, better diversified, and have a long track record of outperforming private real estate investments. There are currently more than hundreds of websites worldwide and many boutique-sized private equity firms have mushroomed in New York, Hong Kong and Singapore specialising in this crowdfunding model. Increasingly, many investors consider it to be a better alternative to other forms of real estate investing, including REITs. The “technology” behind crowdfunding is supposed to lead to reduced fees, allow for greater diversification and ultimately boost risk-adjusted returns.

Many property crowdfunding ‘specialists’ like Hong Kong as the city has consistently surpassed other markets for commercial property transactions in Asia but the heat has reduced tremendously since end 2018 as investors cost in factors such as the impact of the US-China trade war, rising interest rates and lower yields, according to a recent report by Real Capital Analytics.

Crowdfunding websites are very good at selling this concept to unsophisticated retail investors, but they do less of a good job at presenting the risks in a fair manner. Investment via crowdfunding can be very risky as it is not regulated and highly illiquid as compared to REITs. A lot of these schemes are locked up for a period of over 4 years before investors can receive the first pay out.

Many crowdfunding companies attempt to sell their products in a very biased manner. According to them, REITs are not real estate, REITs are riskier, and crowdfunding are set to outperform. All highly questionable statements, to say the least, and outright deceiving to prospecting investors who are mostly amateurs in property investments.

CASE STUDY:

Konrad Putzier from The Real Deal (TRD) did a brilliant investigative exposé on the BAR WORKS crowdfunding scam in America which subsequently led to charges being brought against the perpetrators.(Excerpts of original article appear here): 

Bar Works was allegedly a Ponzi scheme masquerading as a real estate investment.

An Australian in New York, Cindy, who like many other victims only spoke to The Real Deal on the condition that her name be changed, is one of more than a hundred investors from around the world who lost their savings to what appears to be a bizarre fraud. On the surface, Bar Works is just another co-working company in New York. Wedged between Seventh Avenue and Morton Street, with large windows and arching brick walls inside, the street-level space could make for a quaint restaurant. Instead it’s got bland desks dotted with telephones, wheely chairs covered in gray velvet, and a fully-stocked bar. It calls itself a “workspace with vibe,” a fair description if the vibe you’re going for is a cross between a WeWork, a dive bar and an airport terminal.

In reality, however, the space, along with other Bar Works locations in Manhattan, Brooklyn, San Francisco, Las Vegas, Miami and Istanbul, looks to have served as a front for Renwick Robert Haddow, a British career fraudster. Through a labyrinth of agents and websites, of emails and social media ads, Haddow and his associates orchestrated a global fraud scheme, sources said.

Renwick Robert Haddow and Zoya Kiselova, his wife

The pitch to Cindy was compelling: Bar Works would rent or buy retail spaces, turn them into offices with a bar and sublet desks to the creative class. It needed to raise money to fund its expansion, so it offered investors the chance to buy a desk in one of the spaces and get a slice of the rent and it guaranteed double-digit returns.

Haddow went through great lengths to mask his involvement, installing his Ukrainian wife as a co-founder under a pseudonym. Most investors were in the dark until TRD exposed Haddow’s role in January 2017, and even then some held out hope until payments started drying up in March and April.

In the world of scams, Bar Works is relatively small. But it is a perfect example of why real estate investment fraud is on the rise around the globe, bolstered by the spread of e-commerce and social media, the lack of an international enforcement authority, the complex nature of development projects, and investors’ thirst for outsized returns.

“Investors like you are generating a monthly income of up to 16% Pa From Our Two Co-working Spaces On W39th Street and W46th Street close to Times Square,” the email pitch read.

On June 30 2017, the Securities and Exchange Commission and the acting U.S. Attorney for the Southern District of New York unsealed separate fraud charges against Haddow. Prosecutors claimed he raised more than US$36 million from Bar Works investors and wired US$16 million to foreign bank accounts that were likely tied to him or his associates.

A group of 71 Chinese investors also sued the co-working scheme Bar Works and its alleged masterminds Renwick Haddow and Zoya Kiselova in federal court in 2017, alleging that they stole US$7.495 million in a Ponzi scheme.

The suit came three weeks after the Securities and Exchange Commission and the U.S. Attorney’s office unveiled criminal charges against Haddow, who could face up to 40 years in prison if he is found guilty.

Other investors had filed two lawsuits in the same period. The latest also named Kiselova, Haddow’s wife, as a defendant. She was named as a defendant in only one of the two previous suits. Kiselova “was actively involved in the formation of the various Bar Works entities and assisted Haddow to control the Bar Works entities.”

Real estate is an ideal target for con men. It’s easy to explain to lay investors, is popular in major emerging economies like India and China, and has a reputation for stability. But large-scale fraud in the sector could never have taken off were it not for the confluence of two key trends. The first is central banks pumping cash into economies around the world in the wake of the 2008 financial crisis. There is now more capital than ever seeking investments while interest rates are near record lows in most countries.

“If you go to the standard investments you really get little value out of your money.”

The second trend is digitalisation. In 2010, about 30 percent of the world’s population had internet access. By 2016, that number had hit 47 percent, according to data from the International Telecommunication Union.

In the U.S., dozens if not hundreds of crowdfunding platforms now allow small-time investors to buy properties they have never seen and may not understand within just a few steps online. A global maze of lightly regulated online investment agencies, many of them based in the London, market properties to investors.

Cici Cao, a Keller Williams agent in New York who put a local investor in touch with Bar Works for a 15 percent commission last year, said she never suspected the program might be a scam. It was up to the investor to judge the risk, she insists.

Agents often target overseas customers, which helps shield them from legal liability if an investment turns out to be a scam. At any rate, small-time investors often don’t have the financial means to sue. This means agents have little to lose from selling questionable investments as long as they can credibly deny knowledge of fraud. The result is a culture of don’t ask, don’t tell.

Take Square Yards, an Indian online real estate investment platform that recently raised US$10 million in venture and debt funding from big names like L’Occitane vice chair André Hoffmann.  The firm sold investments in at least two U.S. real estate scams (one being Bar Works) to investors in the U.A.E. and Hong Kong.

Tanuj Shori, CEO of Square Yards, said his agents received an 8 percent commission for selling Bar Works investments, but only dealt with the company through another middleman. Sources said this was a common path for real estate fraudsters, who regularly go through two, three or even four layers of agents.

Shori claimed he had never heard the name Renwick Haddow until he read it in TRD. Asked why Square Yards didn’t do basic due diligence on the offering, such as checking if the supposed principals even exist, he said it was an “honest mistake” by a young company.

“Our entire reputation is at stake because of Bar Works,” he added. But when asked whether he would reimburse the victims, he said that’s an issue between Bar Works and the investor. The company later sent an email to its clients claiming it is “retaining an independent investigator to search for useful information about Barworks and its owners as well as assets that may be recoverable.”

Shori claimed that Square Yards stopped marketing Bar Works shortly after TRD’s January report. He painted himself as a victim of Haddow’s but emails sent to one investor and reviewed by TRD suggest otherwise.

Investors can use the courts, but first they have to figure out whom to sue, and where. Take Singh, the U.A.E. resident. His investment in Bar Works was made through an India-based agency, which in turn dealt with Bar Works through a mysterious British middleman with a British accent known as Julian, according to Shori. To complicate matters further, Singh received a “certificate of ownership” from a Delaware company called Bar Works Inc., signed an investment agreement with Istanbul-based Bar Works Istanbul LLC, but signed a separate contract to receive his monthly returns from yet a third company, Bar Works Management Inc. And when it came to returns, investors received them from a U.K.-based account. Much of Singh’s money may be with Haddow, who has denied involvement in any of the above entities and is known to stash his wealth in offshore tax havens like the British Virgin Islands or Anguilla.

Even when regulators do get involved, investors are unlikely to get their money back, as the case of a recent North Dakota real estate scam illustrates.

In April 2015, the SEC filed a complaint against North Dakota Developments LLC, alleging that it stole $62 million from more than 970 investors in a Ponzi scheme. Starting in 2012, the company raised money to build temporary housing for oil workers in North Dakota, but most of the buildings were never completed. According to the SEC, the company used payments from later investors to pay off earlier ones. Like Bar Works, NDD had marketed its investments through online portals, such as a U.K.-based company called United Property Connect, which appears to be connected to United Property Invest, the company that Sarah had invested through.

The SEC put NDD under receivership and froze its assets, but there was little left to freeze. The people behind the scam, a U.K. resident named Daniel Hogan and Malaysia resident named Robert Gavin, were safely out of the country with their loot.

In July 2015, investors filed a class action lawsuit against a U.S. based law firm that had worked as an escrow agent for NDD (another suit had been filed in June). They managed to win around $5.1 million in a settlement — a fraction of the $62 million lost. According to Kons, who represented the investors, that still compares favorably to other international frauds – victims generally get little to nothing back.

“The SEC only has so much jurisdiction and when the money’s overseas there’s little they can do,” Kons said. “It’s just very difficult to bring these guys to justice. White-collar crimes and white-collar fraud are just under-prosecuted.”

One of NDD’s victims is Lam, a 45-year-old schoolteacher in Macau who only agreed to share his surname. Shortly after investing in the scheme, he decided to double down and find more real estate investments.

In mid-2014, he saw an online ad for high-yield real estate investments in the Chicago area. The company, KRI Property, claimed to have relationships with U.S. lenders allowing it to buy foreclosed homes on the cheap and flip them. It guaranteed 30 percent returns.

Unlike NDD’s risky ground-up developments, this seemed like a safer bet to Lam. He would be buying an existing home, and even if the flip didn’t work out he’d still own a property. He borrowed $60,000 from his sister and invested.

KRI turned out to be tied to InvestUS, a scheme run by James Jervis, a 39-year-old U.K. native and Dubai resident who was an old hand at the game of global real estate fraud. His victims claim he never actually bought any properties with their money. They received deed documents signed by Chicago-based attorney Alex Ogoke, but they appear to be fake. One document reviewed by TRD references a sale that doesn’t appear in Chicago property records. Ogoke initially agreed to an interview, but later changed his mind, citing a death in the family. Jervis did not respond to an email seeking comment.

While Haddow took pains to keep a distance from his investors, Jervis did the opposite, sometimes meeting them in person to assure them money was coming. One of the victims, a 72-year-old South African former merchant ship captain named Al Viljoen, said Jervis even stayed at his home on several occasions. Viljoen says he lost his retirement savings, around $130,000, and had to go back to work full-time to make ends meet.

Regular facetime with his victims could prove to be Jervis’ undoing. Earlier in 2017, a friend of Oman-based Ahmed*, who says he invested US$300,000 with InvestUS after clicking on a Facebook ad, came up with a plan to lure Jervis into the country to face prosecution. The friend offered Jervis a follow-up meeting with a prospective investor in Oman. Jervis took the bait, hopped in a car and drove to Muscat from the U.A.E. Meanwhile, Ahmed filed a fraud complaint with the Omani government. As soon as Jervis entered Oman, the authorities slapped him with a travel ban.

Stuck in Oman while his case moves through the justice system, Jervis has been bouncing from hotel to hotel, according to Ahmed, who is keeping track of his movements. One day this spring, Ahmed confronted him at the door of his room. “I think he was really surprised I knew what hotel he was in,” he said. “He looked as if he hadn’t slept in days.” Their conversation was brief and Jervis looked away whenever he said he had no money, according to Ahmed.

Omani government agencies did not respond to several emails and phone calls seeking confirmation of the travel ban and fraud case against Jervis.

Whether Ahmed’s case succeeds is far from certain. And even if it does, it likely won’t help Lam, whose situation is far beyond Oman’s jurisdiction.

After finally losing patience with Jervis last year, Lam, like Ahmed, decided to take matters into his own hands. But he soon discovered his options were slim.

First, Lam called the police in Ireland, where the agent who had sold him his investment was supposedly from. The police told him it could only help him if he was an Irish citizen or traveled to Ireland to file a complaint in person. In November 2016, Lam went to the Macau police. The officer told him there was little they could do since Jervis and the company that had allegedly defrauded him were both overseas. He then filed a complaint with the FBI but never heard back. At one point he called the Chicago police, who told him they couldn’t help him because he’s not a U.S. citizen.

Lam said he has lost around US$400,000 to dubious online investments — more than his life savings — and is currently paying off his sister’s loan with his modest teaching salary. He considered hiring a lawyer, but is loath to throw more money down the drain. “Other than being depressed, what else can I do?” he said. “I have no idea how to get help.”

Exit Renwick

While Jervis was trapped in Oman, the noose started tightening around Haddow in New York. After two months of missed payments, a group of Chinese investors filed a lawsuit against Haddow, Black and nine Bar Works entities on June 16 2017 in state court, alleging he defrauded them out of more than $3 million. On June 21, another investor, Plentium Capital Group, filed a fraud lawsuit in Florida federal court. On June 28, New York attorney Jared Stamell told Crain’s he is considering filing a class-action lawsuit on behalf of 200 investors who gave $30 million to Bar Works.“The audience is investors as well as engineers so a mixed level of expertise but let’s try to avoid the jargon.”  

By that point, the FBI was already investigating Bar Works. And worse for Haddow: Kinard, who had left the firm in May, appears to be cooperating. He told attorneys that FBI agents called him in mid-June 2017 and that he “communicated vigorously” with them. He claimed to have no involvement in investor negotiations or knowledge of where the money went. “My electronic signature was placed on investor contracts without my knowledge,” he wrote in an email filed in court records.

As courts began freezing assets, lawyers for the plaintiffs searched for any money they can recover. There may not be much. According to Kinard, Bar Works only had one U.S. bank account, with Valley National Bank, which held less than US$30,000 as of mid-May 2017.

On June 20, 2017, Adam Birnbaum, one of the attorneys representing the Chinese investors, walked into the lobby of 160 West 66th Street, where public records indicated Haddow rented an apartment, to serve him with the lawsuit. The receptionist told him Haddow had recently moved from an apartment on the 33rd floor to a unit on the 19th floor but abandoned that apartment at the end of May 2017. Haddow called in mid-June to tell the receptionist he would come to pick up his mail, but never showed up.

A day later, on June 21, a legal server rang the doorbell at a Greenwich, Connecticut, home that Haddow appeared to rent. A woman opened the door. She refused to give her name and said Haddow was away. When Birnbaum showed the server a photo of Kiselova, the server identified her as the person who answered the door. Ten days later, the SEC and the U.S. attorney’s office unveiled their fraud charges. At the time of writing, Haddow remains on the run.

Real Estate Crowdfunding Risks

1. Due diligence limitations

Most crowdfunding websites and boutique private equity firms directly target individual investors who are not experts in commercial real estate investing or finance in general. The issue is that without these specialized skills, how are you then supposed to properly assess a given deal on a real estate crowdfunding website? It is simply impossible. You therefore must put your faith in the real estate crowdfunding platform to properly vet each deal.

And even if you are an expert and understand real estate investing, you will mostly lack local market knowledge to make property level decisions. Real estate investors need to specialize for a given region or city to really manage to identify the better deals. You will certainly not be able to perform good quality due diligence on an office building located in Wanchai, Hong Kong if you reside in Shanghai and have limited knowledge of the Wanchai market.

On the other hand, when investing in REITs, you do not need to do any investment decisions on the property level. You directly invest in a well-diversified portfolio and the professional managers then take care of the underlying real estate investment decisions.

2. Unsecured Investment

Real estate crowdfunded investments are generally unsecured investments, meaning that if, say, the platform were to go under, investors could lose their capital. While most investors are aware of the risk, the nature of the security of investments may be changing, and lawyers say investors should keep an eye on that point.

3) Lack of Understanding

Investors need to understand the different types of risks associated with equity versus debt investment and the different types of investment options under each of those umbrellas. Equity is riskier in the sense that you could lose all your money more easily than you could with debt.

Understanding the structure of the deal, when they get paid back, how they get paid back, how much they are going to get paid back are all key elements. It’s important for everyone to spend time reading all the documents on the real estate crowdfunding platform.

Part of that process of getting up to speed on deal terms is gaining a fundamental understanding of whether equity or debt investment is right for the individual investor, lawyers say.

Not only should you read all the research provided on the platform, you should do further diligence over the internet and ask people who live in their area for their opinions regarding job growth, economic growth, etc.

4. High Loan-to-Value Ratio

It’s crucial for investors to consider the loan-to-value ratio for debt deals and to avoid high ratios. The higher the loan-to-value ratio, the more risk the investor might lose a significant amount of their principal investment in a downturn. For example, a 95% LTV means that if prices decline by 5%, the investor loses 100% of their principal.

5. Government Regulation

Government and regulatators worldwide are generally in the best interest of protecting the consumer from risk and fraud. For example, Governments should raise the requirements of who is defined as an accredited investor.

6. Platform Risk

There is risk that the real estate crowdfunding platform could shut down since most are not cash flow positive. If the platform shuts down, your investments should be protected because investors of the platform don’t have a lean on your investments in your respective real estate deals. You are an investor in real estate deals, not the real estate crowdfunding company itself. However, there may be some disruption as individual investments get transferred to a fund administrator, and coverage teams responsible for following up with sponsors get whittled down.