Readers of this text may be interested in the following publications from

the Appraisal Institute:

The Appraisal of Real Estate, 13th edition

The Dictionary of Real Estate Appraisal, 5th edition
Scope of Work, now available in print or as an audio book
by Vernon Martin

Appraisal Institute • 200 West Madison • Suite 1500 • Chicago, IL 60606 •

www.appraisalinstitute.org

The Appraisal Institute advances global standards, methodologies, and

practices through the professional development of property economics
worldwide.
For Educational Purposes Only The materials presented in this text
represent the opinions and views of the author. Although these materials
may have been reviewed by members of the Appraisal Institute, the
views and opinions expressed herein are not endorsed or approved by
the Appraisal Institute as policy unless adopted by the Board of Directors
pursuant to the Bylaws of the Appraisal Institute. While substantial care
has been taken to provide accurate and current data and information,
the Appraisal Institute does not warrant the accuracy or timeliness of the
data and information contained herein. Further, any principles and
conclusions presented in this publication are subject to court decisions
and to local, state and federal laws and regulations and any revisions of
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the understanding that the Appraisal Institute is not engaged in
rendering legal, accounting or other professional advice or services.
Nothing in these materials is to be construed as the offering of such
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professionals.

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© 2011 by the Appraisal Institute, an Illinois not for profit corporation.

All rights reserved. No part of this publication may be reproduced,
All rights reserved. No part of this publication may be reproduced,
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means, without the express written permission of the Appraisal Institute.

Library of Congress Cataloging-in-Publication Data Martin, Vernon,

1957-

Fraud prevention for commercial real estate valuation / by Vernon

Martin.
p. cm.
Includes bibliographical references.
ISBN 978-1-935328-22-3
Ebook ISBN 978-1-935328-26-1
1. Commercial real estate–Valuation–United States. 2. Fraud–United
States–Prevention. 3. Real property–Valuation–United States. 4. Real
estate business–Corrupt practices–United States. 5. Real estate
appraisers–Legal status, laws, etc.–United States. I. Title

HD257.5.M37 2011
333.33’87230973–dc23
2011034038
 Table of Contents
About the Author
Acknowledgments
Foreword
Preface
CHAPTER 1 What Is Fraud?
Proving Fraud
Types of Commercial Real Estate Fraud Conclusion
CHAPTER 2 Why Should Fraud Matter to Appraisers?
Striving for Professional Excellence Legal Precedents
Applicability of a Fiduciary Standard to Appraisers What
Is the Expected “Duty of Care” Owed by Appraisers?
Case Law Concerning Individual Acts of Appraisal
Negligence or Fraud USPAP and Fraud
Current Actions against Appraisers Future Actions against
Appraisers Conclusion
CHAPTER 3 The Causal Factors behind Fraud
CHAPTER 4 The Need for Factual Verification
The Data Verification Process Interviewing the Property
Owner Conclusion
CHAPTER 5 Understanding Conflicts of Interest
Conflicts of Interest in the Financial Industry Conflicts of
Interest in the Taxation Sector Conclusion
CHAPTER 6 Purchase Contract Fraud
Compare the Purchase Price to the Listing Builder
Bailouts
Conclusion
CHAPTER 7 Misrepresentation of Occupancy and Tenancy
Why Verifying Collected Rent Is So Important Talk to the
 Tenants
Verification of Future Tenants Studying Present and Past
Rent Rolls What If the Tenant Is Not There?
When the Landlord Pretends to Be a Tenant The Best Way
to Verify Occupancy and Rents Estoppel Agreements
Conclusion
CHAPTER 8 Misrepresentation of Property Characteristics
Legality of Use
Availability of Utilities and Water Property Size
Property Condition
Transferability of Rights or Funds Tax Credits
Water Rights
Bond Financing
Conclusion
CHAPTER 9 Deceptive Financial Statements
The Numbers Are Too Round
The Numbers Are Too Consistent Not All Obligated
Payments Are Being Made Revenue That Is Not Related
to the Property Is Included “Pocket-to-Pocket” Rental
Income Is Included Necessary Expenses Are Excluded
Conclusion
CHAPTER 10 Misrepresentation of Buyer or Borrower
CHAPTER 11 Other Ways Appraisers Are Influenced
Previous Appraisal Reports
Misleading Data
Character References
Conclusion
CHAPTER 12 Property Types More Susceptible to Fraud
Vacant Land
Rent-Controlled Apartments
Buildings with High Vacancies Condominium Projects
Foreign Real Estate
 Properties with Title Issues Conclusion
CHAPTER 13 Federal Criminal Statutes against Fraud
Conclusion
APPENDIX Real Estate Transaction Fraud Prevention Checklist
BIBLIOGRAPHY
 About the Author

Vernon Martin, Certified Fraud Examiner (CFE), has been a practicing

commercial real estate appraiser since 1984 and is currently president of
American Property Research—an advisory practice he founded in 2006
—in Los Angeles. He has previously served as chief commercial
appraiser at three national lending institutions and as fraud solutions
product manager at First American Real Estate Solutions, now known as
CoreLogic. He received his master of science degree in real estate from
Southern Methodist University and an undergraduate degree in urban
geography from the University of Chicago. He taught real estate
valuation at California State University, Los Angeles, from 1998 to 2005
and has published numerous articles in professional journals, including
The Appraisal Journal.
 Acknowledgments

I am grateful to the Appraisal Institute for inviting me to write about

commercial real estate fraud. This demonstrates a commitment to
professionalism that can only raise the standards of our profession.
I would also like to acknowledge and thank:

R. Wayne Pugh, MAI, CRE, former president of the Appraisal

Institute, who discovered me at the Pan Pacific Congress of Real
Estate Appraisers, Valuers, and Counselors in Seoul, Korea, and
encouraged me to write for The Appraisal Journal.
The staff of The Appraisal Journal, who took my awkward article and
made it sparkle and shine, and the Appraisal Institute’s Publications
Department for their useful suggestions for expanding the article
into a book.
Attorney Peter Christensen of LIA Administrators & Insurance
Services, who provided examples of actions taken against appraisers
without disclosing confidential information. Also, Claudia Gaglione,
a partner in the law firm Gaglione, Dolan & Kaplan, generously
reviewed the manuscript and provided useful suggestions. Gaglione,
Dolan & Kaplan works with LIA and many other errors and
omissions insurers.
All those who have employed me to protect them from fraud,
including Home Savings of America, Bayview Financial Trading
Group, Velocity Commercial Capital, Madison Realty Capital, and
Kennedy Funding. These lenders and others have given me a rich
case history to draw upon in studying fraud.
 Foreword

Real estate fraud has reached an all-time high, and litigation against
appraisers in fraud-related cases is on the increase. Appraisers who are
prepared to detect and prevent real estate fraud can protect their
businesses and their professional reputations.
This timely and relevant book explains common types of commercial
real estate fraud, factors that contribute to fraud, and ways perpetrators
attempt to influence or deceive appraisers into becoming part of their
schemes. It presents real-life examples from the author’s professional
experience, from legal cases, and from current headlines to demonstrate
how appraisers can knowingly or unknowingly find themselves involved
in fraudulent real estate transactions. The author discusses how such
situations can be avoided and provides sensible, straightforward advice
that will help appraisers feel confident in handling any suspicious
situation they may encounter.
The best way for real estate professionals to deal with the problem
of real estate fraud is to learn more about it. Fraud Prevention for
Commercial Real Estate Valuation will help appraisers protect themselves
and those who rely on their work.

Joseph C. Magdziarz, MAI, SRA 2011 President

Appraisal Institute
 Preface

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.
 1

What Is Fraud?

Fraud can be defined as an intentional misrepresentation of a fact that

deceives another to act upon the misrepresentation to his or her
detriment. Within the context of this book, the discussion of fraud will
focus on financial harm done to others when commercial real estate is
involved.
Within the United States judicial system, a misrepresentation is not
considered fraud until proven in a court of law. If the discussion of
commercial real estate fraud was limited to case law, however, this book
would be much shorter and would not be current on the latest methods
of deceiving buyers, lenders, and investors. For that reason, this book
will discuss common methods of misrepresentation in the commercial
real estate industry, many of which have not yet been tested by courts of
law.

Proving Fraud
To prove fraud in a court of law, whether by civil action or criminal
action, five elements are used to establish the guilt or liability of the
defendant:

1. A false statement of material fact

2. The defendant’s knowledge that the statement was untrue
3. The intent of the defendant to deceive the victim
4. Reliance of the victim on the false statement
5. Harm to the victim as a result of that reliance

If these five standards are found to be true, the defendant may be found
to be “liable” in a civil suit or “guilty” in a criminal prosecution.

Types of Commercial Real Estate Fraud

Commercial real estate fraud may include any of the following:

Misrepresentations made by sellers to buyers

Misrepresentations made by brokers to buyers
Misrepresentations made by borrowers to lenders
Misrepresentations made by brokers to lenders (such as short sale
fraud)
Misrepresentations made by syndicators or others who derive fee
compensation for organizing buyers
Fraudulent deed conveyances
Misrepresentations made by anyone else who has a vested interest
in a decision involving commercial real estate

Of particular concern are mortgage fraud, short sale fraud, and

syndication fraud. Mortgage fraud has become a problem in recent years;
it has been clearly recognized in the residential real estate industry but
less so in the commercial real estate industry. In the commercial real
estate industry, the fraud may be sophisticated enough to escape
detection but the results are still catastrophic.

Mortgage Fraud: Fraud for Profit vs. Fraud for Property

The face of real estate and mortgage fraud currently depicted in the
media is that of organized rings of “flippers”—who buy low and sell high
—using “straw buyers,” who default soon after loan origination. This
media depiction of “fraud for profit,” whether it is written about in
newspapers or dramatized on The Sopranos, distracts the public from the
more common types of fraud. These frauds trick lenders into lending
more money than can adequately be secured by the appraised property
and its cash flow, although the borrower intends to repay the loan if
everything goes well. This type of fraud is often called “fraud for
property.” Fraud for property is more common than fraud for profit, but
often goes unnoticed because the losses might not become apparent until
years later.
A loan applicant usually commits fraud in order to control real estate
with little or no cash down. By minimizing cash equity in his or her
property, an owner can earn a high return on investment and pay back
the loan if the value goes up. If the value goes down, however, the
owner has nothing to lose by abandoning the property and defaulting on
the loan because he or she has no equity in the property. This borrowing
strategy is commonly taught in the thousands of “no money down”
seminars held in hotel ballrooms across the country every year.
Nevertheless, this strategy is tantamount to gambling with lenders’
money, as the lack of an adequate equity “cushion” and debt service
coverage significantly increases the risk of loan default.
As an example, Florida attorney John Yanchek and developer Michael
Tringali pleaded guilty to an $82,700,000 fraud against the federally
insured BankAtlantic, Mercantile Bank, and Orion Bank regarding loans
on land in the Sarasota area.1 As the closing attorney, Yanchek
concealed that Tringali was not contributing equity to these land
purchases and was actually receiving cash back from loans in excess of
100% of the value of the properties. Their accomplice, Neal Mohammad
Husani, bought nearly 1,900 acres of land in Manatee and Sarasota
counties for $42.5 million between June 2004 and March 2006. He then
immediately sold the land to Tringali for $117 million, enabling Tringali
to obtain about twice as much in loan money as the underlying real
estate was worth. Only when the Florida land market turned downward
did the loans default. Yanchek pleaded guilty to conspiracy, money
laundering, and making false statements to a federally insured bank in
connection with a commercial loan.
The charges relate to Section 1014 of Title 18 of the United States
Code, which declares mortgage fraud to be a federal crime,
encompassing anyone who “willfully overvalues any land or property, or
knowingly makes any false statement, for the purpose of influencing a
financial institution upon a loan application, purchase agreement or
other related documents.”2 A violation of this federal fraud statute is
punishable by up to 30 years imprisonment and a fine of $1 million.
Title 18, Section 1014 is used to criminally prosecute fraud against
federally insured lending institutions. For fraud against the US
Department of Housing and Urban Development (HUD), including fraud
against the Federal Housing Agency (FHA), the applicable statute for
federal criminal prosecution is Title 18, Section 1010.

Short Sale Fraud

A real estate agent may be retained by a lender to market a foreclosed
property. Rather than presenting the highest third-party purchase offer
on the property, however, the agent might present his or her own offer
instead and then arrange for a double escrow with a simultaneous
closing, allowing the agent to buy the property at a lower price and
simultaneously sell it at a higher price. A bank asset officer could do the
same thing. This practice is known as “short sale fraud” or “flopping.”

Syndication and Tenants-in-Common (TIC) Fraud

Another growing area of concern is fraud committed by syndicators.
Syndicators are those who organize groups of investors to purchase or
develop a property, perhaps as tenants-in-common (TIC). They are often
compensated by investors in proportion to the prices of the assets they
acquire, which provides a strong incentive to overpay for real estate.
Worse yet, some syndicators sell their own properties to the partnership
at a profit.
Abusive syndications of this type were common in the 1980s, as I
personally witnessed in the state of Texas. The syndicator was typically a
successful real estate developer who would have had no trouble
receiving 100% financing from a Texas bank or savings and loan for any
type of venture, as was common in the Texas mortgage lending market
in the early 1980s. When commercial real estate values started to
decline, however, these savvy real estate entrepreneurs instead made
their money reeling in limited partners (investors) to form a syndicate,
often to buy their own properties. The limited partners were typically
doctors, dentists, airline pilots, or lawyers—people who were wealthy,
but not necessarily financially astute. The syndicators got richer while
the investors got poorer. These types of real estate syndicates were
chronicled as early as 1981 by Southern Methodist University professor
William Brueggeman in his widely used textbook, Real Estate Finance:
 In an operation of this kind the syndicate general partners share few of the risks. They may
have originally bought [the property] through another business entity and sold it to the
syndicate at a profit. Through another company which they own they may receive substantial
remunerations for management services. Above all, as the general partners, all earnings and
capital gains not contracted away to the limited partners accrue to their benefit…. This has
been a matter of increasingly grave concern to state and federal securities sales regulators.3

As commercial real estate markets sank, syndicates often made the

general partners richer while making the limited partners poorer.
“Syndication” became a somewhat tarnished word. Real estate authors
and professors David Ling and Wayne Archer of the University of Florida
later explained typical abuses in their Real Estate Principles text:
The syndicator can use his or her information advantage to take unfair advantage of the
investors. For example, the syndicator may “carve out” large upfront fees that reduce the
amount invested in the enterprise. Moreover, if the syndicator’s return is “front-loaded,” this
may reduce his or her incentive to maximize the value of the syndicated assets through
aggressive property management…. Just say no to unsolicited syndication offers from
individuals with whom you are not completely comfortable. We wish we had followed this
simple rule a time or two in the past.4

The past nine years have witnessed a return of real estate purchases by
syndicators at above-market prices, except many now call themselves
“TIC sponsors.” To skirt federal and state securities laws, they have
conducted “private placements” that allow them to escape scrutiny by
the US Securities and Exchange Commission (SEC), even though the SEC
cannot prevent syndicators from charging outrageous fees. However, the
conflicts of interest are often disclosed in the “private placement
memorandum,” a voluminous, catch-all legal document that discloses in
fine print everything the syndicators’ attorneys tell them to disclose.
Many states have securities acts that require syndicators to disclose
material information about their offerings, including disclosure of the
risks of the investments, the source of repayment for the investments,
the payment history of prior investments, and financial information
about the issuers of the investments.
In one Texas syndication, for instance, the general partners purchased
a piece of land from themselves on behalf of the syndicate at a $20
million profit after a one-year holding period, in a market with a
growing inventory of large land parcels for sale at much lower prices. In
addition to the $20 million profit, the general partner and its affiliates
earned fees of about $3,300,000 in selling commissions, $500,000 in
wholesaling fees, $800,000 in placement fees, $600,000 in
reimbursements for offering costs, $350,000 in underwriting fees, and
$5,200,000 in reimbursements for offering and organization expense
fees. This represented over $30 million in profit on a property that
probably lost value since its purchase in 2007, as the demand for
residential land waned.
The recent bankruptcy of SCI Real Estate Investments, LLC, a major
syndicator out of Los Angeles, is exposing similar shenanigans. Most of
the properties they acquired for investors were properties they had
already acquired and then resold to investors at a seven-figure mark-up.
For instance, they made a profit of more than $4.8 million on the
purchase and resale to investors of the Austin City Lights Apartments in
Austin, Texas. This profit did not include the 2.5% “deferred acquisition
fees” owed to them when the syndicate eventually sells the property.
These types of syndicates are not confined to the United States, either.
Many Canadian syndicators are acquiring properties in such places as
Arizona, Southern California, and Costa Rica, exploiting Canadian
investors. They overpay for isolated mountain land or bulk sales of
unsold Phoenix condos, for example, as they are incentivized to overpay
for properties by their compensation scheme.
What is also worrisome is that such syndicators are applying for
mortgage financing in an industry in which most of the loan
underwriters and some appraisers are either too young or too forgetful
to remember the abuses of the past. The purchase price agreed to by the
syndication is often treated as proof of market value by lenders and
appraisers, and the loan is consequently underwritten based on the
inflated purchase price. The consequences to commercial mortgage
lenders and limited partners can be catastrophic.

Deed Conveyance Fraud

Deed conveyance fraud has recently become popular with anarchists and
religious cults. In this type of fraud, the perpetrators convey “wild grant
deeds” on properties they do not own to their organizations. The
organizations then convey title to their members. The latest scams have
often used the word “sovereign” in the organization name in the belief
that the organization and its members are not subject to the laws of the
United States, arguing either that current US laws are unconstitutional or
that the “laws” of their deity supersede US laws. Their delusions often
end up with a criminal conviction in a US court and a sentence to a US
prison, where their gods are unable to help them.

Conclusion
Commercial real estate fraud consists of intentional misrepresentations
(about commercial properties) intended to deceive another party to act
upon those misrepresentations to the party’s detriment. Common forms
of commercial real estate fraud found today include mortgage fraud,
seller fraud, short sale fraud, syndication fraud, and deed conveyance
fraud.

1. “Florida Attorney Guilty in $82M Mortgage Fraud,” North County

Gazette (February 12, 2009).
2. US Code Title 18, Section 1014, “Loans and credit applications
generally; renewals and discounts; crop insurance.” The US Code is
available on the website of Cornell University Law School,
www.law.cornell.edu/uscode/.
3. William Brueggeman, Real Estate Finance, 7th ed. (Homewood, IL: R.
D. Irwin, 1981).
4. David Ling and Wayne Archer, Real Estate Principles: A Value Approach
(New York: McGraw-Hill, 2006).
 2

Why Should Fraud Matter to Appraisers?

There is no professional consensus on an appraiser’s responsibilities in

fraud prevention. It is a matter that has not even been introduced for
discussion yet. Some prominent appraisers believe that fraud prevention
is outside the scope of work expected from appraisers and that lenders
“get what they deserve” when dealing with dishonest borrowers. The
recent global financial crisis has indeed punished careless lenders, but
with far-reaching consequences to millions of innocent people. The
public deserves better than this. Other prominent appraisers believe that
compliance with the Uniform Standards of Professional Appraisal
Practice (USPAP) is all that is needed to accomplish fraud prevention.
Recent court decisions may cause them to rethink this position.
The appraisal profession in the United States originally emerged to
correct the financial abuses leading to the bank failures and Great
Depression of the 1930s. From its origins it has been implicitly
understood that the appraisal profession exists to protect the public,
much like the public accounting profession. More recently, USPAP was
created to codify this purpose. Thus it can be argued that our
profession’s perceived duty to the public should make us care about
fraud prevention.

Striving for Professional Excellence

In order to begin right in appraising, one must first get the facts right. A
popular saying used in the information technology industry is “garbage
in, garbage out,” meaning that even the best systems of analyzing
information produce flawed results when the data input is flawed. Fraud
and deception compromise the data input for the appraisal process.
Consequently, what better way is there to start the appraisal process
than with a search for the truth?
Not caring to find the truth would be like a master chef not caring
about where his ingredients came from. If you asked a master chef about
where his mushrooms were picked (hopefully not the public park) or his
oysters harvested (hopefully not from underneath the Santa Monica
pier), would you respect him for saying, “That’s not my job, but I used
all the best cooking methods learned from the finest culinary academy,”
or would you instead call the nearest poison control center?

Professional Liability
Many of us as appraisers take pride in being incorruptible guardians of
truth and objectivity, earnestly debating ethics at our various meetings
and online forums. How incongruous it seems, then, that so many
appraisal reports contain the standard exculpatory assumptions and
limiting conditions statement, “No responsibility is assumed for the
accuracy of information furnished by the client.” This is the fatal
weakness of the appraisal profession—acceptance of inaccurate
information from biased parties without verification.
Verification can be defined as the act of obtaining evidence that
confirms the accuracy or truth of some piece of information. The
unconcerned appraiser should be aware of the sobering statistic that
failure to verify factual information is one of the six most common
reasons that appraisers are sued.1 Even if assumptions and limiting
conditions legally exculpate the careless appraiser, that appraiser will
still need to employ an attorney for defense if sued.
The recent “just sue everybody” litigation trend will also increasingly
reel in appraisers, rightly or wrongly, in future litigation relating to the
recent financial industry meltdown, just as we see happening
indiscriminately to innocent people who accidentally benefited from the
Bernie Madoff Ponzi scheme.

Legal Precedents
There has been a legal precedent for finding appraisers liable for losses
caused by failure to verify, as in Federal Savings and Loan Insurance
Corporation (FSLIC) v. Texas Real Estate Counselors, Inc.2 In this case, the
appraiser was found liable for 1) failing to verify the alleged completion
of improvements on the property, and 2) failing to disclose reliance on
unverified data when presenting estimates of value and effective age for
the subject property.
In Fusco v. Brennan, the Superior Court of Queens County, New York,
held that an appraiser’s failure to independently verify the data supplied
to him was so negligent that it warranted an inference of fraud,
maintaining that the defendant had a duty to all possible investors to
inform them of the type and source of data used and the extent of
information omitted.3
The same precedent may be exercised by state appraiser regulators.
One commercial appraiser was fined $8,000 by the California Office of
Real Estate Appraisers for several offenses, one of which was accepting
and failing to verify an owner’s assertion that certain swampland had
city water and sewers installed on it.

Applicability of a Fiduciary Standard to

Appraisers
The applicability of a fiduciary standard to appraisers is a particularly
controversial subject. Whether appraisers like it or not, certain case law
has presented the concept that an appraiser has certain duties as a
fiduciary, or someone who is legally considered to have a special
relationship of trust, responsibility, or confidence in his or her
professional duties to others. For example, a trust officer at a bank
would be a fiduciary.
Fiduciaries are held to higher standards of duty and care and are also
more likely to be sued as a result. As this text is being written, for
instance, the Appraisal Institute and the American Society of Appraisers
(ASA) are lobbying the US government concerning an Employee
Retirement Income Security Act (ERISA) law that names appraisers as
fiduciaries. This lobbying effort is meant solely to reduce legal liability
for appraisers and not to reduce the amount of professional care that
appraisers should exercise. The matter is not yet resolved, but it only
affects entities regulated by the US Department of Labor.
One legal concept of fiduciary responsibility applied to appraisers is
the concept of privity, which basically limits parties who can take action
against appraisers to only those who are intended users of the appraisal
report. If an unintended user, such as an investor, relies on an inaccurate
appraisal report to his or her detriment, the concept of privity would
prevent that user from suing the appraiser, as the appraiser owed the
user no fiduciary obligation.
The concept of privity has generally protected appraisers from
lawsuits by property buyers when the appraisal was done for a lender.
This concept has recently been reversed, however, in the 2009 case of
Sage v. Blagg Appraisal Company4 in Arizona and in the 2010 case of
Young v. Bourland in California. Sage sued Blagg after discovering that he
had overstated her house’s measurements by nearly 30% in an appraisal
done for a lender. The trial court granted summary judgment to the
appraiser based on the concept of privity. This was reversed on appeal
by the Arizona Court of Appeals, which stated, “Our recognition of the
duty owed by an appraiser to the buyer/borrower … is consistent with
evolving industry standards that acknowledge that a buyer/borrower in
fact relies on an appraisal prepared at the request of the lender.”
In 2010, a California appellate court made a similar ruling in the case
of Young v. Bourland, stating, “While the disclaimer contained in [the]
appraisal report is evidence that he did not intend third parties to rely
on the report and his opinion as to the value of the property, [the
borrower] presented evidence from which intent may be inferred. [The
borrower]’s name appears repeatedly on [the] appraisal report identified
as ‘borrower.’”5
The appraiser should also bear in mind that some purchase contracts,
mainly residential contracts, are contingent upon a sufficiently high
appraised value, which suggests a buyer’s reliance on an appraisal report
done for a lender.

Relevant Cases Establishing Fiduciary Responsibility to

Lenders
The increasing use of third-party originators (such as mortgage brokers)
in commercial mortgage lending has attracted some unethical appraisers
who are acting as advocates for the broker’s clients. Mindful of privity,
some may label the intended user of the report as the property owner
and the intended use as for “internal management decisions” or
“decision-making purposes,” thinking that the concept of privity protects
them against actions for fraud by a lender or investor if they do not
disclose lenders as a class of intended user.
Case law does not seem to always support such a narrow definition of
intended user. In Chemical Bank v. National Union Fire Insurance
Company,6 in which appraisers Joseph J. Blake and Associates, Inc., were
a third party defendant-appellant, a New York appellate court stated, “If
it be shown that a real estate appraiser, retained by a property owner to
make an appraisal that he knows the owner will use to obtain financing,
makes it in a grossly negligent manner so as to inordinately overstate the
value, we are not … prepared to hold the appraiser exempt from liability
to the damaged financing party.”
The court cited the principle of law stated in White v. Guarente,7 an
action against an accounting firm, stating, “If it were known that it was
within the contemplation of the appraiser and the owner when they
contracted for the appraisal that a financing party would rely upon it
and be persuaded by it, then, since those whose conduct was to be so
governed would be a ‘fixed, definable and contemplated group,’ the
appraiser would have assumed a duty of care for the benefit of those in
the group.8
This case also demonstrates how courts often turn to case law
concerning accounting or auditing malpractice in judging appraisers,
with the logic that each of these professions produces reports that are
relied upon by third parties. Bily v. Arthur Young and Company,9 a case
that governs the extent to which an accountant is held liable to third
parties relying on his or her report, is sometimes cited. In the case of
Soderburg v. McKinney,10 in which the appraiser was found liable for
damages to a third-party investor, the following reasoning was provided
by the High Court:
Accountants are not unique in their position as suppliers of information and evaluations for
the use and benefit of others. Other professionals, including attorneys, architects, engineers,
title insurers and abstractors, and others also perform that function. And like auditors, these
professionals may also face suit by third persons claiming reliance on information and
opinions generated in a professional capacity.
 More recently, in the 1999 case of Rodin Properties-Shore Mall N.V. v.
Ullman et al., the New York Supreme Court held a commercial appraiser
hired by a borrower liable to a lender for a faulty appraisal because the
appraiser was aware that the lender would rely on the work product.11
The New York Supreme Court stated, “When a professional … has a
specific awareness that a third party will rely on his or her advice or
opinion, the furnishing of which is for that very purpose, and there is
reliance thereon, tort liability will ensue if the professional report or
opinion is negligently or fraudulently prepared.”
In this case, the lender was not federally regulated but was a group of
private investors. The Financial Institution Reform, Recovery and
Enforcement Act of 1989 (FIRREA) may prevent an appraiser’s report for
a borrower from being relied upon by a federally insured institution, but
appraisers should be aware that private lenders or investors operating
outside the purview of FIRREA may possibly rely on their reports.
The appraiser in Soderburg attempted to limit his liability by stating in
the appraisal report that “reproduction of [the] appraisal report is
restricted to such use by the [client].” The extension of privity to the
plaintiff investor was only made after evidence was presented that the
appraiser knew that the investor would rely on the report.

Professional Standards Found to Imply Fiduciary

Responsibility
A fiduciary standard was applied in Guildhall Insurance Company v.
Silverman v. O’Boyle,12 holding a jewelry appraiser to the standards of
the ASA, of which he was a member. The standards set forth an
appraiser’s duties to third parties, thereby relaxing the concept of
privity. In 1987, the ASA was among eight professional appraiser
associations to collectively found the Appraisal Foundation, which in
turn issued USPAP, now considered to be the standard for the appraisal
profession in the United States. It is important for appraisers to know
that courts may apply USPAP as a yardstick for appraiser misconduct, so
it behooves appraisers to stay well-versed in USPAP.

What Is the Expected “Duty of Care” Owed by

Appraisers?
Recent court decisions also seem to absolve appraisers of a “duty of
care” to third parties except when it could be reasonably expected for the
appraisal to be submitted to a lender. In Behn v. Northeast Appraisal
Company,13 for instance, the court found no “duty of care” to the seller
of a property appraised for a lender. A California appellate court held an
appraiser not liable to unaffiliated investors for an appraisal done for a
mortgage broker.14
The key issue seems to be whether the plaintiff(s) belonged to a group
that the defendant could expect to be influenced by an inaccurate
appraisal. An appraisal done for a lender is meant for the institution’s
own use, except perhaps in Arizona and California. An appraisal done for
a likely borrower could be meant to be used repeatedly to influence
private lenders or investors who operate outside FIRREA; it could even be
“re-addressed” by a dishonest loan officer at a federally regulated
institution. An appraisal done for a syndicator is meant to be used
repeatedly in soliciting prospective investors or limited partners.
In prosecuting mortgage fraud, the acid test seems to be whether the
appraiser can reasonably expect that the appraisal would be used by a
mortgage lender. Even in situations when lenders experience loss as the
result of faulty appraisals, appraisers may still be found not to be liable
if they can convince the court that they were never told by the client
that the report would be used for a lending decision; appraisers can be
found to not have privity with lenders. Post-FIRREA, it is unlikely that a
regulated lender would make a lending decision on an appraisal report
done for another purpose, although it is possible for a previously done
appraisal report to get relabeled (illegally) as if done specifically for the
lender. Private lenders are not restricted from relying on borrower-
ordered reports, however, and if the lender is actually a loan syndicator
without any of his or her own equity in the deal, it is quite possible for
an inaccurate appraisal to be relied upon by the syndicated investors,
who are often unsophisticated investors.

Case Law Concerning Individual Acts of

Appraisal Negligence or Fraud
In Rodin Properties-Shore Mall N.V. v. Ullman et al., the appraiser was
specifically blamed for 1) stating that Shore Mall was “the principal,
fully integrated shopping complex in its primary trade area” and that the
only other major regional mall serving the area was 20 miles away,
when the competing mall actually dominated the trade area and was
only 5.6 miles away, and 2) making exaggerated cash flow projections.15
In Costa v. Neimon,16 the Appeals Court of Wisconsin established that
an appraiser was guilty of negligent misrepresentation for
mischaracterizing the habitability or functionality of a property. In that
particular case, the appraiser described an unfinished basement as being
habitable.
In United Insurance Company of America v. B.W. Rudy, Inc.,17 a US
district court held that an appraiser’s knowing certification that a newly
built apartment building had been completed in accordance with the
original specifications was actionable as fraud. In actuality, the building
1) had not been completed to the required size, 2) had improper
structural framing, 3) had improper roofing, 4) lacked proper flashings
and copings, 5) had improperly installed doors, windows, and sills, 6)
lacked proper caulking, 7) lacked proper heating, 8) lacked proper
concrete, and 9) did not have the proper air conditioners or the
structural provision for their installation. These cases suggest that an
appraiser who performs an incomplete property inspection could end up
in court.
Improper sales comparisons can also instigate actions against an
appraiser. For example, the federal government filed suit against several
appraisers and realtors in the collapse of Butterfield Savings and Loan in
California for inflating the appraised values of marginally useful
properties, such as swamps and forest preserves, by comparing such
parcels with sales of more useful properties.18 A similarly inaccurate
comparison was cited in the previously mentioned $8,000 fine by the
California Office of Real Estate Appraisers against an appraiser for “the
selection of inappropriate sales comparables and misrepresentation of
relevant property characteristics of the comparable sales.”19
USPAP and Fraud
As was seen in the Guildhall decision, attorneys will turn to the generally
accepted standards of the appraisal profession in order to find blame
against an appraiser. Today that standard is USPAP.
USPAP requires the appraiser to identify the intended use for an
appraisal assignment’s report, apply a scope of work that is appropriate
for that intended use, and clearly disclose in the report the intended use
and scope applied. USPAP further requires the appraiser to identify the
intended users of the report, ensure the report is understandable to those
intended users, and clearly state in the report the identity of those
intended users. In addition, USPAP has specific requirements regarding
the use of hypothetical conditions and extraordinary assumptions.
Failure to take these critical steps is not only a violation of USPAP but
also can result in a misleading report. In cases in which appraisers have
been implicated in fraud, those appraisers failed to meet USPAP’s
requirements regarding scope of work, intended use, intended users, and
the use of hypothetical conditions and extraordinary assumptions.
The conceivably relevant USPAP standards in the context of frauds
being perpetrated today will be discussed in this section. As of the
writing of this book, the most recent version of USPAP is the 2010-2011
edition, and all USPAP quotes that appear in this discussion are taken
from this edition.20

Ethics Rule
The following are relevant excerpts from USPAP’s Ethics Rule,
accompanied by a discussion of how each relates to fraud prevention:

“An appraiser must not advocate the cause or interest of any party
or issue.”
Many who hire appraisers have a specific cause that they want
advanced. Appraisers can get into trouble for advocating for a
client’s cause if it is detrimental to another party, such as a lender
or a tax collection agency.
“An appraiser must not accept an assignment that includes the
reporting of predetermined opinions and conclusions.”
 Predetermined opinions and conclusions may include requests to use
a market rental rate, vacancy rate, capitalization rate, or discount
rate dictated by another.
“An appraiser must not communicate assignment results with the
intent to mislead or to defraud.”
Examples will be provided later in which appraisers communicated
a misleading result thinking that disclaimers, disclosures, and
limiting conditions would somehow negate the misleading result
and warn others not to rely on it.
“An appraiser must not perform an assignment in a grossly negligent
manner.”
Negligence has been found by some courts when an appraiser has
failed to verify certain important data that turned out to be false.

Scope of Work Rule

The scope of work must include the research and analyses that are
necessary to develop credible assignment results. Self-interested parties,
including an appraiser’s own clients, may try to restrict the scope of
work to the detriment of credible and objective assignment results, and
an appraiser must tread carefully in such situations so as not to enable
fraud. For instance, a client’s refusal to show leases to an appraiser could
result in the appraiser performing an inaccurate income capitalization
approach.
USPAP’s Scope of Work Rule also commands an appraiser to not allow
the intended use of an assignment or a client’s objectives to cause the
assignment results to be biased. Self-interested parties seeking loan
commissions or tax breaks could instruct an appraiser, for instance, to
curtail a property inspection that might bring up troubling vacancy or
condition issues.

Standards Rule 1-1

Standards Rule 1-1(b) states, “In developing a real property appraisal, an
appraiser must not commit a substantial error of omission or commission
that significantly affects an appraisal.” For example, commercial real
estate financial losses often stem from a fatal flaw that may not have
been considered in an appraisal. Such a flaw might be a lack of water
availability or lack of demand for space. These would be errors of
omission. Errors of commission might be due to mismeasurement or
inappropriate comparison to allegedly comparable properties.
Standards Rule 1-1(c) states, “In developing a real property appraisal,
an appraiser must not render appraisal services in a careless or negligent
manner.” The legal record suggests that there is a certain minimal
standard of verification below which an appraiser may be accused of
negligence. In Fusco v. Brennan, the appraiser was accused of being “so
negligent as to warrant the inference of fraud.”

Standards Rule 1-2(a) and (b)

Standards Rule 1-2(a) states, “In developing a real property appraisal, an
appraiser must identify the client and other intended users.” According
to Standards Rule 1-2(b), “In developing a real property appraisal, an
appraiser must identify the intended use of the appraiser’s opinions and
conclusions.”
As will be discussed later, these two items are important in
determining an appraiser’s duty of care to others and may also reduce an
appraiser’s legal liability with regard to unintended users or
unauthorized use of the appraisal report. One potential issue is the
misstatement of intended use and intended user in an effort to avoid
legal liability. For instance, would an appraisal performed for a
mortgage broker be considered blameless if the intended use is stated as
“for the client’s internal decision-making purposes only”? In other
words, can appraisers pretend that they have no idea that a mortgage
broker would solicit financing with their appraisal reports? The legal
record suggests that a court would judge that an appraisal done for a
mortgage broker would be likely to be used by a lender for loan
underwriting purposes.

Standards Rule 1-2(c)

According to Standards Rule 1-2(c), an appraiser must “identify the type
and definition of value, and, if the value opinion to be developed is
market value, ascertain whether the value is to be the most probable
price in terms of cash.” Actions against appraisers sometimes happen
when the appraiser is instructed to estimate something other than
market value, but investors and the public may have not read the report
to understand that another concept besides market value is being used.
One classic example is Gibson v. Credit Suisse, which will be discussed
later in this chapter.

Standards Rule 1-2(e)(v)

Standards Rule 1-2(e)(v) states that appraisers must “identify the
characteristics of the property that are relevant to the type and
definition of value and intended use of the appraisal, including whether
the subject property is a fractional interest, physical segment, or partial
holding.” This would suggest that an appraiser might get in trouble for
appraising a property as a whole without disclosing or adjusting for a
partial interest. The appraiser may also be at risk for making
adjustments proportional to the partial interest without applying
discounts for impaired marketability.

Standards Rule 1-2(f) and (g)

Further requirements for appraisers under USPAP Standards Rule 1-2(f)
and (g) are to identify any extraordinary assumptions or hypothetical
conditions necessary in the assignment. USPAP defines an extraordinary
assumption as “an assumption, directly related to a specific assignment,
which, if found to be false, could alter the appraiser’s opinions or
conclusions … Extraordinary assumptions presume as fact otherwise
uncertain information about physical, legal, or economic characteristics
of the subject property; or about conditions external to the property,
such as market conditions or trends; or about the integrity of data used
in an analysis.” A hypothetical condition is defined as “that which is
contrary to what exists but is supposed for the purpose of analysis.
Hypothetical conditions assume conditions contrary to known facts
about physical, legal, or economic characteristics of the subject property;
or about conditions external to the property, such as market conditions
or trends; or about the integrity of data used in an analysis.”
Appraisers often confuse extraordinary assumptions with hypothetical
conditions and can get into trouble this way. For instance, one
misleading appraisal report stated that the appraiser had made an
“extraordinary assumption” that a finished street led to the subdivision
being appraised. A field inspection revealed no street to be present. As
the property was being appraised “as is,” the appraiser misused the term
extraordinary assumption, which refers to something the appraiser
believes to exist. In this case, the appraiser should have used hypothetical
condition, as he knew that the street did not exist. In any event, even if
the appraiser correctly described the missing street as a hypothetical
condition, he could still conceivably be accused of creating a misleading
report, since it was being circulated to subdivision lenders, and many
loan officers do not know where to find hypothetical conditions in
appraisal reports. The upcoming discussion of the Gibson v. Credit Suisse
case will serve as an example of the use and disclosure of hypothetical
conditions being considered insufficient to prevent an action for fraud.

Standards Rule 1-3(b)

According to Standards Rule 1-3(b), an appraiser must, “when necessary
for credible assignment results in developing a market value opinion …
develop an opinion of the highest and best use of the real estate.” The
biggest area of risk here is that the highest and best use may have
changed due to recent events. In recent history, millions of acres of
agricultural land were rezoned for residential or even commercial
development and values increased tenfold as initial development
projects quickly sold out. Nowadays, with the collapse of the housing
market and some commercial markets, an appraiser may be inaccurate
in characterizing this rezoned land as continuing to have a highest and
best use for subdivision development. A lot of money has been lost by
lenders on failed subdivisions.
One example that comes to mind was the appraisal of a cattle pasture
17 miles outside the closest community, a small town with a median
household income of only $18,000 per year. Appraising the ranch as a
potential residential subdivision would be misleading, despite the
existance of a final map of the subdivision by the local county
government.

Highest and best use: Residential subdivision or land for cattle grazing?

Standards Rule 1-4(c)(iv)

Standards Rule 1-4(c)(iv)
Standards Rule 1-4(c)(iv) states, “When an income approach is necessary
for credible assignment results, an appraiser must base projections of
future rent and/or income potential and expenses on reasonably clear
and appropriate evidence.” An appraiser must be careful not to rely on
self-serving pro forma cash flow projections presented by developers or
borrowers. There must be independent confirmation of market trends
relating to rental rates, vacancy rates, and increasing expenses in order
to have an objective appraisal.

Standards Rule 1-5(a)

According to Standards Rule 1-5(a), “When the value opinion to be
developed is market value, an appraiser must … analyze all agreements
of sale, options, and listings of the subject property current as of the
effective date of the appraisal.” I emphasize the word analyze because
the appraiser needs to do more than simply report the price; the
appraiser should also determine if the purchase price is a reliable or
unreliable indicator of market value. Purchase contracts are often
constructed to be misleading, and the appraiser needs to look beyond the
price stated at the top of the contract to ferret out concessions or
inconsistencies with other documents, such as the previous listing. In
one case, an appraiser failed to catch that the purchase price was twice
the amount of the listing price, which would have been unlikely for an
old warehouse building in Kalamazoo, Michigan. Purchase contract
fraud will be explained later.

Standard 2
Finally, USPAP Standard 2 states, “In reporting the results of a real
property appraisal, an appraiser must communicate each analysis,
opinion, and conclusion in a manner that is not misleading.” If an
appraiser has been asked to use an unusual definition of value,
hypothetical condition, or extraordinary assumption, it would be best to
very prominently disclose the departure from expectations. Even then,
the appraiser should consider the following possibilities:

A reader may not look past the conclusion of value stated on the
front page of the report.
 The report would not be made available to be read by investors.
The unusual value conclusion, if considered by someone to be
misleading, may pose the risk for a lawsuit.

This is indeed the case in the Gibson v. Credit Suisse case to be discussed
in the next section of this chapter.

Extraordinary Assumptions Are Not Necessarily a Safety

Valve
When the appraiser lacks information needed to proceed with the
appraisal process, either the missing information must be obtained or the
appraisal process must be completed on the basis of an extraordinary
assumption about that missing information. For example, if the appraiser
suspects that the property may suffer some type of damage but does not
have information that proves or disproves that suspicion, the appraiser
might be able to obtain that information, such as in the form of a report
by a qualified expert that verifies the absence or presence of such
damage and its extent. If not, the only way the appraiser can complete
the assignment is by basing the appraisal on the extraordinary
assumption that there is no such damage. Such extraordinary
assumptions must be clearly and prominently spelled out in the report to
satisfy the intent of USPAP.
Such explicitly stated extraordinary assumptions may comply with
USPAP, but an appraiser also needs to be mindful that anybody can sue
anybody in the United States. Rightly or wrongly, an appraiser may still
be sued for not considering the impact on value of a property detriment
that he or she did not know about. The appraiser may very well win the
lawsuit, too, but at the cost of expensive legal representation and overall
aggravation. In other words, the use of extraordinary assumptions is only
partial protection.

Conclusions about USPAP and Fraud

The purpose of USPAP is to maintain public trust in professional
appraisal practice. One method of maintaining this trust is to prevent
misleading appraisal reports. If an appraiser knowingly or unknowingly
bases an appraisal on information that can be demonstrated to be false,
there may be risk of a civil action for fraud or negligence or, worse yet, a
criminal action.

Current Actions against Appraisers

The following cases are not fully adjudicated and are presented for
instructive purposes only. Understand that in a court of law in the
United States, a defendant is presumed to be innocent until found guilty
or liable, and that some current actions against appraisers may lack
merit.

The Credit Suisse Resort Loans Syndication21

Cushman & Wakefield (C&W), a national appraisal and real estate
services firm, is currently being sued for $24 billion as a co-defendant in
a class action lawsuit against Credit Suisse (CS), Switzerland’s second
largest bank.22 In 2004 CS started a syndicated loan program backed by
14 of America’s most famous resorts, such as Yellowstone Club in
Montana and Turtle Bay in Hawaii (the setting of the movie Forgetting
Sarah Marshall). A syndicated loan is a loan sold off to multiple investors.
CS collected millions of dollars in brokering and servicing fees on these
loans while retaining little or no equity in the securitized loans. Their
profits were therefore based on the size of the loans rather than the
soundness of the loans, giving the bank the incentive to inflate appraised
values.
The alleged loan fraud is described by Bankruptcy Court Judge Ralph
Kirschner as follows:
In 2005, Credit Suisse was offering a new product for sale. It was offering the owners
[developers] of luxury second-home developments the opportunity to take their profits up
front by mortgaging their development projects to the hilt. Credit Suisse would loan the
money on a non-recourse basis, earn a substantial fee, and sell off most of the credit to loan
participants. The development owners would take most of the money out as a profit dividend,
leaving their developments saddled with enormous debt. Credit Suisse and the development
owners would benefit, while their developments—and especially the creditors of their
developments—bore all the risk of loss. This newly developed syndicated loan product
enriched Credit Suisse, its employees, and more than one luxury development owner, but it
left the developments too thinly capitalized to survive. Numerous entities that received Credit
Suisse’s syndicated loan product have failed financially, including Tamarack Resort,
 Suisse’s syndicated loan product have failed financially, including Tamarack Resort,
Promontory, Lake Las Vegas, Turtle Bay, and Ginn [Sur Mer].

CS hired the appraisal firm to appraise each resort according to an

unorthodox methodology known as “total net value” (TNV), which
basically ignores the time value of money in estimating the present value
of each of these resort developments. The developments were going to
take years to sell out, but future revenues were not discounted for time.
The TNV methodology merely subtracted the costs of development
without respect to the timing of revenues. It was tantamount to creating
discounted cash flow models with 0% discount rates.
Investors naturally expect to be paid a rate of return for deferred
profits, so the TNV methodology did not come close to any commonly
accepted definition of market value used in the United States. Its sole
purpose seemed to be to inflate the appraised value to justify a higher
loan amount.
The appraisal firm performed the appraisals according to the TNV
methodology dictated to them by the lender and attempted to cover
themselves with all the necessary disclosures, assumptions, and limiting
conditions in their reports. Others who did not view the reports
mistakenly thought that the appraisals were market value appraisals.
All 14 syndicated loans failed and property owners at four of the failed
resorts—Yellowstone Club, Tamarack Club in Idaho, Lake Las Vegas, and
Ginn Sur Mer in the Bahamas—filed suit against CS and the appraisal
firm, claiming that 1) CS had defrauded them with a predatory “loan to
own” scheme, 2) appraisers had used the TNV methodology to create
misleading and deceptive appraisal reports that violate FIRREA, and 3)
the defendants, knowing this, engaged in a conspiracy to circumvent
FIRREA by creating a special-purpose lending entity in the Cayman
Islands and having the appraisal reports delivered there. The CS Cayman
branch was alleged to be a post office box.
In its motion to dismiss, the appraisal firm claimed that the plaintiffs
were aware that the appraisal reports properly disclosed that they were
not estimates of market values. They also pointed out that there was no
connection between the plaintiffs and the appraisers and thus no basis
for privity, stating, “There is no basis for concluding that C&W could
have intended that plaintiffs rely on an appraisal not prepared for them.”
The motion to dismiss, interestingly enough, also states that the
appraisals’ noncompliance with FIRREA was irrelevant to any of the
loans because the lender was from the Cayman Islands.
The complaint makes no reference to USPAP but does refer to
violations of FIRREA. Interagency appraisal guidelines, for instance,
require that an appraiser “analyze and report appropriate deductions
and discounts for proposed construction or renovation, partially leased
buildings, non-market lease terms, and tract developments with unsold
units.”23 A discount rate of 0% would not meet the standard for an
“appropriate discount.”
The Yellowstone Club example illustrates the magnitude of appraised
value inflation as a result of the TNV methodology. Yellowstone Club is
a private vacation home community in Montana that includes such
notable residents as Bill Gates and Dan Quayle. Prior to CS’s
involvement, the same appraisal firm had appraised Yellowstone Club
for $420 million. CS instructed the appraisers to revalue Yellowstone
Club several months later using TNV methodology, and the appraised
value shot up to $1,165 million, supporting a $375 million loan decision
by Credit Suisse. The loan later went into default and foreclosure.
On July 17, 2009, the foreclosed Yellowstone Club was sold for $115
million to Cross Harbor Capital Partners. The loan loss was therefore
about $260 million. On January 17, 2011, US Magistrate Judge Ronald
E. Bush ruled that the class action plaintiffs could proceed with their
lawsuit against the appraisal firm based on claims of negligence and
conspiracy.
Judge Bush provided the following instructive remarks:
Without Cushman & Wakefield’s appraisals, there is no “loan to own” scheme from which
plaintiffs can premise their claims … The unusual nature of Cushman & Wakefield’s TNV
appraisals can further be inferred in Plaintiffs’ favor to support its participation in a RICO
enterprise, recognizing that they appear to have been created to obtain the highest possible
dollar value for the uncompleted developments, resting primarily on forecasted, not yet
realized, net cash flow streams, but without discounting the net cash flow back to a present
value.

Nevertheless, the judge dismissed the RICO claims. (RICO stands for the
Racketeer Influenced and Corrupt Organizations Act of 1970, a federal
law originally intended to combat organized crime.)
In terms of the disclosures, disclaimers, and limiting conditions
prominently displayed in the appraisal reports, the judge stated:
Cushman & Wakefield may technically be correct in arguing that the appraisals’ language
insulates it from any claim that the appraisals somehow represent bogus market values. Such
an argument assumes, however, that a reader negotiating the appraisals’ provisions
understands (or should have understood) the quoted language to mean what Cushman &
Wakefield and/or Credit Suisse understood it to mean. At the moment, it is unclear what the
developers/homeowners understood these figures to represent—assuming they even read
them in the first place. Did the referenced appraisal amounts reflect cash flow analyses? Total
net values? Total net proceeds? Or something else? Separately, whatever it is, what is the
difference between that and market value? Although it is indeed possible to view the
appraisals’ language through the lenses of Cushman & Wakefield’s arguments, the Court must
consider the limited record before it and accept Plaintiffs’ allegations as true.

The judge refused to dismiss claims against the appraisers, rejecting

the privity argument on the grounds that the plaintiffs were pursuing a
claim that they were victims of a conspiracy enabled by the appraisers
and thus had the right to have their allegations heard. This should not be
interpreted as a finding of guilt, however.

Lessons to Be Learned
Some appraisers may think that liberties can be taken in an appraisal
report as long as they are prominently disclosed. Appraisers may agree
among themselves on what these types of disclosures are, but those
outside the appraisal profession may not understand disclosures when
they see them. The Credit Suisse case may test the limits of how far this
possibly undue reliance on disclaimers can go.
The complaint against the appraisers is emblematic of a surprising
new trend in litigation against commercial appraisers, which is to charge
the appraiser with aiding and abetting a lender’s “predatory lending” or
“loan to own” scheme. There is insufficient case law to judge the likely
outcome of these lawsuits.
The appraisal reports for CS were previously published on the Internet
and contained standard disclosures, disclaimers, assumptions, and
limiting conditions. The “intended use” was for loan underwriting and
the “intended user” was CS. An appraiser reading these reports could
reasonably infer that the appraised values were not labeled as or
intended to represent market values. The plaintiffs in this case would not
normally be considered to have a claim based on privity, either.
Nevertheless, the appraisal firm is still facing a $24 billion lawsuit after
an unsuccessful motion to dismiss.
Judge Bush has raised the question of whether the plaintiffs properly
understood the reports or had such capability. This raises the question of
whether disclosures, assumptions, and limiting conditions are enough to
prevent the public from being misled. Appraisers should consider that
any number printed as an “appraised value” is likely to be interpreted by
others as an expression of market value. Many persons, including loan
officers, may rely on an “appraised value” without reading the report
and finding the disclosures. Some properties or projects are even
marketed with representations of appraised value without ever allowing
the public to see the supporting appraisal reports, as was the case with
Credit Suisse.
Large firms, in this case a national brokerage and appraisal firm, have
deep pockets that can serve as a target for lawsuits. It would be in such a
firm’s best interest to avoid all situations allowing accusations of
impropriety. In this case, the reason for using TNV methodology instead
of market value was not explained, making it seem that TNV’s sole
purpose was to inflate the appraised value. This may make the
appraisers seem complicit in the alleged loan fraud by CS, which the
appraisals enabled. It is questionable if the appraisers expected to be
part of a syndicated loan fraud scheme, however, as the only benefit to
them was the fees earned for the reports. Nevertheless, whistleblower
Michael Miller at C&W has come forward with allegations and
incriminating e-mail messages (one of which included “not in jail yet
and continuing to write these appraisals”) indicating that his colleagues
knew they were creating misleading appraisal reports.
The final lesson to carry away from this case is that appraisers should
consider the reasons and consequences any time they are asked to apply
unorthodox and possibly misleading appraisal methodology.

The Federal Deposit Insurance Corporation vs. The

Appraisal Profession
The Federal Deposit Insurance Corporation (FDIC) is a federal agency
charged with insuring deposits at depository institutions. They also act
as financial regulators and legal receivers of the insolvent lending
institutions that they seize.
The FDIC’s actions against appraisers have been described by some as
a systematic shakedown of the appraisal profession. In the first eight
months of 2010, the FDIC named 17 individual appraisers as defendants
in lawsuits.24 In June 2011 the FDIC filed suit against 89 appraisers
within the state of Florida with regard to the failure of Washington
Mutual. What is far more common, however, are demand letters sent to
appraisers connected with any loss to the FDIC, such as the letter in
Exhibit 2.1.

All FDIC complaints against appraisers have been for overvaluation.

These letters may perhaps only be “fishing expeditions” to see if the
appraiser will admit wrongdoing or have his or her liability insurer
cover the loss. It has been alleged that in some cases, the loan loss may
not have had anything to do with the appraisal but was instead due to
fraud of another kind or a market downturn. However, in the case of a
first payment default as described in Exhibit 2.1, appraisers look bad
when the foreclosed property cannot sell for a price equivalent to the
very recent appraised value.
Current FDIC litigation against appraisers that is searchable online
includes FDIC v. JSA Appraisal Services (California), FDIC v. Anoka
Appraisal Services (MN), FDIC v. Long Island Appraisal Network, Inc. (New
York), FDIC v. Behr Residential Appraisal Group (IN), FDIC v. Quest F.S. et
al. (California), FDIC v. LaMarsh Financial et al. (California), and FDIC v.
M&M Appraisals et al. (California).

Lending Institutions as Plaintiffs

Exhibit 2.2 shows a formal complaint against a commercial appraiser
who apparently relied on incorrect measurements for the appraised
building.

Source: Peter Christensen, Fall 2010 Appraisal Summit.

Conclusions to Be Deduced from the Legal Record

Conclusions to Be Deduced from the Legal Record
Appraisers are sometimes asked to perform appraisals according to
subjective criteria, such as the use of hypothetical conditions,
extraordinary assumptions, or unorthodox methodology. Appraisers may
think they are protected from liability by making prominent disclosures
and disclaimers and stating any limiting conditions in their reports. The
legal record suggests that such disclosures may not always be sufficient
to avoid legal liability or, at the very least, an opportunistic lawsuit. An
appraiser might also mistakenly think that all the caveats placed in a
misleading report would automatically exclude it (per FIRREA) from
consideration by a lending institution, not realizing that a private lender
might rely on the report instead or that a mortgage broker or loan officer
may repackage and relabel the report for a regulated lender, even
illegally, as I have personally witnessed in my banking career. An
appraiser’s estimate of value may also be used by an unscrupulous
person trying to capitalize on the appraiser’s reputation, such as
advertising “Appraisal Firm X has appraised the property to be worth X
amount of dollars.” Others may rely on the estimate of value without
being able to read the report and all of its disclaimers.
The best recourse may be to just refuse any appraisal assignment that
does not seem honest. If the appraisal assignment must be done,
however, the report should prominently state that its purpose is for a
specifically intended use and intended user and no others and should
prominently disclose the assumptions and limiting conditions that apply
to the value conclusion, such as, “This appraisal was done for a
developer for capital planning purposes. The conclusion of ‘aggregate
retail value’ reached in this report is not to be interpreted as a
representation of market value, which would be less due to discounting
to reflect the rate of sales absorption and the time value of money.”
The important concepts here are that the report must not be
misleading and should also warn the unintended user to not rely on the
report or expect a fiduciary duty from the appraiser. Even then, such
disclosures and disclaimers are no guarantee of safety from lawsuits, as
we have seen in Gibson v. Credit Suisse. My personal advice is to think
twice—no, think three times—before accepting an appraisal assignment
to deliver appraised values that differ from market values.
Future Actions against Appraisers
Appraisers should be aware that there are law firms that specialize in
suing appraisers, some of whom have been retained by the FDIC. Berk
and Moskowitz, for instance, is the Arizona firm that prevailed in the
Arizona appellate court decision erasing privity as a defense for lenders’
appraisers against lawsuits by homebuyers. More can be learned on their
website, www.appraisernegligence.com.

Conclusion
A great financial crisis has recently occurred, and the process of finding
scapegoats is just getting started. As a result, many lawsuits have already
been brought against appraisers. An appraiser may become a target for a
fraud lawsuit even if he or she was unknowingly complicit in a fraud
committed by someone else. This is perhaps the most compelling and
self-serving reason why fraud should matter to appraisers: because
appraisers can be blamed for fraud, even if it happens without their
knowledge.

1. LIA Administrators & Insurance Services, www.liability.com.

2. FSLIC v. Texas Real Estate Counselors, Inc., 955 F.2d 261 (5th Cir.
1992).
3. New York Law Journal 13 (January 1982).
4. Berk & Moskowitz, PC, Attorneys at Law,
www.appraisernegligence.com.
5. Presentation by Peter Christensen, Fall 2010 Appraisal Summit.
6. 74 A.D.2d 284, 502 N.Y.S.2d 165 (1st Dept. 1986).
7. 43 N.Y.2d 356 (1977).
8. Chemical Bank, 74 A.D. at 787.
9. 3 Cal.4th 370, 376.
10. 44 Cal.App.4th 1760, 52 Cal.Rptr.2d 635.
11. FindLaw website, www.findlaw.com.
12. 688 F. Supp. 916 (S.D.N.Y. 1988).
13. 483 A.2d 604 (Vt. 1984).
14. Christiansen v. Roddy, 186 Cal. App. 3d 780, 231 California Reporter
72 (1986).
15. FindLaw website, www.findlaw.com.
16. 366 N.W.2d 900 (Wisconsin Court of Appeals 1985).
17. 42 F.R.D. 398 (1967).
18. Statement of William K. Black before the House Subcommittee on
Commerce, Consumer and Monetary Affairs, 100 Congress, 1st
session 10 (1987).
19. California Office of Real Estate Appraisers, Details of Licensee
021394, www.orea.ca.gov.
20. Uniform Standards of Professional Appraisal Practice, 2010-2011 ed.
(Washington, D.C.: The Appraisal Foundation, 2010), pp. U-3–U-21.
21. Gibson et al. v. Credit Suisse et al., US District Court Idaho, Case no.
1:10-cv-00001-EJL.
22. Jim Robbins, “Credit Suisse Is Accused of Defrauding Investors in 4
Resorts,” The New York Times (January 4, 2010).
23. Federal Deposit Insurance Corporation, Interagency Appraisal and
Evaluation Guidelines, www.fdic.gov/regulations/laws/rules/5000-
4800.html.
24. FDIC Reporter, August 20, 2010.
 3

The Causal Factors behind Fraud

Let’s begin this chapter with one fundamental frailty of human nature:
People lie. Why do people lie? People lie to get what they want. Some of
them want your client’s money, your employer’s money, or the
government’s money.
The real estate industry does not attract saints. While it may attract
sincere people, many of these people just sincerely want to become rich,
and real estate is a proven way for people to become wealthy.
The eminent criminologist Donald Cressey defined the three causal
factors leading to fraud as:

1. Motive
2. Rationalization
3. Opportunity

These three factors combine to form what he termed the “fraud

triangle.”
In the case of real estate fraud, the motive is often greed. In one case
study presented later in this book, we will see how the fraudster’s
obsession over living a life of luxury drove him to commit fraud. In other
cases of real estate fraud, the motive may be desperation, such as the
desire to bail out of a losing investment and stick someone else (a buyer
or lender) with the problem. This type of motive has become common in
recent years.
Rationalization is the process by which the fraudster justifies to himself
or herself a valid reason for perpetrating the fraud. Human beings
generally do not like to think of themselves as bad people;
rationalization is the thought process that allows them to believe that
their fraud is justifiable. Common rationalizations for fraud in the real
estate industry include:

1. Everyone is doing it.

2. I am trying to help people.
3. I am trying to help my family.
4. I am trying to help my community.
5. I can give more to charity with all the money I am making.
6. The property’s performance will improve, and no harm is done.
7. I need to pay off my debts.

There are also less noble causes, such as drug or gambling addiction, in
which the rationalization is simply the need to feed the addiction. Once
again, the fraudsters do not think of themselves as bad people but rather
as unfortunate people.
Rationalization can cause some fraudsters to even become
philanthropists. Some of the best known “robber barons” of the
nineteenth century (and at least one from the twentieth century) became
philanthropists. Bernard Madoff, creator of the world’s largest Ponzi
scheme, was also a known philanthropist. Perhaps criminals turn to
charitable giving to assuage the guilt they feel in receiving ill-gotten
gains.
Opportunity consists of the circumstances that allow the fraud to occur,
such as a lack of controls, oversight, supervision, regulation, or
enforcement. For instance, most mortgage fraud occurs with lenders who
do not visit the properties they lend on, relying instead on third parties
such as brokers and appraisers.
Let’s suppose that the golf course loan default described in the Preface
of this book was indeed the result of fraud, perhaps the use of a phony
purchase contract. Here is a hypothetical example of how it could be
explained by the fraud triangle:

Motive
To purchase the golf course without any cash down payment.
Perhaps we lacked cash or just did not want to put our cash at risk.
Rationalization
 The golf course’s performance will improve because we know how
to improve golf course operations. The loan will be paid back, but
it’s not our fault if the market value is appraised too high because of
the phony purchase contract. We can also use the golf course for
fundraising events to help charities serving crippled children.
Opportunity
The appraiser and the lender have no way of knowing that the
purchase contract is fake and the real price is $4,700,000. The
lender does not have instructions for escrow agents to notify the
lender immediately if the closing of escrow occurs according to
terms different than those stated in the purchase contract. Perhaps
the lender is even allowing us to choose our own escrow agent, our
sister-in-law.

In conclusion, it is important to keep in mind that appraisers should

expect to be lied to, considering the self-serving motives of property
owners or brokers. A proper understanding of motive, rationalization,
and opportunity can go a long way toward understanding how
commercial real estate fraud can happen, and such an understanding can
help appraisers prevent such fraud from occurring.
 4

The Need for Factual Verification

“Wherever possible there must be independent confirmation

of the ‘facts.’”
—Dr. Carl Sagan, “The Fine Art of Baloney Detection,” The
Demon-Haunted World

In order to begin right in appraising, one must first get the facts right.
The previous chapter showed how appraisers can expect to be lied to.
How can a liar be detected, though? One way to detect lies is to have the
powers portrayed by Tim Roth on the Lie to Me television series. Indeed,
there are interesting courses offered by the Association of Certified
Fraud Examiners on visually detecting clues of deception. A far more
effective way to detect lies, though, is by taking the time to verify the
information that is given.

The Data Verification Process

Looking for facial twitches and “panic blinking” is a poor substitute for
simply doing your homework, which entails doing as much research as
possible before the property visit. Useful steps to take include:

1. Checking public records for the property concerning size, zoning,

ownership, sales history, and utilities.
Some public records are better than others, unfortunately, but they
should still be a starting point.
2. Checking to see if the subject property is listed for sale.
If the appraisal is being done for loan refinancing, a listing for sale
might suggest that the owner is having cash flow problems and is
looking for any way out of the predicament. If the appraisal is being
done for purchase money financing, is the purchase price greater
 than the listing price? If the purchase price is higher than the listing
price after an extensive period of time on the market, there may be
something fishy about the purchase contract.
3. Googling the property address to get background information.
One can sometimes find out about bankruptcies of the landlord or a
tenant or perhaps find previous listings of the subject property this
way. One can also find tenant complaints about an apartment
building. In one case involving a mixed-use building in Melrose
Park, Illinois, it was found that the so-called “sports bar” on the
ground floor was actually a strip club that had recently been closed
by police for prostitution, while families lived upstairs. In another
case, a “spa for women” in Houston was advertising itself in the
adult services section of the Yellow Pages as a massage parlor
catering to men. Such tenants may diminish the marketability of a
rental property by attracting undesirable visitors or police raids.
4. Calling or visiting the local planning department regarding proposed
developments.
You can find out how close developers are to receiving final
approvals, if they have received the necessary conditional use
permits, or if they have had their development plans rejected.
5. Checking the zoning map.
Developers have applied for construction loans for projects that are
not even allowed by the applicable zoning ordinance, as if they
think that lenders are stupid.
6. Visiting the property beforehand or arriving early, if possible.
This will arm you with facts that may later be misrepresented. Here
are some examples:
Measuring the building beforehand will alert you to a property
owner’s exaggerations.
Showing up early and speaking one-on-one with the property
manager may reveal facts that the owner may want to hide.
In one case, a real rent roll was observed before the owner
showed up with a fake rent roll. In another case, the subject of
delinquent tenants was discussed.
Checking for illegal uses.
 For example, Buddhist monks were found to be residing in an
office building in Monterey Park, California, which constituted
a zoning violation. In other situations, prostitutes or drug
dealers have been bribed by landlords to stay away during
appraisal time.
Checking for squatters.
In Latin America, squatters may be difficult to legally extricate,
and in Mexico, the ejido system of land expropriation in use
between 1934 and 1991 has created conflicting title claims for
many properties. (This will be explained further in Chapter 12.)
In such situations, the purported owner of the property may
steer the appraiser away from sections of the property that are
being occupied by squatters.

We live in an extraordinary time that is sometimes called the

“information age.” More than ever before, we are able to verify facts
with just a few minutes of Internet research.
For example, a real estate developer claimed to have purchased some
remote California mountain land for $30 million, but the purchase price
was unpublished. In California, Proposition 13 directs county assessors
to assess at market value upon sale, and they are the ones who know the
sale price. In most cases the purchase price is considered the market
value. The new assessed value is then increased by the consumer price
index or 2% each year, whichever is less. In this instance, a quick
Internet trip to the assessor’s website indicated a total assessed value of
less than $14 million two years after this reported purchase, suggesting
that the land had been purchased for closer to $13 million. This fact may
seem insignificant until one considers that the phony purchase price
helped to deceive an appraiser into valuing the mountain for $100
million.
A generation ago, such research would have required a time-
consuming visit to a government office. Now it can be done in a matter
of minutes by anyone with an Internet connection.
 This remote parcel of mountain land in California was valued at $100 million when its
actual purchase price was closer to $13 million.

Interviewing the Property Owner

While appraisers cannot conduct polygraph examinations of property
owners or brokers, having a command of the facts prior to the interview
will help you to calibrate a base level of honesty. If you have already
done your research, you can ask the property owner or broker some
baseline questions, such as:

When did you purchase this property, and for what price?
How large is the property? (This question is best asked if you have
already measured the property in advance.)
When was it built?
Does the project have final approval for development?
Does the parcel have water and sewer available?

If many answers vary from the facts you already know, you may need to
judge whether you are dealing with an exaggerator or liar and rigorously
verify any further representations made by the owner.
One critical aspect of your interview of the property owner and/or
representatives, brokers, and tenants is the ability to elicit accurate
information and to distinguish the lies from the truth. One always has to
be tactful, of course, to keep the discussion going and maintain the trust
of the subject, so an appraiser might wish to save the hardball questions
until a later e-mail or phone conversation. It is not productive to call a
property owner a liar, particularly if you need a ride back to your car.
One interviewer I find particularly effective is television’s fictional
LAPD detective Lieutenant Columbo (portrayed by the late actor Peter
Falk). He never starts interviews with suspects by telling them that they
are suspects. He is deferential, inquisitive, and persistent enough to keep
suspects talking under a false sense of security, revealing valuable clues
along the way. It’s only at the end of several encounters that he finally
says his trademark “Just one more thing …” and takes the suspect by
surprise by establishing proof of guilt.
If Lieutenant Columbo were an appraiser, the end of his interview
might go something like this:
Well, I’ve taken up enough of your time today, sir. You’ve got a beautiful property here, if I
may say so. I’ll have to show the photos to Mrs. Columbo. [Turns and walks away, then
doubles back.] Oh, just one more thing. You see, here’s the part I just don’t get. You say
you’re selling this property for $20 million, but the property is listed for sale on LoopNet for
only $15 million. Help me understand that part.

Continuing to ask questions on the fly, even if you already know the
answers to them, can sometimes dislodge details that may have
otherwise remained hidden. Sometimes it opens up inconsistencies that
can, in turn, open up a whole new avenue of questioning. The
inconsistencies are often clues to misrepresentations, as the truth should
not vary. The inconsistencies are how Columbo caught killers, too.
Here are some examples of how inconsistencies exposed
misrepresentations:

1. Inconsistent representations of the rent and tenant improvements to

be paid by a major incoming tenant.
Discovery: A forged lease.
Method of discovery: A phone call to the would-be tenant. This case
involved a mixed-use building in the downtown area of a town in
Pennsylvania, and the new tenant was to be the local state
representative. The State of Pennsylvania does not give its
representatives authority to sign leases.
 When an appraiser called the local state representative, who was supposed to be an
incoming tenant of this building in a town in Pennsylvania, it was learned that the
lease had been forged.

2. Three conflicting purchase contracts between the buyer and seller,

in which the price was the same but the size of the acreage being
bought was different.
Discovery: The purchase contracts were shams, as the buyer and
sellers were business partners.
Method of discovery: A slip of the lip from one of the sellers when
asked where he would be moving after the property sold.
Pick the dumbest member of the group and ask this question.
3. Very different interest rates on two different seller financing
agreements for the purchase of a golf course near Orlando, Florida.
Suspicion: The sellers were providing a “soft second” (forgivable
financing) and the interest rate didn’t matter.
Supporting data: Comparable sales did not support the purchase
price but did support the purchase price reduced by the amount of
seller financing.

Sometimes an unsolicited appraisal report can present clues to an

owner’s deception. At first blush, one would wonder how an appraiser
hired as an advocate for the owner could help an independent appraiser
expose a fraud, but appraisers are great about including exculpatory
clauses that they think give them “plausible deniability” if things turn
out wrong as a consequence of their appraisal reports.
 Two different seller financing agreements for the purchase of this golf course in Florida had
two very different interest rates, suggesting the possibility of a “soft second.”

Take, for instance, the following statement: “This estimate of value is

based on the developer’s representation that 90% of the units are pre-
sold. As previously stated in our assumptions and limiting conditions, we
assume that this information is accurate.” An appraiser is not likely to
make such a statement unless there was some doubt as to the honesty of
the representation. The repeatedly stated assumption that the owner is
telling the truth can be a case of “Methinks the lady doth protest too
much.”
In another case, the advocating appraiser’s report repeatedly and
prominently disclosed that all value conclusions were based on the
extraordinary assumption that the local government had already built a
road to the subdivision being appraised at no cost to the developer. A
site visit revealed no road present. As one can see, the owner-ordered
appraisal report, no matter how biased it is, can often serve as a
roadmap to a lie.

Conclusion
Fact verification is an essential part of the appraisal process. The earlier
it is started, the more that can be accomplished in fraud prevention, as
factual inaccuracies can prompt a line of inquiry that leads to other
inaccuracies, hidden agendas, or conflicts of interest.
Research prior to the property inspection can help the appraiser
pursue a line of inquiry that yields even more important facts and can
alert the appraiser to possible dishonesty. The interview with the
property owner or agent is also an important part of factual verification
and should not be rushed, as it can calibrate honesty, introduce
inconsistencies pointing to misrepresentations, or dislodge other relevant
facts.
As was indicated earlier in Chapter 2, what an appraiser does not
know can hurt the appraiser in addition to hurting others. Factual
verification is the obvious place to start for appraisers who want to
ensure they do not cause harm to themselves or others.
 5

Understanding Conflicts of Interest

“Incentives are the cornerstone of modern life.”

–Dr. Steven D. Levitt, University of Chicago economics
professor and coauthor of Freakonomics

Chapter 3 discussed how the real estate industry often attracts unethical
people. The reason is simple: Real estate is where the money is. The
word unethical is strong, though, and might lead the reader to overlook
situations in which otherwise decent, respectable professionals mislead
appraisers because the system rewards such behavior without the threat
of consequences. Deception is a real and expected human response to
uncontrolled incentives and conflicts of interest.

Conflicts of Interest in the Financial Industry

Commission-Compensated Professionals
When working with commission-compensated professionals such as
realtors or mortgage brokers, always be aware of the possibility that
they will provide inaccurate or biased information. Lending institutions
may also have conflicts of interest from their own staff if staff
compensation is variable and dependent upon loan production; such
conflicts can extend all the way up into senior management.
Dishonesty is like a snowball rolling down a mountainside. Once
others are seen doing it, it gets rationalized within the institution and
then becomes an acceptable industry practice, perhaps even taught in
weekend seminars. Fraud and dishonesty become rationalized with the
excuse that everyone else is doing it.

Borrower-Retained “Experts”
Property owners and developers may also retain “expert” consultants to
give appraisers a positive spin on their properties or development
projects. While dealing with experts may be intimidating to an appraiser
who may not be as specialized, keep in mind that the expert’s objectivity
must always be considered.
Steven D. Levitt and Stephen J. Dubner, authors of the book
Freakonomics, explain this phenomenon by stating that “experts are
human, and humans respond to incentives. How any given expert treats
you, therefore, depends on how that expert’s incentives are set up.
Sometimes his incentives may work in your favor…. But in a different
case, the expert’s incentives may work against you.”1
For example, a general appraiser values a golf course in a severely
overbuilt market and has his appraisal challenged by a well-known golf
course management consultant retained by the property owner. The
expert states that the comparable sales are all considerably inferior golf
courses—non-championship courses with less yardage. Perhaps the
appraiser may feel that the valuation must be changed in deference to
the expert, not considering that the expert carefully dodged the subject
of the poor financial performance of the subject golf course. Always
consider the notion that expert opinions, including appraiser’s opinions,
are bought and paid for.
Any consultant hired by an owner, developer, or borrower, no matter
how impressive the credentials, should be considered to be acting in the
capacity of an advocate. Their remarks should be critically examined
before being accepted at face value. If the brilliant attorney Johnnie
Cochran told you his client was innocent, would you accept that without
question?
Remember, also, that USPAP Standards Rule 2-3 requires an appraiser
to certify that “the reported analyses, opinions, and conclusions … are
[the appraiser’s] personal, impartial, and unbiased professional analyses,
opinions, and conclusions.”2 This would prohibit an appraiser from
relying on a borrower-hired expert’s conclusions.

Understanding Conflicts of Interest within Lending

Institutions
The financial institutions that have failed during the current global
financial crisis have been publicly owned and traded corporations. The
system of public ownership has created an incessant need to delight
shareholders on a quarterly basis, particularly if management is
rewarded according to benchmarks like growth in earnings per share
(EPS). This, in turn, has caused many senior managers to turn to
accounting gimmicks and loan sales incentive policies that go against
sound lending practice. The shareholders and stockholding managers
who sell early do quite well, but once the institution is seized by the
FDIC, the remaining shareholders are wiped out. In this sense, the
largest failed thrift institutions of the last decade seem almost like Ponzi
schemes, with Washington Mutual being larger than the Madoff scheme.

Executive Compensation
Looking at the mortgage industry meltdown of 2007 and 2008, it would
be reasonable to ask why so many of the best and brightest financial
minds were so wrong again so soon after the savings and loan fiasco of
two decades ago.
One explanation is that financial executives were gaming the system
in response to unsound executive compensation systems commonly used
by public companies. Earnings can often be booked at loan origination,
regardless of the soundness of the loan. During the good times, these
unsound loans can be sold off to sit in mortgage pools or portfolios as
ticking time bombs to be dealt with long after the senior executives have
received their bonuses and exercised their stock options. Some
executives succumb to such a compelling enrichment scheme.

The Political Environment

What do Washington Mutual (WAMU), IndyMac Bank, and Downey
Savings have in common? These failed institutions were all regulated by
the Office of Thrift Supervision (OTS), which became politicized in favor
of deregulation by the incoming Bush administration in 2001 and was
merged into the Office of the Comptroller of the Currency (regulator of
commercial banks) on July 21, 2011. The accompanying photo shows
one of the first symbolic acts of the 2001 administration: at a press
conference, a chainsaw was applied to the existing OTS regulations that
guarded the safety of the American financial system.
 Thrift deregulation in the twenty-first century: chainsaws and the failure of all of the largest
thrifts.

World Savings
As recently reported on CBS’s Sixty Minutes, Herb and Marion Sandler
safely and soundly managed World Savings for years before finally
succumbing to temptation and receiving millions of dollars in the sale of
their doomed institution to Wachovia Bank, which was so badly
damaged that the federal government had to force its sale to Wells
Fargo.

IndyMac Bank and Washington Mutual

The two other largest savings and loan institutions in the country,
IndyMac and Washington Mutual, were respectively seized by the FDIC
in July and September of 2008.
Both institutions were fast growers that were rewarded by Wall Street
with high price-earnings multiples and soaring stock prices. Those in the
mortgage lending business know, however, that such rapid growth is
inconsistent with prudent lending.
Many mortgage-lending institutions rewarded their CEOs and COOs
with incentive-based compensation that dwarfed their annual base
salaries and encouraged them to do whatever was necessary to increase
the stock prices of their institutions. Stock prices moved in tandem with
reported earnings.
 IndyMac CEO Mike Perry, for instance, had an annual salary of $1
million per year, but his incentive-based compensation (bonuses and
stock options) was many times as high. Perry earned over $32 million by
selling IndyMac stock from 2003 to 2007, in addition to performance
bonuses that were typically 75% to 100% of his base salary.
A 2006 IndyMac press release plainly explains the radical difference in
future (year 2007) compensation to Perry under various scenarios, with
his total compensation limited to $1,250,000 for an EPS growth of less
than 5% but a compensation of $8,943,000 for an EPS growth of 17%.3
With a compensation structure like this, it was no wonder why rapid
growth was pursued at all costs. Making and selling unsound loans
would be the easiest way of meeting such a financial goal.
Kerry Killinger, CEO of Washington Mutual, was also paid a base
salary of $1,000,000 in WAMU’s last full year of existence and was
incentivized with stock options that brought his total pay package to
more than $14 million. The New York Times reported that Killinger
received $38.2 million in performance pay ($7.6 million in cash and the
remainder in stock) between 2005 and 2008. WAMU’s mortgage-related
losses of $8 billion in 2007 and 2008 wiped out all of its earnings in
2005 and 2006.4 Both Perry and Killinger are now facing numerous
lawsuits from the FDIC, the US Securities and Exchange Commission,
and unhappy shareholders.

Fannie Mae
Franklin Raines, CEO of Fannie Mae, received $52 million in
compensation between 1999 and 2004, with $32 million from an
incentive plan generating big bonuses for Fannie Mae achieving certain
performance yardsticks, such as a 15% annual growth in earnings. Mr.
Raines was accused of falsifying the reported earnings to gain his
bonuses and was therefore terminated, leading to a $9 billion profit
restatement covering the years 2001-2004.

When Loan Origination Staff Select or Harass Real Estate

Appraisers
The conflicts of interest in the financial industry have had a very real
effect on the integrity of the appraisal profession. The Dodd-Frank Wall
Street Reform and Consumer Protection Act of 2010 has not eliminated
the need to please stockholders, and some of these conflicts of interest
still exist. In performing appraisals for lenders, appraisers need to be
alert to possible conflicts of interest that might compromise their
appraisals. Objective appraisals have been changed or undone by
interference from loan origination personnel and senior executives with
compensation linked to loan production. The independent appraiser who
has never worked at a financial institution may be confused as to who is
in charge and might change the appraisal report at the request of an
executive perceived as having a higher rank. Loan salespeople sometimes
have “regional vice president” or “senior vice president” titles that serve
to confuse independent appraisers. No matter what the perceived rank
is, though, the appraiser should “just say no” to loan officer interference
that would result in a misleading appraisal report.
If a loan officer calls an appraiser to request a change in violation of
USPAP, the appraiser should simply say no. Larger institutions typically
have chief appraisers who can advise the appraiser on the proper course
of action, but even they can be conflicted at institutions pushing loan
sales. Smaller institutions without chief appraisers usually have chief
credit officers who can be consulted.
If the chief appraiser or chief credit officer advises you to commit
appraisal fraud, however, scratch that institution off your client list. If
the institution fails, it is always possible that independent appraisers will
be pursued by the FDIC for losses on failed loans.

Conflicts of Interest in the Taxation Sector

It is intuitively obvious that a property owner appealing a property tax
assessment will want the lowest appraised value possible. Likewise, a
property owner establishing a conservation easement, charitable
deduction, or trust may want the highest appraised value possible. In
these cases, a property owner may expect the appraiser to act as an
advocate. An appraiser who succumbs to such pressure may be in
violation of state or federal laws in addition to USPAP and professional
association codes of ethics.
An appraiser promising to deliver an appraised value as low or as high
as possible in order to evade taxes is clearly crossing the line, but
sometimes an appraiser is cornered into misrepresenting market value
through accepting certain appraisal assignment parameters that would
skew the appraised value. Here are certain unacceptable instructions
that may cause an appraiser to overvalue a property:

Do not make negative time adjustments.

Assume a longer exposure period.
Do not use sales of distressed properties.
Assume that the property is 95% occupied.

The Internal Revenue Service

The Pension Protection Act (PPA) of 2006 allowed the Internal Revenue
Service to strengthen rules regarding appraisals done for income tax, gift
tax, and estate tax purposes, recognizing that appraisals supporting non-
cash charitable contributions in particular had previously been inflated
in many cases and valuations done for estate or gift taxes had often been
understated. Section 1219 of this act spells out new penalties against
appraisers for “substantial or gross valuation misstatement.” Appraisals
are now required to meet “generally accepted appraisal standards.”
USPAP is an example of generally accepted appraisal standards, as is the
Uniform Appraisal Standards for Federal Land Acquisitions (also known as
the “Yellow Book”) used by federal agencies. For tax returns filed after
February 17, 2007, an appraisal report supporting a tax deduction must
include language stating that the appraiser understands that a
substantial or gross misstatement resulting from an appraisal of the
property value that the appraiser knows, or should have known, would
be used in connection with a return or a claim for refund may subject
the appraiser to a civil penalty under Section 6695A.5 Penalties are the
greater of $1,000 or 10% of the amount of underpayment attributable to
the value misstatement, not to exceed 125% of the appraisal fee earned.

Conclusion
Whenever an appraisal is performed, money is usually at stake. For an
appraiser to remain objective, it helps to understand the conflicts of
interest at work behind the ordering of the appraisal report, as these
conflicts of interest may influence the accuracy of the information that
the appraiser is relying upon or even steer the appraiser to a conclusion
that does not logically follow from the information presented. The
financial industry, in particular, is still troubled with many unresolved
conflicts of interest that may steer an appraiser away from the most
accurate and objective conclusions possible.

1. Steven D. Levitt and Stephen J. Dubner, Freakonomics: A Rogue

Economist Explores the Hidden Side of Everything (New York: Harper
Perennial, 2009).
2. Uniform Standards of Professional Appraisal Practice, 2010-2011 ed.
(Washington, D.C.: The Appraisal Foundation, 2010), p. U-28.
3. IndyMac Mortgage Services, “IndyMac Signs Long-Term Contract with
High-Performing CEO, Michael Perry,” Sept. 22, 2006.
4. Gretchen Morgenson, “After Huge Losses, a Move to Reclaim
Executives’ Pay,” The New York Times (February 21, 2009).
5. Internal Revenue Bulletin 2006-46.
 6

Purchase Contract Fraud

Sometimes a buyer conspires with a seller to fool a lender or appraiser,

and the purchase contract is one favorite vehicle for this type of
deception.
The first question an appraiser should consider is, “Is this purchase
real?” Various studies have consistently reported that appraisers estimate
values identical to purchase prices (such as in the golf course appraisal
described earlier) in 96% to 97% of appraisals, a condition known as
“anchor bias.” This bias is quite well known to fraudsters, so much so
that creating deceptive purchase contracts is taught in the many “no
money down” real estate investment seminars held every weekend. I
have personally witnessed the Robert Allen group teaching it while on a
coffee break from an Association of Certified Fraud Examiners (ACFE)
seminar on mortgage fraud prevention. Some Robert Allen seminar
leaders have ended up in prison.
When appraising an acquisition for a syndicate, the appraiser should
also consider the possibility that the purchase itself is not an arm’s-
length transaction but a pocket-to-pocket transaction in which the
manager or general partner purchases for the syndicate a property that
he or she already owns.
To give an example of purchase contract fraud, a doctor in the Atlanta
area fooled a lender into overleveraging an apartment property with the
use of a “double escrow,” an escrow process in which two purchases are
accomplished at the same time. Using an LLC (limited liability company)
that he controlled, the doctor bought the property from the seller for
$1,800,000 and then sold the property to himself for a price of
$2,700,000. This latter contract is the one he submitted with his
purchase loan application. He was thus able to buy the property for no
money down. He then practiced “skimming” by collecting as much
income as possible while cutting expenses and services before unhappy
tenants moved out, net cash flow became negative, and he defaulted on
the loan. Because the fraudster deceived the lender into lending at a
100% loan-to-value ratio, he would lose no money and gain all the
income skimmed.
A Connecticut man, Edward Safdie, created two LLCs to accomplish
the same type of fraud. Operating as 318 Main, LLC, he purchased the
Inn at Cheshire for $2,350,000 and then transferred it to Quantum 318,
LLC, (wholly controlled by himself) at a much higher price, securing
$3,500,000 and then another $1 million in loan proceeds.1 The
defrauded bank, Beal Bank, ultimately foreclosed on the Inn and sold it
for $2,450,000, losing over $2 million.
It is not usually possible to prove that a particular purchase
transaction is deceptive or fraudulent, but one needs to be suspicious
when the purchase price is not supported by comparable sales. It is folly
to treat a contract purchase price as prima facie evidence of market value
rather than as just one piece of data needing reconciliation, and too
many appraisers feel that they have to manipulate market data in
strange ways in order to support a purchase price that may not even be
real.

This apartment property in the Atlanta area became the scene of fraud when the perpetrator
used a double escrow to buy the property, simultaneously sell it to himself at a much higher
price using an LLC he controlled, and obtain a loan based on the falsely inflated purchase
price.
 price.

Exhibit 6.1, an excerpt from an escrow document, shows what can

happen behind the scenes. In this transaction, a Kansas City apartment
building was being purchased at a price per unit seemingly 50% above
comparable sales, in a zip code that often leads the nation in apartment
building foreclosures. By using a fake cash down payment, the purchase
price was inflated from $3,732,500 to $4,475,000, although the net cash
deliverable to the seller remained the same. This document was obtained
just by asking the mortgage broker’s assistant for a chance to see the
loan application file. The PayoutOne program, the sender of this letter, is
no longer in operation.2

In another case, several hundred acres of land in New Mexico were

being purchased at a price seemingly three times as high as similarly
zoned comparable sales, and it was observed that the seller had made a
transfer of ownership to an LLC several months before at an undisclosed
price.
The buyers operated a website that advertised “transaction facilitator”
services in which they could form a joint partnership with the seller
before officially purchasing the property. This could have explained the
nature of the previous transfer of ownership, which was the transfer
from the seller to the joint venture, making the current purchase
transaction a sham since the alleged buyers were already half-owners.
In the case of pre-sold lots in subdivisions or pre-sold condos in
unfinished condo projects, developers have also been known to boost
their claims of pre-sales through entities that they control. For instance,
a luxury vacation home subdivision in rural Montana (a Yellowstone
Club “wannabe”) had a significant proportion of purchase contracts from
LLCs in Lincoln, Nebraska, several hundred miles away, which not-so-
coincidentally was also the hometown of the developer.

Do you think it was only a coincidence that many of the purchase contracts for this vacation
home subdivision in Montana were from LLCs in Lincoln, Nebraska, which also happens to
be the hometown of the subdivision’s developer?

Another vacation condo complex in Corsicana, Texas, had numerous

purchase contracts from Macomb County, Michigan, which was also the
home of the developer. Examining individual purchase contracts for
units in a subdivision or condo project can be a useful exercise in
detecting deception.
A struggling developer can also exaggerate demand for a project by
advertising claims of “First Phase Sold Out!” An examination of the deed
transfers in the first phase can often tell an interesting story.
In appraising a proposed second phase for a supposedly successful
North Carolina marina condo project, it was represented that the 20-unit
first phase had sold out in a matter of days. Upon inspection, only one of
the 20 units was occupied and several were listed for sale or lease in the
multiple listing service (MLS). An examination of the deed transfers,
however, revealed that most of the transactions were between the
partnership that developed the project and individual partners and vice
versa, and most of these partners were realtors in the same office 90
minutes away. It looked like a game of smoke and mirrors. These condos
that “sold” for $500,000 in 2006 are now listed for sale for as little as
$155,000.
Sometimes an illusory “market” can be created by just two or three
investors buying and selling amongst themselves, as is the case in the
market for hotel/casino land along South Casino Drive in Laughlin,
Nevada. This extremely rugged terrain has been traded at prices
exceeding $1,000,000 per acre under the illusion that these parcels are
“in the path of casino growth,” yet the Laughlin casino industry is
shrinking rather than growing due to competition with Las Vegas and
Indian casinos. The last Laughlin-area casino was built in the 1990s.
These parcels are also so rugged that hotel construction may not even be
an option.

Do you think it’s slightly unusual that this rugged land in Laughlin, Nevada, has been traded
at prices exceeding $1,000,000 per acre because it is “in the path of casino growth”?

Even genuine purchase contracts can be misleading thanks to the use

of seller concessions, stated or hidden, such as “allowances for repair,”
“guaranteed rental income” (in excess of actual rental income), seller-
paid closing costs (beyond what is customary), and favorable seller
financing. These techniques are commonly taught in “no money down”
seminars for investors and real estate agents. However, sometimes the
concessions are hidden.
Some common techniques to hide seller concessions include:

Seller financing that is forgiven in a side agreement. It is amusing to

see letters from attorneys written to Internet legal forums asking for
advice on how to accomplish such a deception without accidentally
causing the buyer liability for repayment.
 The hiding of written concessions in an addendum to the purchase
agreement, an addendum that is then excluded from the purchase
contract submitted to the lender or appraiser.
Any form of monetary consideration other than cash at closing. For
instance, equity in another property might be offered as
consideration. How is the equity measured, and is it measured by an
objective, competent source?
The claim of cash or equity, other than a small earnest money
deposit, that has supposedly been contributed to the purchase
transaction before closing.

It would be safer for the investor or lender to focus on the cash

deliverable to the seller at closing, adjusted by the canceled check for the
earnest money deposit. Also ascertain that the canceled check is not
endorsed back to the buyer and that the check comes from the buyer’s
bank.3 Anything to the contrary might indicate cash concessions being
made to the buyer.
The appraiser should not consider the purchase price until after the
preliminary valuation analysis; in fact, more objective results would
arise if the appraiser was not even informed of the purchase price. If
your initial conclusion of value is different from the purchase price, this
is the time to ask yourself hard questions about either the purchase
transaction or your own analysis. Too many appraisers feel compelled to
appraise value as the same as the purchase price, either due to a lack of
confidence or for fear of upsetting a lender. It doesn’t help that some
lenders have a policy of disciplining appraisers who fail to “hit the sale
price.”

Compare the Purchase Price to the Listing

In one instance, the purchase price was twice the list price for a
warehouse in Kalamazoo, Michigan. This was discovered by Googling
the address and finding the former LoopNet listing (www.loopnet.com).
Warehouses in Kalamazoo and other Rust Belt cities do not typically sell
for twice their list price.
Another example of a purchase agreement that may have been
deceptive involved a golf course being purchased for $5,700,000. The
seller was providing a $500,000 cash concession and $2 million in seller
financing. However, different purchase contracts listed different interest
rates for the seller loan, ranging from 5% to 10%. The net cash to the
seller at closing was $3,200,000.
In this situation, it was suspected that the seller financing was a “soft
second” (forgivable financing) meant to inflate the contract purchase
price in order to mislead the lender and appraiser. Having inconsistent
interest rates in the respective purchase documents was one clue. More
importantly, though, the comparable sales supported an appraised value
of $3,200,000, not $5,700,000. As in this instance, there is usually no
way to prove that a purchase contract is deceptive. Nevertheless, an
appraiser should feel free to doubt a purchase contract, particularly if it
cannot be supported by comparable sales.

Phony Offers to Purchase

One of the oldest and most transparent scams is to provide a phony
written “offer to purchase” while attempting to refinance a property.
These offers should not be accepted as true indicators of market value,
especially if they cannot be supported by comparable sales. I have seen a
$100 million offer (originating from the borrower’s hometown of
Atlanta) for raw land on South Padre Island, Texas; a $100 million offer
(from the borrower’s home state of Idaho) for a vacant mountain in
Lassen County, California; and a $67 million offer for desert land in
Cochise County, Arizona. None of these offers could be justified by
comparable sales and listings, and the offers often came from someone in
the borrower’s hometown, even if it happened to be hundreds or
thousands of miles away from the property. Appraisers should feel no
duty to accept such offers as valid market data.

Case Study: Syndication Fraud Using a Deceptive Purchase

Contract
The following real-life situation involved a 50-year-old Indianapolis
warehouse and a fraudster named Ed Okun, sentenced in 2009 to a 100-
year prison term. Okun established a company known as the 1031 Tax
Group, LLC, which managed and operated “qualified intermediaries”
acquired by him and then invested these funds in TIC (tenants-in-
common) syndicates that he organized and managed, doing business as
Investment Properties of America (IpofA). One of the syndicates was
organized to acquire the Park 100 Industrial Building in Indianapolis.
This building was a two-story, single-tenant warehouse containing
459,000 square feet of area, built in 1959. The local tax assessor
described the condition of the building as “fair” (as in between
“average” and “poor”). The building was acquired by IPofA for
$12,650,000 in December of 2004 on behalf of IPofA West 86th Street,
LLC, a group of 20 senior citizens as TIC partners in this syndicate. Okun
was the manager/servicer.
LLCs are often used to cloak non-arm’s-length transactions. The
secretary of state’s office in each state publishes the names of officers
and directors of all LLCs established in that state, as well as the date
each LLC was established. In this case, the Indiana Secretary of State’s
office had on file the document concerning the seller of the warehouse,
5201 West 86th Street, LLC, shown in Exhibit 6.2.
Okun’s signature was on the bottom of the document. The Park 100
Industrial Building had already been acquired by Okun, doing business
as 5201 W. 86th St., LLC, for $3,300,000 in November of 2001. The new
syndicate, in which Okun was the manager, was thus acquiring Okun’s
own property for $12,650,000 three years later, giving Mr. Okun a
$9,350,000 profit on this aged warehouse property and a return on
investment (on a free-and-clear basis) of 283%.
The investors were informed that the warehouse had just been leased
to an entity known as Brickyard Properties, LLC, at an annual rent of
almost $1,000,000 per year, triple net. Per the lead investor, Brickyard
was a subtenant in a master lease to IPofA 5201 LeaseCo, a shell
company formed by Ed Okun. The lease document promised a $1 million
lease incentive to be paid to Brickyard “upon successful syndication of
the property.” Brickyard occupied the property for about a year but did
not pay rent.
 All of the information used to mislead the investors was also used to
mislead the appraisers, who valued the property for $12,650,000—the
stated purchase price—for the Canadian Imperial Bank of Commerce.
The appraisers may have felt compelled to “hit the purchase price,”
presumably not knowing about the “pocket-to-pocket” nature of the
purchase transaction. They used sales of twenty-first century warehouses
to support their appraised value of the Park 100 Industrial Building.
As Okun’s assets had already been seized, the investors also wanted to
sue the appraisal firm. However, the appraisal was done for a lender, not
the investors, and the legal doctrine of privity precluded any fiduciary
duty or liability to the investors. The originally intended lender, perhaps
suspecting foul play, elected not to fund this transaction.
Ed Okun’s first wife described him as a con man who stole $150,000
from his father-in-law and raided his own family’s trust fund to buy a
53-foot yacht, a Rolls-Royce, an Aston Martin, and a Mercedes before
fleeing from Canada to the United States to escape a civil judgment.
Prior to his arrest for embezzlement, Okun attracted unfavorable
attention with a small dinner party in the Bahamas that ran up a tab of
$56,000.
As some real estate syndicates fail nowadays, others like Ed Okun’s are
being exposed. Appraisers hired by real estate syndicators must be extra
careful to not get caught up in a predatory scheme that harms investors.
Using a syndicator’s acquisition price as a “target value” may be
particularly risky and may make the appraiser unknowingly complicit in
a dishonest scheme, such as the Okun fraud or the previously discussed
Credit Suisse fraud.

Builder Bailouts
Over 38,000 homes in the city of Las Vegas, Nevada, are available for
purchase or are being foreclosed on as of March 2011, representing
about a year and a half of unsold inventory. There are even whole
neighborhoods with new homes but no occupants. Some builders are
advertising Las Vegas “rental homes” for sale which they or their agents
promise to find, rent, and manage for out-of-state investors. Most leases
are one year in length. What happens at the end of the lease? Will there
be a qualified tenant available or will the owner be competing with
thousands of other landlords for an inadequate number of qualified
tenants?
There is a name for many of these schemes: “builder bailouts.”
Appraisers and buyers are often misled with purchase prices that may be
inflated by the monetary amount of “free” concessions such as free
homeowners association dues, cash at closing, and free management
services for one or two years. Using comparables exclusively from the
same development project may blind an appraiser to such a scheme.
“Guaranteed rental income for the first two years” is a seller promise
that should be interpreted as a sign of weakness rather than security
because an adequately performing rental property does not need to be
sold with any such guarantees. What often happens is that the property’s
previous asking price has been inflated to more than cover the amount
of these guaranteed rents.

“Only a scammer will ‘guarantee’ your transaction.”

—Craigslist

Unsold condos in Kissimmee, Florida, that are being individually marketed as rental
properties in a market with a high vacancy rate.

Conclusion
Fraudsters have learned how to exploit weaknesses in the appraisal and
lending industries, one of which has been the historical undue reliance
by these industries on purchase price as the best indicator of market
value. Studies have consistently indicated that appraisers “hit the
purchase price” about 96%-97% of the time, a fact well known to those
who would commit fraud. Complicating the situation are lenders who
punish appraisers for failing to appraise the value of the property at the
stated purchase price.
Deceptive purchase contracts are created for the following reasons:

To allow the buyers to acquire a property with no money down or

even take cash back
To allow dishonest syndicators to receive higher fees or even sell
their own properties to unknowing investors
To inject cash into a fraudulent sale between related parties
 To cover the cost of concessions, such as guaranteed rent or
renovation allowances

It is quite difficult to ascertain whether a purchase contract is fraudulent

or misleading, but it is much easier to arrive at an independent estimate
of value without having to always consider the purchase price as the
primary market value indicator. Appraisers who use independent
thinking to arrive at an estimate of value insulate themselves from the
undue influence of a deceptive purchase contract.

1. “CT Man Pleads Guilty in Commercial Mortgage Fraud,” The Mortgage

Fraud Reporter (January 16, 2009).
2. Their YouTube video is still on the web, however, at
www.youtube.com/user/payoutone.
3. Jenny Brawley, Associate Director for Fraud Investigation at Freddie
Mac, “Mortgage Fraud,” seminar for ACFE.
 7

Misrepresentation of Occupancy and Tenancy

Sometimes it’s hard for a property owner to misrepresent occupancy.

Retail centers, for instance, tend to have large glass windows and
merchants open for business during business hours. With mobile home
parks, the unit is either there or not there. On the opposite end of the
spectrum are large apartment buildings and hotels. When inspecting
these types of properties, the appraiser needs to be much more careful to
protect against deception because many units may not be freely
accessible or visible from the outside.
Sometimes it’s not practical to fully inspect an apartment complex of
several hundred units. In these cases, it is important for the buyer or
inspector to be in control of the sample selection of the units to be
inspected, so as not to be “steered,” and to select units in different
sections of the property. (“Steering” is the practice of preventing access
to units that may have been misrepresented as to size, occupancy, or
condition.) As you verify that each tenant who is supposed to be there is
actually there, you will come to a point at which you can feel confident
about the rent roll’s representation of occupancy and tenancy. But wait,
there’s more!

Why Verifying Collected Rent Is So Important

It is important to remember that occupancy alone doesn’t bring in
revenues; rental income does that. A property inspection should include
some elements of rent verification whenever possible and some study of
past rent rolls to better understand tenant histories.
For an income-producing property, a non-paying tenant is a worse
drag on profit than a vacancy. At least the vacancy may be promptly
filled without having to hire a lawyer. One of the costliest mistakes for a
client that an appraiser can make is to assume that all occupants are
paying rent. It is better to have vacancies than deadbeat tenants. A
property that is 25% vacant might be preferable to one that has 25% of
its tenants not paying rent, as deadbeat tenants can be difficult to
dislodge.

Talk to the Tenants

To guard against relying on a fraudulent rent roll, ask tenants on site
how much rent they pay. The responses may surprise you.
The most revealing answers tend to be made out of earshot of the
landlord, where some tenants may feel more comfortable divulging
embarrassing information. The following are some actual answers I have
received from tenants that suggested possible rent collection problems:

“The landlord is giving me a break because so many of us got laid

off.”
“The landlord asked me to sign this lease that says $2,500 per
month, but he told me I only have to pay $1,800 per month. He just
wanted to show the lease to the bank.”
“I’m not actually paying rent now.”

Some tenants speak foreign languages, so it pays to learn numbers and

simple questions in other common languages. In the Southwest and
many major American cities, apartment tenants may speak Spanish.
Asking “Cuanto paga para la renta cada mes?” (“How much do you pay in
rent each month?”) and learning numbers in Spanish can be helpful. If
you cannot memorize numbers in Spanish, supply the tenant with a pad
of paper and a pencil to bridge the language barrier. Written numbers
are a universal language.
An appraiser should never be afraid to examine leases or call tenants if
there is any doubt in the appraiser’s mind about the tenancy.

Verification of Future Tenants

When improvements are only proposed, verifying tenants is trickier.
Developers often stretch the truth, representing letters to prospective
tenants as lease commitments. Nothing is a substitute for a signed lease
with a real tenant. Letters of intent can sometimes be relied upon, but to
have any credibility they should come from recognized credit tenants on
company letterhead.
In one case, a vacant, former Costco warehouse was purchased for
$1.62 million in 2001 and appraised one year later for $21.5 million,
resulting in a $14 million funded loan. The property was appraised
under the assumption that Federal Express, Walgreen’s, AutoZone, El
Pollo Loco, and Global Terratransit would be leasing it, even though
there was no documentation of interest from any of these tenants. None
of the so-called tenants ever moved in. An appraiser should value a
property based on market rents, vacancy rates, and absorption rates if
authentic leases cannot be produced.

Case Study: A Loss Incurred on a Fully Occupied Building

In the early 1990s, Home Savings made a purchase loan on a fully
occupied apartment building in Riverside, California. The loan went
almost immediately into default. As it turned out, the building had been
50% vacant only a short time before. The owner quickly filled it by
offering free rent, no-money-down specials to homeless individuals and
then sold it to an unsuspecting investor, who financed his purchase with
the Home Savings loan. As the buyer quickly discovered, many of the
new residents had no intention of paying rent, and as they defaulted on
their leases, the borrower defaulted on his loan.
The buyer had performed a property inspection and presumably
verified full occupancy. The appraiser was seasoned, respected, and
considered to be competent. How could this fiasco have been prevented?

Studying Present and Past Rent Rolls

Most professionally managed properties have standardized rent rolls and
management reports that indicate when a tenant moved in and what the
tenant paid each month. In addition to requesting the current rent roll,
the buyer should also request prior rent rolls. These prior rent rolls could
indicate prior periods of high vacancy as well as free-rent specials. It can
arouse suspicion when a large, multi-tenanted property goes from 50%
occupancy to 100% occupancy in a matter of weeks, and the free-rent
specials only add to the suspicions. Good management reports also
indicate collection trends.
Just as importantly, one should request and receive complete lease
documents, including any amendments, in addition to the rent roll. As
tedious as this might be, it is a useful fraud prevention procedure, as
rent rolls can sometimes be inaccurate. When inspecting a building,
every space and tenant needs to be accounted for within the limits of
practicality. Relying only on the rent roll is inadequate due diligence.
For example, a field review of a struggling shopping center in
Henderson, Nevada, revealed that the appraiser failed to notice that the
highest-paying tenant on the rent roll, a Baptist church, was not actually
occupying any space at the center. Based on the square footage claimed
for the church on the rent roll, it was apparent that the church was
supposed to be occupying a vacant Blockbuster Video store, but anyone
could see through the plate glass windows of this vacant store that there
was no provided seating, a prerequisite for holding most religious
services (including Baptist services).

According to the rent roll for this shopping center, a Baptist church was occupying this
former video store.

What If the Tenant Is Not There?

If the tenant is obviously not occupying the property, it may be because
1) the tenant has vacated the premises prematurely, or 2) a new tenant
has not moved in and might not actually intend to.
One should be skeptical of vacancies that are not described as
vacancies. If the tenant has left, for instance, it may be claimed that the
tenant is still making rent payments. These payments should be
documented with copies of rent checks. “Credit tenants,” such as
financially sound national retailers, often continue making their
contractually obligated rental payments, but lesser tenants cannot
necessarily be expected to do the same.
Likewise, the landlord can claim that a lease has “just been signed” for
a vacant space, but one should be skeptical of tenants who have not yet
moved in. For instance, a large, older medical office building in south
Phoenix was described as being fully leased but found to be half vacant,
with every vacant suite having a sign announcing the upcoming arrival
of a new tenant. Half-vacant, older, multi-tenanted buildings in low-
income areas do not typically increase from 50% to 100% occupancy
overnight.
In another case, an inspection of a multi-tenanted industrial building
in Connecticut revealed that the tenant paying the highest rent, a
nightclub, had still not moved in after supposedly paying rent for 15
months.

The rent roll for this building in Connecticut stated that the property’s highest-paying tenant
was a nightclub. An inspection revealed that the tenant still had yet to move in after
allegedly paying rent for 15 months.

When in doubt, request copies of checks or bank statements

establishing that the tenant actually paid rent. As the Internal Revenue
Service has known for a long time, bank statements can be a powerful
auditing tool.
When the Landlord Pretends to Be a Tenant
A “pocket-to-pocket” lease is what results when a landlord pretends to
be a tenant. For example, two developers of a speculative new office
building in Phoenix were having trouble leasing out enough space to
satisfy the occupancy requirements of most takeout lenders, so they
wrote leases to themselves creating company names from their initials.
Using this strategy, John Doe could write a lease to JD Development,
Inc., and move some used office furniture into a vacant space.
One clue in detecting “pocket-to-pocket” leases are unknown tenants
signing leases at rental rates that are obviously above market rates.
Walgreen’s may pay above-market rates because of the specialized
tenant improvements they require, but unknown tenants occupying
generic office space would not have a reason to sign a lease at an above-
market rate. This should motivate the appraiser to find out what the
market rental rates are.
For example, a loan made on a renovated, century-old warehouse
building on a dirt road near downtown Denver was based on an
appraisal report that described the building as a fully occupied, Class A
downtown office building. The appraised value was $4,250,000. A
knowledgeable broker revealed that the owner had signed a high-rent
lease to an entity he controlled in order to make the building appear
fully leased at high rents. Upon reinspection, the owner’s space was
found to be vacant. Seven months after the original appraisal, the
building was valued at $1,550,000, relying on market rents for such
space.
Any above-market lease with a tenant who has not yet moved into the
space should also be viewed skeptically. During the inspection, it is
useful to ask, “What does this tenant do?” to sort out possible straw
tenants, relatives, in-laws, or John Doe Developments, Inc.

The Best Way to Verify Occupancy and Rents

The person who is often in the best position to provide accurate and
objective information is often lower on the totem pole and closer to the
action than the property owner or developer. Try to interview the
property manager before the owner shows up and puts words in his or
her mouth. You may be able to do this if you show up at least half an
hour before your scheduled appointment with the owner. Managers are
more likely to have objective reports and may not have yet been
instructed to mislead you, so one-on-one time with the manager can be
time well spent.

Estoppel Agreements
Estoppel agreements signed by tenants are intended to verify lease
obligations, advance payments, renewal options, options to purchase,
defaults by the tenants or landlord, and any claims against the landlord.
Estoppels can be counterfeited, though, by desperate landlords,
particularly if they are so bankrupt as to be considered judgment-proof.

Conclusion
The central theme of this chapter is the need to verify that the full,
obligated amount of rent is being received from the tenants that are
supposed to be occupying the space. Occupancy and/or lease documents
should not necessarily be considered proof that rent is being paid. An
appraiser should also be skeptical of vacant space that is represented as
being paid for by an absentee tenant. An examination of historical rent
rolls can alert the appraiser to suspicious changes in occupancy or
phantom tenants. Lastly, a well-planned inspection of a property will go
far in spotting misrepresentations about occupancy, rent, unit sizes, and
habitability.
 8

Misrepresentation of Property
Characteristics

A host of unfavorable property characteristics can be misrepresented by

property owners. The commonly misrepresented conditions that we will
discuss in this chapter are:

Legality of use
Availability of utilities and water
Property size and measurements
Condition of property
Transferability of rights or funds
Tax credits
Water rights
Bond financing

Legality of Use
An illegal use—a use that is contrary to zoning laws or building and
safety codes—can be discovered by local authorities, who might then
force the owner to remove the improvement and/or pay for the
conversion of the space back to a legal use. This can often lead to
financial loss for the buyer or lender.
One particularly memorable example is a scam carried out in the early
1990s. A New York City walk-up apartment building on a residential
street was acquired by three phony doctors who claimed that they had
the permits to remove all ground-floor, rent-controlled tenants and
replace them with an MRI facility. There was no such zoning variance
approved by the city, but the appraiser never checked for zoning or
permits and used MRI facility rent comparables justifying a much higher
potential income for this rent-controlled residential building. The
purchase loan went into immediate default, at a major loss to the lender.
Unknown to the appraiser, these same three “doctors” also acquired
another walk-up building in Greenwich Village with an above-market,
“pocket-to-pocket” lease with a natural foods store they wished to
operate in a hard-to-rent basement space, and this lease was used to
support a purchase price well above the building’s market value. This
purchase loan also went into immediate default. Legality can often be
verified online or with a recent certificate of occupancy or a phone call
to the city’s building department, steps the appraiser in this case most
likely didn’t take.
Some appraisers may argue that lax code enforcement has caused
some buyers to pay full price for illegal improvements, thus requiring
them to give full value to such illegal improvements. This could get an
appraiser into trouble, though, as unexpected future enforcement of city
codes could jeopardize these illegal uses and cause a loss to the buyer or
lender. All it takes is one major fire or loss of human life to change the
political climate for code enforcement. So the unit is unheated? What
will happen to local code enforcement when a tenant freezes to death in
another unheated apartment elsewhere in the city?
Be alert to clues of illegal improvements. For instance, a studio
apartment without a thermostat in a building with central heating and
cooling could actually be a master bedroom that was walled off from
another two-bedroom apartment. Some landlords do this because they
can get more rent from a one-bedroom apartment and a studio combined
than they could from a two-bedroom apartment alone. Abrupt changes
in a roof line or exterior cladding (i.e., one type of material covering
another) could also be signs of an illegal addition.
As verifiable as it is, even a property’s zoning can be misrepresented.
For example, a landowner in south Florida who wished to build a
community shopping center claimed commercial zoning. Checking with
county officials, the appraiser found that the parcel actually had
agricultural zoning with a designated future land use of commercial, but
the only commercial use the county government intended to approve for
the subject site was use as a warehouse.
 When in doubt, talk to the local government departments that make
the rules. In all of these cases, of course, a properly performed highest
and best use analysis could have averted trouble.

Availability of Utilities and Water

Some owners of land that does not have access to fresh water or sewers
may try to hide this fact. The availability of utilities and water on a
property needs to be verified with the relevant municipality or private
utility company. In one case in Lake Elsinore, California, the owner’s
misrepresentation of water and sewers caused an appraiser to appraise a
raw land parcel—that was acquired nine months previously for
$236,000—at $16 million. Property owner claims of receiving water or
sewer service “any day now” also need to be verified.

The owner of this property claimed that the property had city water and sewers installed on
it when in reality it was a Flood Zone A property with limited usefulness. The abrupt change
in vegetation at the lower elevation is an indication of a high water table.

Water rights can be very important for appraisers in western states.

For example, one property owner claiming to have rights to a large,
underground aquifer with many potential users instead had rights to an
underground stream that was only available to a few other potential
users. Water rights tend to be less valuable in thinly traded markets,
particularly when the pace of land development has subsided, as has
happened recently. Water rights can typically be verified by an engineer
who works for the state’s department of water resources.
Property Size
The larger the building, the harder it is to verify building area. Relying
on rent rolls or landlord claims of property size can be risky.
A 17,000-sq.-ft. warehouse in Philadelphia, for instance, was
appraised as a 22,000-sq.-ft. warehouse. When he was asked to explain
this discrepancy, the appraiser said he knew the warehouse was 22,000
square feet in area because the rent roll said so.
Property managers sometimes create more rentable area than there is
building area. For instance, regional mall managers have been known to
brag about their ability to create extra rentable area out of thin air.
Twenty-five years ago, when tenants would discover a discrepancy and
protest that they were paying for too much space, the mall manager
would simply say something like, “We’re at full occupancy here. You can
either keep paying the same rent or else we’ll find someone else who
will.”
Today in the United States and elsewhere, many regional malls are in
a different negotiating position, due to escalating vacancies and
struggling retailers. A savvy tenant (such as a major retail chain) may
audit the amount of space and be able to negotiate the rent downwards
or sue the landlord for years of overpaid rent.
Architectural building plans can be more reliable in indicating
building area but may not reflect change orders that could have affected
the area. Public records are objective but can often be inaccurate. Public
records often understate building area due to unrecorded, but permitted,
additions as well as local customs that exclude certain types of building
area, such as basements. Basements are inherently less valuable than
ground-level space but can still have value if they bring in rental
income.

Property Measurements
By process of elimination, then, the best way to verify building area is to
measure it. This is not always easy. For buildings with irregular areas,
one trick to simplify the task of measuring is to draw a building sketch,
divide the area into rectangles, and then add up the areas of the
rectangles, as shown in Exhibit 8.1.
 The building area for the property shown in Exhibit 8.1 can be divided
up into ten rectangles, as follows:

For a particularly complex assignment, an appraiser may even want to

subcontract property measurement to a commercial property inspection
firm.

Property Condition
Although the condition of the property is somewhat obvious at the time
of inspection, the severity of the deferred maintenance can often be
understated. Non-functioning equipment, particularly elevators, may be
permanently rather than temporarily disabled. If your client is a lender,
it is best to have the client order an expert inspection for any valuable
building components, such as elevators, HVAC systems, or even kitchen
equipment.
Some owners may contend that major renovations have occurred since
they acquired the property, even though the renovations may not be
evident. For example, one apartment landlord in Tulsa claimed to have
made $350,000 in recent renovations, but the property still had shag
carpets, appliances, and HVAC units that dated back to the 1970s. What
had actually happened was the previous owner had made a $350,000
cash reduction in the sale price for a “renovation allowance.” However,
since this was not a cash allowance but a cash reduction of the purchase
price, the money was never spent. When in doubt, politely ask to see
receipts for the renovations.

Transferability of Rights or Funds

Sometimes a property owner holds extra rights that may add to his or
her own value-in-use of the real estate, such as:

State or local tax exemptions

Governmental subsidies
Bonus densities
Federal or state tax credits

An appraiser needs to determine the transferability of such special

rights by examining the source documents that allow the transferability.
A right may create great value for the existing property owner but may
not be available to subsequent owners of the same property. If a right
cannot be transferred, it has no market value.
For example, the city of Monument, Colorado, granted lucrative tax
exemptions to a developer for the specific purpose of building a water
park. Although the parcel was being purchased for about $20 million, a
local appraiser appraised the land for $80 million by adding $60 million
in anticipated tax savings. No one argued that $60 million in tax savings
was possible, but the city ordinance declaring the tax exemptions
specifically stated that the tax exemptions were not transferable. A city
official explained, “Why should we allow the exemption to be
transferred to someone who doesn’t need it, like Wal-Mart or Home
Depot?”
Community redevelopment agencies often create subsidies for
developers to undertake projects in underdeveloped areas, which are
euphemistically relabeled as “redevelopment areas” or even “arts
districts” or “theater districts.” These “project funds” often come with
many conditions as to use, density, or aesthetics. Some developers then
approach lenders offering these project funds as additional collateral, but
appraisers need to determine:

If the project fund runs with the property rather than the developer,
If the project fund is transferable upon foreclosure, and
If the project fund is available for alternative development should
the original project become infeasible.

Too often, the answer to these questions is “no.”

There are also situations in which the subsequent owner would be
made liable for repayment of project funds extended to the previous
owner. City agencies use such language to ensure that project funds get
paid back if the project is not erected as planned.

Tax Credits
Some redevelopment projects may be eligible for federal and state tax
credits, such as the federal “new markets,” “historical preservation,” or
“low-income housing” tax credits that offset federal income taxes.
However, care should be taken to establish that these tax credits have
already been awarded, as tax credits are often competitively allocated
and limited in supply. For instance, less than 25% of applicants for “new
markets” tax credits (that encourage qualified investment in
economically challenged communities) are successful in gaining the
credits.
Some developers claim value for imminent historic tax credits before
their buildings are officially registered as historic structures. In one case,
a developer claimed to have historic and (state) theater tax credits for a
1950s-era office building on the grounds that he intended to convert the
building to a parking garage for a historic theater one block away. No
tax credits had been awarded, and there were no architectural drawings,
plans, or specifications to support the intended renovation.

A developer prematurely claimed to have historic and theater tax credits for this 1950s-era
office building because he intended to convert it to a parking garage for a nearby historic
theater.

Water Rights
In the western United States, water resources (river water, lake water, or
groundwater) are usually rationed. Water rights can usually be sold, but
one must be careful to identify what the exact water rights are and who
can practically use them.
 For instance, groundwater rights are quite valuable in the Reno
metropolitan area and can be transferred to potentially hundreds of
other users with access to the underground aquifer.
A golf course near Reno was represented as having substantial water
rights, presuming that these rights had the same value as Reno-area
groundwater rights, but the engineer’s report indicated the water sources
to be surface and underground mountain streams shared by few other
property owners. The market value of these water rights was
substantially less than the value of groundwater rights because the
market for these rights was so much smaller. These stream water rights
could only be practically used by the few other landowners along the
streams.
Other factors that also go into the valuation of water rights include
“priority date” (seniority), season of use, location of the water source,
and water quality.

Bond Financing
“I don’t have to pay back the bond money,” developers will often claim.
In one case, a promise of up to $100 million in bond financing for the
developer was made by the town council of a small, low-income
Delaware town of less than 4,000 residents. The developer was supposed
to build 2,384 new “senior townhomes” (restricted to those who are at
least 55 years old), and the bond payments were to be made by special
assessments paid by the eventual new residents of this massive town
addition. The appraiser assigned a present value of $41,500,000 to this
“free money,” which was roughly twice his estimate of the real estate
value alone.
 The council of a small, low-income Delaware town promised up to $100 million in bond
financing to a developer, who was supposed to build over 2,000 new senior townhomes on
this plot of land. The money was supposed to come from special assessments paid by future
residents of the townhomes. The appraiser assigned a present value to this bond financing
that was almost twice the real estate value.

Special assessment bond financing is often a zero-sum game, however.

Experience has shown that homebuyers discount their purchase offers by
the amount of the extra bonded indebtedness because of the extra
monthly payments they will make.
In California, many subdivisions have been built with “Mello-Roos”
bonds requiring residents to pay extra special assessments. The term
“Mello-Roos” comes from the names of the coauthors of the Community
Facilities District (CFD) Act, which allowed these special districts to be
established with the stipulation that the homeowners who live in the
districts re-pay the money used to fund the community’s infrastructure.1
Competing California subdivisions often use the phrase “no Mello
Roos” in their advertising to attract buyers not wanting to make these
extra payments. This phenomenon works the same way in other areas,
such as with special assessment districts in Florida and municipal utility
districts in Texas. Always remember that a bond has to be paid back.
There is a four-letter word in the expression “bonded indebtedness,” and
that word is debt.
While there may be a value to public bond financing at rates more
favorable than lenders’ rates, one first has to establish that there really is
bond financing in place. The Delaware seniortownhome scenario would
be a non-starter in today’s bond markets, particularly since the
repayment scenario seems so doubtful as to be absurd. Would there even
be buyers for such a bond? Assigning value to a bond that has not even
been issued is “jumping the gun” and very risky.
Small-town bond financing can be particularly perilous, too, as the
bonded indebtedness can be an albatross that sinks the city’s finances. A
recent example is the town of Buena Vista, Virginia, population 6,500,
which used bonds to finance a golf course development to rescue the
town’s ailing economy.2 The bond was to be repaid by profits from the
golf course and potential luxury homes, hotel rooms, and restaurants.
The golf course failed to be profitable, but the town also put its own city
hall building up as collateral for the bond. The town defaulted on its
bond payments in the summer of 2010 and now faces the prospect of
having its city hall foreclosed on and sold.

Conclusion
An appraiser should verify all property characteristics significantly
contributing to value, such as property size, utilities, zoning compliance,
the functionality of critical mechanical systems (e.g. HVAC or elevators),
the transferability of special rights or funds, or claims of renovations.
Owner representations should not be accepted without verification of the
property attributes having a major impact on the overall value of the
property. A properly conducted highest and best use analysis will also go
a long way in preventing some of these frauds.

1. Todd Foust and Charmaine Ngo, “What is Mello-Roos?” Realty Times

(July 10, 2009), www.realtytimes.com.
2. Ianthe Jeanne Dugan, “Fight Over City Hall—Literally,” The Wall
Street Journal (August 17, 2010), p. C-1.
 9

Deceptive Financial Statements

A knowledge of standard property accounting practices can help an

appraiser detect unreliable financial statements. Request financial
statements, preferably prepared by independent accountants, for the
year-to-date and the two previous years if possible. Also check the
footnotes and fine print for any disavowals of responsibility for the
accuracy of the numbers. It is common practice for lenders to request tax
return schedules for a property and some, burned by counterfeit tax
returns, are even requiring borrowers to sign and submit IRS Form
4506T, which permits the lender to contact the IRS directly to request a
copy of the borrower’s actual tax returns. An appraiser should ask lender
clients to supply them with these tax returns when available.
In this chapter, we’ll discuss some “tricks” to watch out for when
analyzing financial statements.

The Numbers Are Too Round

Professional property management reports are typically exact to the
penny, as are utility bills and property taxes. Round numbers for every
line item of income and expenses tells you that actual numbers were not
used. When actual numbers are not used, it is often because the owner is
using pro forma estimates or relying on memory, perhaps an incomplete
memory.
Rent-controlled apartments are experiencing high foreclosure rates in
some parts of Los Angeles. Controlled rents are typically uneven and
based on the application of legally set limits. For instance, a $500-per-
month apartment that is allowed a 3% increase per year will go up to
$515 the next year, $530.45 the following year, and $546.36 the year
after. A rent roll for a rent-controlled apartment should have uneven
amounts for tenants who have been in place for two years or more.

The Numbers Are Too Consistent

The following is part of an operating statement submitted by a struggling
hotelier who had supposedly “fired” his Choice Hotels franchise. What
clues can we find that suggest that the 2006 figures are fictitious?

Here are some clues that suggest the numbers are made up:

Every 2006 line item is the same multiple of the 2005 line item
(1.433). This is a statistical impossibility.
The 43.3% increase in room revenues alone offends common reason
because the loss of the Choice Hotels Group franchise would have
been a severe blow to revenues since the hotel would be cut off
from Choice’s extensive reservation system. (Choice operates
Comfort Suites, Comfort Inn, Clarion, Quality Inn, Sleep Inn, and
EconoLodge hotels, among other brands.) Firing a known franchise
may help a hotel owner save on expenses but almost never results in
an increase in revenues. Franchises are specifically used by hotel
owners to increase revenues, and such franchises as Marriott, IHG
(Holiday Inn), Hilton, Starwood, and Choice have the proven ability
to do so.
It is unlikely that telecommunication revenues would have
increased 43.3%, since telecommunications revenues have been
universally declining among all hotels as more and more guests are
opting to use personal cell phones instead of hotel phones.

Not All Obligated Payments Are Being Made

When tenants get into trouble, they may stop paying escalation income,
expense recoveries, or percentage rental income before they stop paying
their base rent. Some landlords allow them to get away with it,
particularly if the property is listed for sale. Remember to verify
collected income, as a deadbeat tenant can be worse than no tenant at
all.

Revenue That Is Not Related to the Property Is

Included
Operating statements may sometimes include revenues from other
properties, activities, or businesses not being appraised. For example, the
owner of a strip mall in Texas supplied deceptive operating statements
that included “capital infusions” as actual income and double-counted
“common area maintenance” (CAM) reimbursements in “base rents” and
as a separate line item of income. Also, an unusually high percentage of
revenues came from late fees, which may have been uncollected. As a
result of this deception, the reported net operating income had been
inflated from $67,000 to $178,500. (Three of the eight leases were also
pocket-to-pocket leases.)
Some owners even pay themselves management fees and include these
as revenues. Most appraisal assignments, however, employ a definition
of market value that presumes a sale of the appraised property, so what
the owners claim to collect is immaterial if it is not a custom of that
market.
Operating statements may also include revenues that cannot be
expected to be consistent. Apartment owners, for instance, typically
include “late fee” income in their financial statements. An apartment
owner in Tulsa, Oklahoma, reported so much “late fee” income that it
was apparent he had a big collection problem. These late fees were
probably being accrued, but not collected.
Watch out for one-time sources of income, such as a legal award or the
sale of a part of the property. One apartment building owner in Utah
applied for refinancing after an unsuccessful condominium conversion,
representing sales of condominium units as rental income.
A property owner may also be operating a business out of the
appraised property, and one must be able to distinguish between
property-related revenues and business revenues. The following
business-related revenues are not real property items and require a high
amount of labor and business or marketing expertise:

Cover charges and liquor sales from a nightclub

Product sales
Food and beverage sales
Services such as valet parking, spa services, or car washing

“Pocket-To-Pocket” Rental Income Is Included

If a landlord is paying rent to himself just for occupying space, this is not
rental income that can be counted on if the property goes into default.
This is an extra reason for the appraiser to try to know who each tenant
is in commercial properties such as office buildings or retail centers.

Necessary Expenses Are Excluded

The owner of a 30-year-old Houston-area apartment property reported
expenses 28% below the market average, which he considered to be
evidence of his superior management ability. However, the property
inspection indicated significant deferred maintenance, with extensive
termite and water damage to structural wood, potholes in the parking
lot, and over 200 original condensing units needing replacement.
Skimping on maintenance only increases the amount of future expenses
an investor can expect to incur.
To determine actual expenses, request bank statements and cancelled
checks. One can also compare reported expenses with expense
comparables or expense data from the Institute of Real Estate
Management (IREM), Building Owners and Managers Association
(BOMA) International, and the International Council of Shopping Centers
(ICSC).1 These three groups organize operating data in many ways, such
as by region, property size, building age, or property type.

Conclusion
Income and expense statements should not necessarily be taken at face
value. They should be scrutinized for common types of
misrepresentation, such as overly round numbers, the inclusion of non-
realty revenue or management fees as a source of income, the exclusion
of customary expenses, or patterns that do not make sense with respect
to the operating performance of the property (such as increasing
revenues in a situation of increasing vacancies). Whenever possible—
particularly when appraising for a lender—request to see the property
owner’s tax returns, as they may indicate rent collection problems or
understated expense items. Bear in mind, too, that property owners
wishing to commit fraud often do so through the use of false financial
statements.

1. More information on these organizations can be found at

www.irem.org, www.boma.org, and www.icsc.org.
 10

Misrepresentation of Buyer or Borrower

Nominee fraud, as it is called by the FBI, is the practice of concealing the

real identity of a buyer or borrower with the use of a false stand-in
buyer, often called a “straw buyer,” who is more creditworthy. Nominee
fraud is different from the previously described types of fraud because it
typically affects credit decisions rather than valuation.
No one has suggested that appraisers police such fraud. Nevertheless,
your lender clients would be better protected if you inform them when
the name on the purchase contract is different from the name of the
borrower; not all lenders look for this. The borrower could be a straw
buyer. LLCs are often used to conceal the discrepancy, however, making
such detection difficult.
Nominee fraud has become quite prevalent and is arranged openly on
online Internet forums and at real estate investment seminars. Its
perpetrators do not even seem to consider it illegal. The straw buyers are
often convinced by the fraudster that nothing illegal is occurring. Take,
for instance, the ad shown in Exhibit 10.1, which appeared on a
LinkedIn forum.

Similar “real estate partners needed” ads are often seen on Craigslist
or on personal real estate investment forums such as Bigger Pockets or
Norada.
The FBI has defined this type of scheme on its website as a nominee
loan, in which “the identity of the borrower is concealed through the use
of a nominee who allows the borrower to use the nominee’s name and
credit history to apply for a loan.”1 This straw buyer fraud falls within
the FBI’s definition of mortgage fraud, “a material misstatement,
misrepresentation, or omission relied upon by an underwriter or lender
to fund, purchase, or insure a loan.”2
When the straw buyer leaves after the transaction and the less
creditworthy owner is left to pay the debt, the loan could go into
default. Sometimes the straw buyer is not so lucky, though, and is left
holding the debt obligation.
Such behavior has also been interpreted by prosecutors as a violation
of US Code Title 18 (Crimes and Criminal Procedure), Part I (Crimes),
Chapter 47 (Fraud and False Statements), Section 1014, also known as
the fraud statute:
§ 1014. Loan and credit applications generally; renewals and discounts; crop insurance
Whoever knowingly makes any false statement or report, or willfully overvalues any land,
property or security, for the purpose of influencing in any way the action of the Federal
Housing Administration, the Farm Credit Administration, Federal Crop Insurance Corporation
or a company the Corporation reinsures, the Secretary of Agriculture acting through the
Farmers Home Administration or successor agency, the Rural Development Administration or
successor agency, any Farm Credit Bank, production credit association, agricultural credit
association, bank for cooperatives, or any division, officer, or employee thereof, or of any
regional agricultural credit corporation established pursuant to law, or a Federal land bank, a
Federal land bank association, a Federal Reserve bank, a small business investment company,
as defined in section 103 of the Small Business Investment Act of 1958 (15 U.S.C. 662), or the
Small Business Administration in connection with any provision of that Act, a Federal credit
union, an insured State-chartered credit union, any institution the accounts of which are
insured by the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, any
Federal home loan bank, the Federal Housing Finance Agency, the Federal Deposit Insurance
Corporation, the Resolution Trust Corporation, the Farm Credit System Insurance
Corporation, or the National Credit Union Administration Board, a branch or agency of a
foreign bank (as such terms are defined in paragraphs (1) and (3) of section 1(b) of the
International Banking Act of 1978), an organization operating under section 25 or section
25(a)[1] of the Federal Reserve Act, or a mortgage lending business, or any person or entity
that makes in whole or in part a federally related mortgage loan as defined in section 3 of the
Real Estate Settlement Procedures Act of 1974, upon any application, advance, discount,
purchase, purchase agreement, repurchase agreement, commitment, loan, or insurance
agreement or application for insurance or a guarantee, or any change or extension of any of
 the same, by renewal, deferment of action or otherwise, or the acceptance, release, or
substitution of security therefore, shall be fined not more than $1,000,000 or imprisoned not
more than 30 years, or both.3

It is unfortunate that affluent and otherwise legitimate citizens (such

as doctors, for instance) get mistakenly caught up in straw buyer
schemes in an effort to improve their own investment returns. Fraud is
fraud, and it is never excusable. However, initiators of straw buyer
scams can be very persuasive and may influence naive investors to serve
as straw buyers, all the while convincing them that nothing illegal is
occurring.
Nominee fraud, also known as “straw buyer” fraud, is a common
element of mortgage fraud. Appraisers should be alert to evidence that a
loan applicant is not the real borrower or buyer of the property. If you
are suspicious or see evidence that such a scheme is occurring, it is best
to notify the lender and let the lender decide on what type of action to
take.

1. Federal Bureau of Investigation, Operation Quick Flip,

www.fbi.gov/news/stories/2005/december/operation-quick-flip.
2. Federal Bureau of Investigation, 2009 Mortgage Fraud Report “Year in
Review,” www.fbi.gov/statsservices/publications/mortgage-fraud-
2009.
3. This section of the US Code appears courtesy of Cornell University
Law School, www.law.cornell.edu. Direct link:
http://www.law.cornelLedu/uscode/18/usc_sup_01_18.htm.
 11

Other Ways Appraisers Are Influenced

Property owners often try to influence appraisers in ways that are not
necessarily illegal but have the potential to steer the naive toward
unjustifiably higher estimates of value. In this chapter I’ll discuss some
of my observations of such tactics.

Previous Appraisal Reports

In some cases, owners or brokers may have already ordered their own
appraisal reports before you enter the scene. Expect these reports to be
biased. Consider the possibility that many honest appraisers may have
turned down that appraisal assignment until the owners or brokers found
an appraiser who would do their bidding.
When calling to schedule a property inspection, owners or brokers
may say, “We don’t know why the lender sent you. We just had the
property appraised by the best appraiser in town.” Their definition of
“best appraiser” can be a subjective one.
Do not be intimidated by the other appraiser’s company or credentials.
National companies with good intentions and reputations sometimes
have rogue appraisers in their midst who are willing to satisfy a
dishonest client. The Credit Suisse lawsuit discussed in Chapter 2 may be
an example of such a situation. Likewise, 99 designated appraisers may
have turned down the assignment before the broker or owner found the
one dishonest one.
Sometimes the local appraiser may be biased by local chauvinism.
There are some appraisers who cheer on their local real estate market
much as they would cheer on their local sports team. Some have even
suggested that prosperity is a permanent feature of their community, not
subject to the laws of economics such as supply and demand. Keep in
mind that you were hired as an appraiser because of your independence
and objectivity.

Misleading Data
Now that we have covered lies and damned lies, let’s move on to
statistics. Owners or brokers sometimes provide slanted statistics in
order to influence appraisers. Let’s talk about some common ways they
do this.

Average Price Data

Misleading average price data is more likely to be given to you when
you are appraising in the worst section of the city. Some perpetrators
may even provide data from an adjacent neighborhood in the hopes that
the appraiser doesn’t know the area well enough to notice, such as
substituting Sherman Oaks data for a Van Nuys property in Los Angeles
or Hyde Park data for a Wood-lawn property in Chicago.

Household Income Data

Owners and brokers like to present “average household income” data,
but be careful in distinguishing between average household income and
median household income. Average is another term for the mean of the
sample. The median, on the other hand, is the number that bisects the
sample into halves. It is at the exact middle of the sample when ordered in
numeric sequence.
Median income is typically lower, and it is the statistic relied upon by
retailers and homebuilders for good reason. For example, let’s take a
look at Irwindale, California, a city of 1,446 residents, 365 households, a
median household income of $45,000 per year, and an average income
of about $52,000 per year. What would happen to these statistics if the
Bill and Melinda Gates household moved to Irwindale? Let’s assume that
Mr. and Mrs. Gates are earning $1 billion per year.
The median household income would increase only a little, perhaps to
$45,001, the next wealthiest household on the totem pole. The average
household income, on the other hand, would jump enormously,
calculated as follows:
(365 × 52,000 + 1,000,000,000)/366 = $2,784,098 average
household income

The average household income in Irwindale would have increased to

more than 50 times the original figure with the entry of the Gates
household.
Which figure would matter more to the local supermarket? Will it sell
50 times as many groceries? Will the carwashes wash 50 times as many
cars? Will 50 times as many homes be sold?
With few exceptions, the median household income statistic is the one
that retailers and homebuilders rely on. Unsolicited data on “average
household income” in a property’s area is generally designed to mislead
someone.

The “Dog and Pony Show”

A good real estate investment should almost sell itself. Good location,
good occupancy, good cash flow, good condition, a growing local
economy: these are all self-evident property attributes that don’t need
sales pitches.
Then there are some properties that need all of the best capabilities of
professional spin doctors. One can almost measure the desperation of the
owners by the length of the presentations they force an appraiser to sit
through and the number of spin doctors they hire to convince the
appraiser of a conclusion that would have otherwise been considered
improbable. A thick binder might await you, accompanied by a
PowerPoint presentation and the phrase “This is everything you will
need to know” appearing somewhere in the introduction. Sometimes the
fraudsters may even bring their own hired appraiser. (“Joe from
Appraisal Advocates has already assembled all the comps you’re going to
need!”) It’s as if someone is trying too hard. How did Lieutenant
Columbo always instinctively know who the killer was? It was the one
with the most carefully prepared alibi.
When fun and excitement are involved in the presentation, judgment
can get particularly clouded. Consultant Stephen Roulac used the term
“Golden Palomino effect” to describe the motivation behind a poor
acquisition decision made by an executive smitten by a golden palomino
horse he was allowed to ride on, followed by outdoor barbeques and
campfire songs.1
The most suspicious dog and pony shows feel like abductions. The
appraiser may be presented “comparable properties” first before being
shown the subject property. In one excursion in Louisiana, for instance, I
was driven to successful marina residential developments for more than
two hours before being shown the subject property, a swamp. As I stood
about 18 inches over the Houma Channel, which is at sea level, my hosts
insisted that I was 10 feet above sea level. As I looked down at the
gravity drains below, they emphatically told me, “This is not a swamp! It
rained hard yesterday.”

A Cajun tall tale: “This is not a swamp! It rained hard yesterday!”

Character References
Real estate markets are inherently cyclical. Some legendary investors
like Sam Zell know when to get in and get out, but not all investors
make the best choices all of the time. If you think that Donald Trump
never makes mistakes, just tell that to the lenders holding notes on his
casinos and unbuilt condominium towers.

“What a Successful Developer!”

“What a Successful Developer!”
You may be told about a developer’s or owner’s record of success. All
that shows is that the party in question got into the market at the right
time. In commercial real estate, it’s all about timing. The cyclical nature
of markets has turned many successful real estate developers into failed
real estate developers. Some do not see the end coming; others don’t
care, as long as they can get highly leveraged financing.

“What a Fine Person!”

You may also be told of the developer’s or owner’s reputation for
integrity. For example, one developer deceived a bank into making a $30
million land speculation loan at a 5% interest rate and a loan-to-value
ratio of at least 97%. The loan was allegedly for the purpose of
constructing a surface parking lot supposedly worth $65 million, but the
site had just been bought for $24,375,000. When doubts were raised
about the developer’s representations, the loan officers countered with
information about how the developer had just received an “ethics
award” from a realtors’ organization. Such awards may be no more
credible than humanitarian awards from Al Qaeda.

Conclusion
Be aware that some people out there would try to influence an appraiser
in every way possible towards achieving a certain valuation income,
whether it is through the provision of misleading appraisal reports or
statistics, irrelevant character references, or carefully staged
presentations involving thrills or “experts.” Be particularly careful to
avoid undue influence by so-called experts who were bought and paid
for by the property owner or broker.

1. Stephen Roulac, 255 Real Estate Investing Mistakes (San Francisco:

Property Press, 2004), 105.
 12

Property Types More Susceptible to Fraud

Vacant Land
Let’s begin with the simplest and yet most complex property type.
Sometimes lenders and less sophisticated investors fail to understand the
vast gulf in value between raw and finished land, between flat and hilly
land, or between unentitled and entitled land.
Dishonest real estate syndicators particularly like land deals, because
unsophisticated investors can be misled about land value. So can
unsophisticated lenders. This occasionally allows remote, hillside land
without utilities and development approvals to be sold or financed at
amounts many times the actual land value.
The appraiser should talk to the relevant local planning department to
verify owner representations of final tract map approvals or how much
needs to be done before final map approval can be given. The route from
tentative approval to final approval often involves satisfying dozens of
conditions—some of which may even be outside the developer’s control,
such as receiving federal agency approvals or acquiring easements or
agreements from private third parties. Representations of water and
sewer availability also need to be verified. The “will serve” letter from
the local utility is typically used to establish proof.
When developers represent that they have received all necessary
approvals, also be aware that more than one government approval may
be necessary. If wetlands or waterways are involved, an approval from
the US Army Corps of Engineers or a public utility company may be
necessary. If the property is near a coastline, an approval from a state
agency regulating coastline development may be needed. If a billboard is
on the property, there may be approval needed from a separate local or
state agency.

Rent-Controlled Apartments
Depending on the severity of the local rent control ordinance and the
shortage of apartments, rents for some tenants can be significantly below
market value. This might tempt a dishonest landlord to submit a fake
rent roll to the appraiser.

Buildings with High Vacancies

Here is a riddle:
When is a tenant that is not occupying space considered to be occupying
space?
Answer: In an appraisal report.
In other words, appraisers too often accept misrepresentations about
“leases just signed” or departed tenants who are allegedly still paying
rent. If these leases are a significant proportion of forecasted income,
confirmation is strongly recommended. Future tenants of any
significance should be contacted. Bank records should be requested to
confirm rent being received on vacated space.

Condominium Projects
The recent housing market collapse has been particularly hard on
condominium projects that aren’t fully sold out or completed or that
haven’t been built yet. Desperate condo developers have been known to
create fake sale contracts to provide the illusion of feasibility. Even real
contracts may be distorted by concessions in order to present an illusion
that higher prices are being achieved. In one such instance in Los
Angeles, a leading mortgage bank became suspicious of a high-rise
condominium complex that was experiencing a significant number of
loan defaults. It was found that the developer was offering buyers an
18% cash concession from the contract purchase price. Appraisers, not
knowing about the concessions, were hitting the contract prices and thus
overvaluing the condos, setting the stage for early loan defaults.
 This condominium building in Los Angeles experienced a significant number of loan
defaults. The developer was offering buyers an 18% cash concession from the contract price.
Appraisers who didn’t know about the concessions were appraising the units at contract
prices and thus overvaluing the condos.

Foreign Real Estate

Regulated lenders are usually restricted from making loans on foreign
properties, but some private lenders operate in this risky area.
It is almost a given that the least desirable properties must be
marketed the furthest distances to find buyers or lenders. Good real
estate opportunities tend to get picked off by local investors and lenders.
It pays for an appraiser to be skeptical, then, when appraising foreign
real estate and to make an effort to find and collaborate with an
independent local real estate professional who can alert you to
misrepresentations.

This “ecological preserve” was represented as a proposed residential subdivision and as

collateral for a loan.

Do not trust unsolicited appraisal reports from foreign countries, even

if they are by appraisers with designations. If the appraisal was ordered
by a property owner or broker, consider the possible bias.
The use of foreign appraisal reports is riskier because of the
considerably lower documentation standards in countries outside the
United States. Reports from other countries, even the United Kingdom,
are briefer and present much less evidentiary support for their value
conclusions. Even Canada does not require appraisers to present “as is”
values (as required by FIRREA in the United States) or to disclose that
the appraisal is merely hypothetical (as required by USPAP).
There are many obstacles to analyzing foreign markets, starting with
the lack of good quality market information. Lack of market
transparency creates a considerable disadvantage for appraisers. Western
investors accustomed to the abundance of public real estate data in
countries such as the United States, Canada, and Australia usually won’t
be able to find such resources in most foreign countries. What passes for
public data in places such as Mexico or Costa Rica, for instance, is often
a fiction serving a hidden agenda, usually tax avoidance. The process of
gathering data on foreign soil may not be able to transcend collecting
hearsay from real estate brokers who may have vested interests.

Properties with Title Issues

There is always the possibility that the property owner may not have
clear title to the property. Title problems are common in Latin American
and African countries, for instance, which have histories of changing
governments or property expropriation in the name of land reform. Title
fraud is also a possibility. Title issues merit consultation with a local real
estate attorney. For example, it is estimated that half of the properties in
the Dominican Republic have title problems.
The ejido system in Mexico, too, has resulted in conflicting ownership
claims. The Spanish colonization of Mexico undid the Aztec communal
system of land ownership, the antecedent of Mexican ejidos, which the
Mexican Constitution of 1917 pledged to remediate. Starting in 1934,
the Mexican government began seizing land from private landowners in
the name of land reform, transferring ownership to occupying peasants
organized as ejidos, which are basically agricultural communes without
cultural, religious, or political trappings. This program of expropriation
continued until its abolition by President Carlos Salinas in 1991 as a
condition of the ratification of the North American Free Trade
Agreement, since American firms did not want to build factories on land
that could conceivably be taken away from them. This has created many
title disputes, even in urban areas.
In many Latin American countries, possession is nine-tenths of the
law. Squatters sometimes cannot legally be removed, such as in Peru,
Brazil, and the Dominican Republic. A property owner may steer the
appraiser away from the location of the squatters, as I have personally
witnessed.
 Ejido de Llano Largo—disputed communal land in Acapulco

Conclusion
Certain property types may be more prone to fraud due to:

Distressed market conditions

Lack of knowledge about the property type
Great disparities in income or value which may be hard to detect
The ability to conceal or misrepresent vacancies
Lack of transparency in the markets where the properties are
located

The types of properties that are most vulnerable to fraud are often those
that could be considered the exact opposite of investment-grade real
estate—those situated in distressed or illiquid markets or having high
vacancy rates.
 13

Federal Criminal Statutes against Fraud

Most actions alleging fraud are civil suits, mainly because there are
insufficient prosecutorial resources to file criminal actions against all
fraudsters. For instance, each FBI office has a different minimum dollar
threshold that determines which fraud cases will be investigated. There
have been a number of criminal cases against mortgage fraudsters,
however, and the amount of the fraud in those cases has typically
exceeded $1 million. The FDIC has instead chosen civil courts to pursue
fraudsters and those who aid and abet them, including appraisers. The
SEC has also launched high-profile lawsuits against high-profile CEOs of
the mortgage banking industry, such as Angelo Mozilo of Countrywide
and Mike Perry of IndyMac.
Title 18 of the US Code is a useful place to start in defining criminal
misconduct relating to fraud. Title 18’s Chapter 47, Fraud and False
Statements, includes the following fraud statutes:

Section 1001. Statements or entries generally

Section 1001 is the broadest of the fraud statutes, as it basically

states that in any matter under the jurisdiction of the federal
government, whoever knowingly and willfully “1) falsifies, conceals,
or covers up by any trick, scheme, or device a material fact; 2)
makes any materially false, fictitious, or fraudulent statement or
representation; or 3) makes or uses any false writing or document
knowing the same to contain any materially false, fictitious, or
fraudulent statement or entry”1 shall be fined or imprisoned.

Section 1002. Possession of false papers to defraud United States

Section 1005. Bank entries, reports and transactions
 Section 1007. Federal Deposit Insurance Corporation transactions
Section 1010. Department of HUD and FHA transactions
Section 1014. Loan and credit applications generally; renewals and
discounts; crop insurance
This statute is the most specific about fraud against lenders and was
discussed in Chapter 10 of this book.
Section 1028. Fraud and related activity in connection with
identification documents, authentication features, and information
Section 1031. Major fraud against the United States
Section 1032. Concealment of assets from conservator, receiver, or
liquidating agent of financial institution
Section 1037. Fraud and related activity in connection with
electronic mail

Title 18, Chapter 63, Mail Fraud and Other Fraud Offenses, includes
additional fraud statutes:

Section 1341. Frauds and swindles

Section 1342. Fictitious name or address
Section 1343. Fraud by wire, radio, or television
Section 1344. Bank fraud
Section 1345. Injunctions against fraud
This statute is used against those who intend to violate banking
laws.
Section 1348. Securities and commodities fraud
This statute is used against corrupt real estate syndicators.
Section 1349. Attempt and conspiracy

These mail and wire fraud statutes are more often used in federal fraud
prosecutions, partly because they are broad enough to cover just about
any fraud and also pack a powerful punch in sentencing, allowing for
prison sentences of up to 20 years. Almost any type of real estate fraud
can be classified as mail fraud or wire fraud because it relies on either
the mail, telephones, or the Internet. These statutes also allow US postal
inspectors to help in investigations that may otherwise lack staffing
resources.
Finally, Chapter 73, Obstruction of Justice, includes these statutes:

Section 1510. Obstruction of criminal investigations

Section 1516. Obstruction of Federal audit
Section 1517. Obstructing examination of financial institution
Section 1519. Destruction, alteration, or falsification of records in
Federal investigations and bankruptcy

These statutes are particularly relevant to corporate fraud.

Conclusion
Until now, fraud has not been discussed in the commercial appraisal
profession. The near collapse of the financial system and the escalating
litigation against appraisers compel our profession to take fraud more
seriously. What commercial appraisers don’t know about fraud can hurt
them as well as others.
This book has presented the causes of fraud, the types of commercial
real estate fraud known to be occurring, and specific methods used by
fraudsters to deceive or influence commercial appraisers. The legal
framework for the prosecution of fraud has been presented, including
applicable federal statutes.
The next few years are likely to produce new case law concerning the
expected obligations of commercial appraisers in preventing fraud. There
may be some high-profile cases that will cause upheaval in our
profession, embarrassing us and changing our professional rules.
Ignoring the fraud problem will not make it go away; in this way, fraud
is like a cancer. The best way we can tackle the problem is to know more
about it and prevent it whenever we can. If we fail to do this as a
profession, others will force a solution on us with less favorable terms.

“Whoever commits a fraud is guilty not only of the particular

injury to him who he deceives, but of the diminution of that
 confidence which constitutes not only the ease, but the very
existence of a society.”
-Samuel Johnson

1. US Code, Title 18, Part I, Chapter 47, Section 1001. The US Code is
available on the website of Cornell University Law School,
www.law.cornell.edu/uscode/.
 Appendix

Real Estate Transaction Fraud Prevention

Checklist
Items checked yes suggest the possibility of fraud.
 Bibliography

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