How to Protect Yourself from Fraud When Investing in Real Estate

by Darin Styles, CPA, CFE

Everyone knows conducting due diligence is critical when making a real estate investment. Over the past two years, however, the pandemic has made it more difficult than ever. Property assessments, walkthroughs, and even fund transfers have all been done virtually. Combine this with the pressure to get in on a hot market, and conditions become ripe for fraudsters.

Case in point: According to a report by the FBI’s IC3 cybercrime unit, victims in the U.S. lost more than $213 million in 2020 because of fraud involving real estate investments or rental or timeshare properties. Many fraudsters rely on Ponzi schemes and have no qualms about targeting unsuspecting investors. When looking at their slick property renderings and attractive numbers, it’s hard to discern who is and isn’t being truthful.

If you’re planning to make a real estate investment, it’s important to be vigilant at every step. Here are a few ways to protect yourself from real estate fraud.

Beware of fraudulent balance sheets

When making a real estate investment, it’s easy to get caught up in the rush. Resist the temptation and take the time to meticulously review the potential investment’s balance sheet, ideally with a financial advisor. You’ll want to pay close attention to debt owed to third parties as well as the total principal amount of outstanding debt. Doing so can help you confirm—or deny—the numbers are truly as attractive as they appear.

Investigate income statements

Diving into an investment’s income statements can help you ensure its legitimacy. Make sure expenses like sales commissions, professional fees, and property maintenance correlate with revenue. If a property’s revenue increases, its expenses should, too.
What’s more, conducting a thorough review of a property’s revenue could uncover related party transactions. If these transactions significantly contribute to revenue, it could be a marker of fraud.

Carefully examine cash flow

One of the most critical pieces of the due diligence process is an examination of cash flow. Be sure to closely review not only the company’s cash flow but also the personal expenses of its principals. If money is being funneled into a fraudster’s account, this is how you’ll see it. If you find abnormal financial records, request an explanation.

Know what you’re looking at

If you’re conducting business remotely, you’re likely relying on a virtual tour, aerial photos, or renderings for your property assessment. Be sure to get third-party confirmation of what you’re seeing whenever possible. Also, watch out for investment advertisements that include lots of buzzwords and promises of guaranteed returns. All too often in this climate, they are too good to be true.

Expand your perspective

As I mentioned, it can be hard to know who and what to trust when making a real estate investment. We’re here to help you get a better vantage point. By comparing industry reports to the investment’s financial statements, we can determine if other investments are seeing the same returns—and if your potential investment seems reasonable. If you have questions or would like to talk further, contact us today.