We are long overdue for a conversation about your real estate investment research. You are inundated with information on a daily basis regarding researching the stock market and analyzing your portfolio. Investors spend hours poring over revenue projections, conference calls, and expert analysis. However, when faced with diversification to real estate investment, investors frequently succumb to flashy presentations and personal relationships. The lack of due diligence and aversion to hiring counsel prior to making a real estate investment frequently results in lost fortunes.
In August, we learned that Equitybuild, a real estate investment company that had been operating in Chicago since 2010 and popular with long distance investors, was a Ponzi scheme. The Security and Exchange Commission (SEC) filed charges that the $135 million collected from over 900 investors was not invested properly and new money was used to pay old debt. Investors that were promised 15% to 20% returns on their money are now involved in lengthy litigation in hopes they can recover some of their investment.
The promise of Equitybuild was simple. Instead of purchasing income property for $500,000, they would purchase a property for $200,000, spend $200,000 restoring and renting the property, and the investors would have profitable, income producing property, with $100,000 instant equity. Investors were so eager to make huge profits and cash in on the dream of owning income producing real estate, that they did not take the time to look closely at the real estate or hire local counsel to walk them through the process. I spoke to one investor that was so excited about the possibilities, he sent $750,000 that represented all of his life savings and investment portfolio.
Five years ago, I spoke to a client that was interested in investing in Equitybuild. He asked me to review their investments and report back. Almost immediately, I found “red flags.” On its face, the building they were telling investors they purchased for $200,000 was purchased for closer to $100,000. The Cohen family running the company misrepresented the purchase price of the properties in order to make a sizeable profit from the beginning. This issue was glaring, and honestly, extremely easy to discover issue that makes me question if other investors made any effort to do research.
The deeper I dug, the more red flags I found. In order to purchase buildings that would result in the promised profits, Equitybuild was adding buildings in historically poor performing neighborhoods. The buildings had wonderful Pro Forma rent rolls, but the actual rent rolls after factoring in evictions, problem tenants, and resistance to pushing rent prices were not considered.
Having followed Equitybuild for many years, I saw the problems they had with the City of Chicago Department of Buildings. If the City feels a building is in poor condition, they file suit and place a lien on the property to ensure compliance. The lien also serves to make selling or financing the property without disclosing the lack of repairs extremely difficult. The constant flow of uninformed, out-of-state investors allowed Equitybuild to continue bringing in new money when a conventional investor would have cut them off. The Equitybuild investors I spoke to were not aware how much money and how many investors were attached to each property. They were so convinced by the presentation, they never stopped to ask how a fractional interest investment works.
Towards the end, Equitybuild found themselves in a tough spot. They had taken money at the front of the deal, overstated rehab costs (and I’m assuming skimming rehab money) while failing to complete repairs, allowed liens to remain on the property to prevent refinance and pulling out investor money, couldn’t get the buildings to appraise for the value advertised, and the rental income wasn’t resulting in the promised profits. Rather than stopping, the Cohen family made the decision to keep recruiting new investors and use new money to pay old investors the promised returns. The SEC had to step in to prevent further loss and investors have expressed concern the Cohen’s have fled the country.
Could this have been prevented? Absolutely. After conducting research in Equitybuild, I heavily advised my client to decline their investment opportunity and avoid their alluring emails. I’ve spoken to many investors and they either never thought to consult with a local real estate attorney or didn’t want to “waste” the money. Investors need to approach real estate investment with the same caution and preparation as they do with their stock portfolio.
Before you take the leap of investing with a company promising profits in real estate, you need to take a step back and consult with a local real estate attorney. My office provides a variety of services, but one of the most important is helping review and analyze real estate investment opportunities. Most investors avoid this process because of experiences with an attorney overanalyzing document or holding up the process. A trained real estate attorney can investigate quickly, and for a cheaper price than investors would expect. The reality is that you need a trained set of eyes to review your sure-fire, money making opportunity to know for certain it’s not “the next Equitybuild.”
The next time someone pitches you a real estate investment, ask yourself, what would you do if you were one of the Equitybuild investors hoping to get any of their money back? Then ask yourself, can you afford not to hire a local real estate attorney?