Property fraud allegations surge as commercial real-estate values fall, exposing schemes and shaking the $4.7 trillion industry.

via WSJ:

U.S. prosecutors are cracking down on commercial mortgage fraud, a growing push that is sending shudders through the $4.7 trillion industry by raising questions about the numbers underpinning major property loans.

Regulators and federal prosecutors say that property loans based on doctored building financials and valuations have been rising. This type of fraud became more widespread between the mid-2010s and 2021, federal investigators and real-estate brokers say, when commercial property prices surged to new highs and landlords had much to gain from such maneuvers.

Now, the drop in property values caused by higher interest rates and a rise in defaults are exposing more of these schemes, dealing another blow to a commercial real-estate market suffering through its worst stretch since the 2008-09 financial crisis.

“It’s a general trend throughout history that fraud occurs during boom times and is revealed during bust times,” said John Griffin, a professor of finance at the University of Texas’ McCombs School of Business.

In most cases, real-estate fraud is made possible because lenders take a hands-off approach to assessing a building’s value. As long as the numbers look in line with those of similar properties, lenders usually trust that they are accurate, brokers say. Auditing books is expensive and time consuming, and lenders competing for deals may be reluctant to antagonize landlords with onerous due diligence…

Two New York men were recently sentenced for their involvement in a wide-ranging mortgage fraud scheme that affected numerous multifamily housing properties in Hartford. The scheme totaled nearly $50 million1. Here are the details:

• Jacob Deutsch (age 58) and Aron Deutsch (age 63), both associated with B H Property Management, LLC (BHPM), were at the center of this fraudulent activity. BHPM manages several multifamily housing properties in Hartford.
• Between September 2016 and May 2021, Jacob Deutsch (who oversaw BHPM’s day-to-day operations) and Aron Deutsch engaged in a scheme to defraud financial institutions, government-sponsored enterprises (such as Freddie Mac and Fannie Mae), and the U.S. Department of Housing and Urban Development (HUD).
• They provided false information to lenders, overstating the value of multifamily housing properties managed by BHPM in connection with loans secured by those properties.
• Jacob Deutsch submitted false rent rolls and falsified leases to financial institutions and appraisers. These documents either overstated the number of renters (including fictitious renters) or inflated the rent amounts paid by occupants.
• To deceive inspectors, Jacob Deutsch staged unoccupied apartments with furniture and instructed BHPM employees to falsely claim they lived there. If inspectors asked about vacancies, they were instructed to lie.
• For instance, Jacob Deutsch submitted a rent roll and income summary for a property at 16 Evergreen Avenue, falsely claiming it was 100% occupied when no tenants resided there. He even sent pictures of money orders and checks purporting to be rent payments from fake tenants to prove payment, but these were fraudulent as well.

Jacob Deutsch received a 62-month prison sentence, four years of supervised release, and a $10,000 fine. Aron Deutsch was sentenced to five years of probation and ordered to pay a $1 million fine. Their actions had significant consequences for the housing market and financial institutions.