People may assume that fraud in
the real estate industry doesn’t
exist. “In the real estate arena, people think there is no inventory to
steal,” says Mary Ann Gehringer, a
director who specializes in real estate
auditing at SS&G Financial Services,
Inc. “It’s not like a manufacturing company where employees could walk out
with their pockets loaded or fill the
trunks of their cars.”
In business, companies are going
paperless, technology is improving
and online transactions further cloud
the traditional audit trail. Similar
trends in the real estate industry
impact the way owners must manage
their buildings.
So, if you decided to invest in a real
estate endeavor rather than the stock
market in hopes of seeing better
returns, you may find out the hard way
that the same accounting checks and
balances you apply at your company
need to be put into place in your real
estate pursuits.
“The fact that I can alter an electronic invoice by changing the payment
address to my home and, in five more
seconds, manipulate it to reflect a
larger amount is incredible,” she says,
explaining how a scanned invoice for
$250 is inflated to $2,500 with the click
of a mouse.
Smart Business gained insight from
Gehringer about real estate red flags
that building owners need to identify
immediately in order to prevent fraudulent activity that will gradually chip
away at their return on investment.
How does fraud occur in real estate?
If you own a building as an investment outside of your primary business, chances are you employ a building manager or leasing attendant to
oversee administrative duties and
daily operations. This person collects
monthly rent and keeps track of which
units are vacant. There may not be
segregation of duties because this
employee is the only person on duty.
Residential tenants move in and out of apartments, so a building manager
could shift monies around for months
without you noticing.
If a tenant moves out, the manager
reports this to you. But when a new
tenant moves in, the manager may
continue to call the unit ‘vacant,’ while
collecting payment for rent. Another
scenario is a manager that tells tenants, ‘Just pay me in cash.’ Does your
building manager pay vendors? What
about the elevator service company, a
landscape company or cleaning service? Maybe the manager isn’t honest
about price increases — maybe a vendor doesn’t exist.
What are signs of fraud in real estate?
A suspicious operating cost coverage
ratio is one clue. Are costs, such as
maintenance services, increasing drastically in a flat market? Operating
costs that are not in proportion with
the building’s occupancy level are
another sign. Also, what is the occupancy ratio? How much rent does your
building manager report to you each
month, and how many units are supposedly vacant? Take a personal
inventory by counting which units are
occupied. Just because an anomaly
may exist does not mean fraud is occurring, but it may serve as an early
warning flag if it is.
How can an owner protect against fraud?
First, set up a lockbox and request
that all rent be paid by check directly
to that address. A lockbox can serve
as one of your ‘checks and balances.’
If your building manager never has an
opportunity to touch tenant rents,
there is no opportunity to misappropriate the funds. If you do not have a
lockbox and an in-house manager collects rent, do not allow tenants to pay
in cash.
Concerning occupancy, owners
should control the tenant security
deposit and require that tenants submit a letter in writing to you upon
lease termination or move out to get
their deposit back. That way, you are
not relying on your manager’s word.
As an owner, be visible to tenants.
Count occupancy levels for yourself
— open up a dialogue for tenants to
share their thoughts.
A periodic newsletter to the tenants
can convey acceptable practices, and
a tip line to report strange activity can
also be very effective. An employee
hot line directly to the owner can be
equally effective as well. Additionally,
locking paperless documents will help
prevent tampering and forgery. Applying security can prevent the file from
being edited, printed or even opened
without appropriate passwords.
As a general rule, employees commit
fraud when the conditions are right.
This is called the fraud triangle, consisting of motivation, opportunity and
rationalization. In today’s economy,
with soaring gas prices and record
foreclosures, there is plenty of motivation. As a business owner and investor
in real estate, you must protect your
assets and returns by taking measures
to control your risk of being a target of
fraud.
MARY ANN GEHRINGER is a director specializing in real
estate auditing at SS&G Financial Services, Inc. Reach her at
[email protected] or (800) 869-1834.