Fraud or Incompetence… does it matter if the result is the same?

When investing your hard-earned money, one question you never want to ask is whether a loss occurred because of fraud or incompetence. Facing a financial loss from an investment is not something anyone plans on and whatever the answer the result is lost income, lost time, and lost opportunity when those funds are tied up and unable to fund the next investment. Mistakes and fraud happen occasionally, but if you take the time upfront and do your due diligence, you will be more secure with your investments and your documentation process will enable success in litigation if push comes to shove.

"An ounce of prevention is worth a pound of cure" - Benjamin Franklin

Was It Fraud?

Fraud comes in various forms, including misrepresentation, identity theft, or loan stacking. Misrepresentation occurs when a borrower lies about an aspect during the investment process, like their income or a falsified property value. Identity theft happens when fraudsters pose as other people to take out loans or sell a property. Examples of instances where identity fraud have occurred happened with an AirBnB property rented out for 30 days and sold at a steep discount . And if borrowers secure multiple loans on a single collateral, it is called loan stacking.

All of these frauds will cost you money. Even if you can hold the fraudster accountable, going to court will take time and money. Additionally, if you are awarded a judgment, it does not always mean you get paid, as these people have already proved they are unreliable.

Was It Incompetence?

If you lose money on a deal, you will ask yourself what went wrong. If you can point to any of the following things, you likely didn't take the time upfront and do your due diligence. This is why it is crucial that you verify the underwriting and experience of the investor you're lending to.

• Insufficient insurance coverage: properties should be covered at a minimum to the outstanding loan value. Not requiring this amount of insurance from your borrower creates unnecessary risk to your investment.

• Youtube University: while videos on Youtube share insightful and helpful information, relying too heavily on Youtube can lead to mistakes in private lending. If you are new to private lending, we recommend consulting with trusted professionals to help you.

• Relying on HUDs: HUDs are insufficient in determining the experience or performance in property management and revenue of a wholesaler vs a fix and flipper vs a buy-and-hold investor.

Other Considerations: Beware of Creative Exit Strategies

Borrowers may propose creative exit strategies and try to deceive you with a bad deal. While I am all for creative solutions, it is critical you are verifying the investors knowledge and capacity to execute said “solution”. Ideas are cute, but can they perform? As an investor, you need to be skeptical of deals and ensure you understand everything to be confident that a borrower isn't fooling you. Some creative exit strategies borrowers may propose involve short-term rentals (Airbnb), mid-term rentals (30-day stays), or special use like assisted living or co-op living arrangements. While your rental income potential can be high with special use strategies, it is highly dependent on the experience of the operator, management capabilities and skill, and the market. If you cannot determine these factors with verifiable proof, when it comes to asset-based lending, it is recommended to underwrite it’s feasibility based on the basic numbers like long-term rental income potential and comp it based on the current market value.

Learn From Mistakes

I know from experience that you can lose your hard-earned money as quickly as it takes to send a wire. Since I've been doing due diligence, I've seen the many ways a deal can go south when we start peeling back the onion of what these allegedly experienced investors plan on doing with your money. I have not only experienced this myself but saw it countless times when I was helping new investors as a creative finance consultant and transaction manager. You need to be cautious of whom you trust with your money, as people will try to take advantage.

Final Thoughts

It is better to be proactive than reactive. Chasing payments taking borrowers to court, and trying to identify what went wrong is exhausting. Creating sound due diligence and vetting processes is the best way to avoid defaulting to damage control methods. Check out this free webinar Steve Ernest, Esq, Geraci LLP’s director of litigation, and I did for considerations to familiarize yourself with fraud.