From comps to construction costs, lenders who question everything stand the best chance of protecting themselves from fraud.

Private lenders face a material risk of fraud, and the cases have become increasingly more sophisticated. Mix in the complicated nature of lending for renovation or construction in the residential space, and you have a recipe for unwanted and challenging situations.

Some of the fraudulent issues lenders and industry leaders have faced —and are speaking up about—related to valuation and construction include:

Price collusion to inflate value

Bribes to appraiser

Borrower persuasion/misrepresentation

Bribes to site inspectors

Budget shortfalls

Excessive budget

Budget and ARV mismatch (overinflating target condition)

Fraud related to valuation and construction often involves subtle manipulation or misrepresentation, but real-world case studies reveal practical strategies lenders can use to detect and prevent these risks. Let’s take a look at three case studies, each related to either price collusion, borrower persuasion/misrepresentation, or excessive budget.

Price Collusion to Inflate Value

The standard appraisal process typically uses the existing purchase contract to help determine the property’s current “as is” market value. This assumes that an independent buyer and seller have agreed on a fair price, reflecting true market conditions. Appraisers also review the property’s historical listing and sales activity to provide additional context.

Relying simply on the contract price or recent sales of the subject property to determine the As-Is Value (AIV) becomes an issue when the contract price is significantly out of line with other market pricing activity in the immediate area, especially when the home is in moderate, poor, or very poor condition.

This issue often arises in deals sourced through wholesale buyers who assign contracts. In such cases, prices may be inflated to convince a seller to accept an offer. Sometimes, an unsophisticated buyer may not realize they are overpaying. In other situations, it can be worse: The buyer may be colluding   with the seller or wholesaler.

The incentive for such collusion typically involves a promise to share in the profits, which often amount to thousands, tens of thousands, or hundreds of thousands of dollars in cash the seller or wholesaler will generate from the fraudulent transaction.

Traditional appraisals can be vulnerable to valuation issues, especially when the appraisal ordered is a “Subject to Completion” or After Repair Value (ARV) appraisal. In these situations, appraisers often focus heavily on ARV   and give little attention to analyzing As Is Value with much rigor, if at all.

To protect against this, it’s important to independently assess market comparables and establish a market-based value for the property in its current condition. Lenders can take several approaches, including (1) perform that analysis internally, (2) order valuation products that apply equal rigor to both AIV and ARV, or (3) order a secondary valuation product such as Automated Valuation Model (AVM), Evaluation, or similar to gain an independent perspective of current market value.

In an example from 2023, a Florida-based lender was evaluating a fix-and-flip loan for a deal in Springfield, Missouri. The borrower provided the purchase contract to the lender at a price of $260,000, telling the lender their expectations for AIV was $260,000 with an ARV of $325,000. The lender ordered a third-party evaluation to assess the AIV, borrower budget, and ARV. The RicherValues report reviewed hyperlocal market activity, and conducted an interior inspection, assessing the AIV at $130,000 with ARV for the proposed budget (conducting a partial remodel) as $245,000, numbers substantially lower than the existing contract price (see Fig. 1).

After receiving the report, the lender conducted a deeper investigation and uncovered that the wholesale seller and the buyer were colluding to inflate the purchase price, likely to pull material cash out of the deal significantly above value. But because the lender pursued market-based diligence, the fraud was discovered up-front, preventing the lender from a potentially damaging situation and material financial loss.

Borrower Persuasion / Misrepresentation

The standard appraisal process usually includes direct interaction between the borrower and the appraiser, often during the site inspection and any communications before or after the visit. Because many appraisers lack hands-on construction experience, they tend to rely on the borrower’s input to understand the scope and intent of the proposed renovations. Using this information, the appraiser conducts the analysis and identifies comparable properties that reflect the finished condition described by the borrower. 

The challenge arises when the borrower’s description to the appraiser doesn’t match the actual renovation budget provided to the lender. Borrowers are aware that most “Subject To” appraisals don’t involve detailed scrutiny of the budget, as appraisers lack the data and construction expertise to determine whether line items are realistic, inflated or missing. Many appraisers therefore base their assessments on conversations with borrowers rather than on the budget itself. As long as the borrower is being truthful, that approach works fine. 

The issue arises when the borrower intentionally embellishes the budget to misrepresent what the finished product will look like. The goal is to influence the appraisal or third-party results to secure an overinflated ARV that doesn’t match the actual work being performed.

In a Q4 2024, a client ran a test on several properties by ordering side-by-side valuation reports for the same property: one using a standard ARV appraisal and the other using a RicherValues Renovation Analysis. The results were revealing.

Traditionally, the appraisal process involves the appraiser scheduling and conducting the onsite visit, opening the door for direct communication with the borrower. In contrast some valuation providers intentionally use a bifurcated process, where the person scheduling and conducting the on-site inspection has zero involvement in analyzing the renovation  budget, selecting market comps, or determining value. This eliminates a key channel for potential persuasion and significantly reduces risk.

In one example from this test, the ARV appraisal assigned a value of $375,000 based on fully remodeled C2 comparables due to “conversations with the borrower” about the proposed renovations. The appraiser also assumed the basement would be fully finished and counted as livable square footage, an assumption the documented renovation budget did not support. (See Fig. 2 for appraisal definitions.)

The budget included no line items to finish the basement, and the scope was too limited to bring the property to a true, market-based C2 or fully remodeled condition (see Fig. 3). The budget line items and costs were only sufficient to bring the property to a partially remodeled C3 condition, leading to a more conservative ARV estimate of $288,000. 

The important lesson is that a traditional “Subject To” appraisal alone is often not enough to protect against borrower manipulation or misrepresentation. For an ARV to be reliable, it needs to accurately reflect a qualitative and quantitative analysis of the borrower’s proposed renovation budget.

Lender’s can conduct this analysis internally—either through appraisal review or a separate budget evaluation—or they can engage an outside vendor that separates the site inspection from the valuation process and conducts a detailed budget review based on proven residential construction expertise.

Excessive Budgets

The final example highlights an important oversight in how many lenders evaluate borrower budgets. Many rely on internal processes or third-party reports to evaluate whether a budget is sufficient. If no shortfalls are identified, the projects are given a green light, particularly when using third-party feasibility reports.

The problem is this one-sided review can leave a major blind spot, one that savvy borrowers realize they can exploit. In a 2024 case, a national lender evaluated a proposed fix-and-flip loan for a 1,247-square-foot, three-bedroom, two-bathroom single-family home in moderate (C4) condition in Henderson, Nevada. The borrower submitted a $170,000 renovation budget, and the lender’s usual third-party feasibility report approved it, citing no shortfalls and deeming the budget sufficient to complete the work.

However, the $170,000 figure amounted to $136 per square foot, which was well above the norm for a home of that size, condition, and market finish. As part of its risk process, the lender ordered a RicherValues report to analyze the renovation budget alongside the AIV and ARV. That report raised a construction fraud warning, identifying several line items that were priced significantly higher than market expectations. Based on local benchmarks, the report estimated the renovation should cost between $55,000 to $65,000, making the submitted $170,000 budget more than three times higher than the reasonable cost.

The warning helped the lender to catch the issue early and avoid a material financial loss.

The real estate field is not always friendly. Some actors in the space try to push into the gray areas or worse. At the end of the day, lenders must protect themselves.

To reduce risk and strengthen your defenses:

Use a market-based approach for establishing AIV.

Ensure your ARV reflects both qualitative and quantitative budget analysis.

Evaluate budgets for both shortfalls and excessive overages.