Market pressures mean more fraudsters and more mistakes, but there are effective strategies to combat this growing trend.

In the complex world of commercial real estate, the threat of fraud looms large, impacting stakeholders at every level – from investors and developers to lenders and attorneys. The scale of fraud in real estate transactions is both alarming and costly.

Real estate fraud: part of a broader trend

According to the Federal Bureau of Investigation (FBI), in 2022 alone, real estate-related fraud, which appears to have peaked, led to losses of over $350 million, with wire fraud constituting a significant portion of these losses. In 2023, FBI Cybercrimes Report details real estate-related cyber-crime was down slightly, but it still accounted for approximately $145 million in losses.

This is part of a broader trend: The FBI’s Internet Crime Complaint Center (IC3), the FBI’s cybercrime reporting and investigative task force, has noted a steady increase in real estate fraud complaints during the past decade, emphasizing the critical need for robust preventative measures.

Common types of fraud

The perpetrators of these frauds are often sophisticated criminals who leverage advanced technology to exploit vulnerabilities within the real estate transaction process. Wire fraud, in particular, has seen a sharp rise, with cybercriminals intercepting and redirecting funds during the closing process through carefully orchestrated phishing attacks. The National Association of Realtors (NAR) reports that in 2021, nearly 13,638 people fell victim to wire fraud in real estate transactions, with losses exceeding $213 million.

Other common schemes include:

• Property-flipping schemes in which properties are bought and sold at inflated prices within a short period, often involving collusion between appraisers, mortgage brokers, and buyers.
• Entity document fraud, in which fake or altered documents are used to misrepresent the ownership or financial status of a property.
• Identity fraud, in which a perpetrator assumes another person’s identity to conduct transactions.
• Equity-stripping schemes, in which fraudsters gradually deplete the equity in a property, further complicating the landscape.

Additional types of fraud highlighted by the 2023 FBI Cybercrimes report details a real estate fraud scheme in Connecticut in March 2023 that IC3 received: ìThe individual was in the process of purchasing a home and received a spoofed email from their supposed attorney instructing them to wire $426,000 to a financial institution to finalize the closing. Two days after the wire was initiated, it was realized the instructions came from a spoofed email. Upon notification, the IC3 RAT immediately initiated the FFKC process to freeze the fraudulent recipient financial bank account. Collaboration with the domestic recipient financial institution and the local police department confirmed $425,000 was frozen and returned to the individual which enabled them to complete the real estate transaction.î

This type of fraud, classified as business email compromise (BEC) scams, is the second most devastating type of cybercrime, resulting in losses totaling $2.9 billion. These attacks involve the compromise of vendor accounts, unauthorized requests for sensitive information such as W-2 forms, and real estate frauds, highlighting the urgent need for strict email security protocols and employee awareness training.

The FBI ranked the top 10 states by losses in 2023. Figure 1 shows the top 10 states for cybercrime loss by dollar figure.

Protecting real estate transactions from fraud

One of the most effective strategies in mitigating these risks is using attorneys specializing in private lending and commercial real estate transactions. These legal professionals are not title companies that are merely facilitators and settlement agents. The attorneys serve as critical safeguards against fraud. Closing attorneys play a pivotal role in ensuring the legitimacy of the transaction and documents submitted, securely managing the transfer of funds and scrutinizing the actions of the title company. By meticulously reviewing entity documents, conducting thorough due diligence, and overseeing the disbursement of funds, closing attorneys serve as a formidable barrier against fraudulent activities.

Larry Andelsman, CEO and managing partner of Andelsman Law, a New York-based law firm focused on private lending and commercial real estate with more than 30 years’ experience in the industry, discussed how closing attorneys protect their clients against fraud and offered best practice advice for the private lending community.

Andelsman noted that market conditions such as reduced credit liquidity, tighter credit parameters, and rising interest rates can increase the risk of fraud. In times of economic constraint, individuals and businesses may feel pressured to engage in deceptive practices to secure funding or alleviate financial stress.

“Simply stated,” Andelsman said, “when there are fewer deals in the market, brokers and fraudsters become more aggressive in their tactics to get their deals closed. Consequently, private lenders often feel pressure from the brokers that feed their pipeline to push the deal through and close fast. Closing attorneys act as an additional, well-trained ally that can assist lenders, capital providers, borrowers, and brokers in preventing many common fraud schemes.”

As a result of increased and perpetually evolving deceptive practices, every transaction must be highly scrutinized. Real estate closing attorneys must proactively adjust their fraud detection policies to address these heightened risks, said Andelsman. “Conscientious attorneys continually review their due diligences processes to increase vigilance in transaction monitoring and refine their legal strategies to adapt to shifting environments. By staying ahead of evolving fraud schemes, firms are better equipped to protect client interests and financial security.”

Andelsman said that in private lending, after wire fraud, the most common type of fraud his firm encounters involve fraudulent property flips and wholesale deals with inflated prices. “These are often supported by falsified documentation and accompanied by disbursements to parties benefiting from the scheme. Good closing attorney firms readily identify red flags and scrutinize all documents and parties to a transaction, usually seeing what others do not see.”

He pointed out that most title companies and their employees have little training and experience in this area; their role is to check that documents have been signed correctly and that the numbers add up. Moreover, he explained, in some cases, the title companies are not actually title companies and are part of the fraud that is being perpetrated (for an example of this, see “A First-Hand Account of Our New Fraud Reality” published in Private Lender’s Summer 2024 issue). “As legal representative for the lender,” he said, “we scrutinize all parts of the transactions, including the acts of the title agents.”

Using technology to prevent fraud

Technology plays a crucial role in fraud prevention within the commercial real estate sector. Advanced encryption, AI technology, and secure communication platforms are increasingly being employed to protect sensitive information and ensure the integrity of transactions. For example, blockchain technology offers a transparent and immutable ledger that can significantly reduce the risk of document fraud by providing a verifiable record of ownership and transaction history. Blockchain technology exists in many of the loan operating systems, appraisal AMC platforms, and bank verification platforms such as Plaid.

A Glimmer of Hope

The 2023 cybercrimes report offers a glimmer of hope: 2022 appears to have been the peak of fraudulent activity. Figure 2 shows a comparison of the past three years, reflecting reductions in 2023 of identity theft, real-estate-related cybercrimes, malware, and phishing/spoofing schemes.

Despite these advancements, the commercial real estate industry remains a prime target for fraudsters due to the large sums of money involved and the complexity of transactions. Preventing fraud in commercial real estate requires a multifaceted approach that combines legal oversight, technological innovation, and industry best practices. Education and awareness are key components in this battle, with all parties involved needing to stay informed about the latest trends in fraud and the best strategies to combat them. Collaboration among industry professionals, including real estate agents, attorneys, lenders, and title companies, is essential to create a unified front against these pervasive threats.

As the commercial real estate industry continues to evolve, so must the methods for preventing fraud. By embracing technology, leveraging the expertise of real estate closing attorneys, and fostering a culture of vigilance and transparency, the industry can better protect itself from the costly consequences of fraud. The stakes are high, but with the right tools and knowledge, commercial real estate professionals can safeguard their transactions and maintain the integrity of their investments.