A good deal is hard to find. A bad deal will find you. During the turmoil in the real estate market in 1990, property was at its lowest price in a decade. Real estate investors were looking for a good deal. An office building in downtown Pittsburgh, PA was for sale at a fair price.

A group of investors heard about this fantastic opportunity from their local Rabbi. The Rabbi informed this group that this office building was once the jewel of Pittsburgh. After years of mismanagement and fluctuations in the real estate market, the building was up for sale. Additionally, the loss of some major tenants affected its value. The building was on the market at ten times the rent roll.

The deal was presented to the investor’s group, which we will call “Pittsburgh Development Corp.” The building was offered as is. A presentation of the outstanding leases was included in the deal. The building was solid and structurally sound. It had approximately a twenty percent vacancy rate, which was standard for that type of building at that time. The growth potential for the investment was in renovating the existing vacant space. This space could then be sold at market value. At the time, Pittsburgh’s market value was about $18.00 per square foot. There were also some small leases due to terminate soon. This would allow the investors to rent larger parcels of office space to more prestigious clients.

The building had two or three national corporations as tenants. This was a draw for the renting agent to bring in other good tenants. At closing, this was all presented to the investors. The average price was fifteen to sixteen dollars per square foot. On paper, it showed a gross income of approximately Two million Four Hundred Thousand Dollars. The only expenses that they could realize were a debt service to the building, maintenance, taxes, electricity, and other expenses. These expenses indicated a reasonable return on the investment.

The group invested approximately Eight Million Dollars and got a mortgage for Twelve Million Dollars. The deal went through without a hitch. As a result, Pittsburgh Development Corp. had itself a sixteen-story office building. The partners decided to keep the existing real estate agent. They proceeded to send out notices to all the tenants. The notices were about new management. They set up a computer-generated billing system. It printed bills according to leases in July 1990. In August 1990, they received half the anticipated rent. They were perplexed as to why they did not receive the full amount.

The partners contacted the managing agent and tenants individually. They asked them how much they were paying. Many of the tenants produced the same lease the partners had. However, their lease had a rider attached to it. The rider stated that if the tenant did any leasehold improvements, their rent would be reduced considerably. They could automatically take that deduction from their rent. In essence, someone paying $15 a foot was able to do improvements. Improvements included putting up a sheetrock wall, painting their office, and installing some carpeting. They were entitled to deduct $6 or $7 per square foot from their rent. However, the new owners did not know about this. The tenants were unaware that the new owners did not know. They maintained that they were paying legal rent as per their prior agreement.

It did not take long for the partners to realize that they have been had. As they were scurrying around the building, trying to straighten out the rent so they could pay their mortgage, they knew they had a big problem. They tried to renegotiate leases with the tenants, but to no avail. When they did renegotiate their leases with the major tenants, they were forced to give major concessions. This caused them to default on their mortgage and lose the building.

They started a multimillion-dollar lawsuit. During the investigation we discovered that there were many different types of side deals that were made with the tenants. One was sublet agreements which were not disclosed to the new buyers. There were many deals through the managing agent and the tenants that would be considered “sweetheart deals.”

This matter was brought to the district attorney’s office in Pittsburgh. They declined to prosecute, claiming that it was a business transaction. The buyers did not perform proper due diligence. Further investigation indicated that this group, headed by a Rabbi, perpetrated the same fraud in Queens, NY. Some of his real estate cronies were also involved. In Queens, they were caught by the buyers and forced to make some restitution. However, they did pull a scam on another group of buyers.

STEPS TO PREVENT THIS TYPE OF FRAUD

• Visually inspect the premises to determine if there are any leasehold improvements required.
• Interview tenants and read the leases that are outstanding to see if they conform to the offering.
• Conduct an in depth background investigation of the sellers to ascertain if they perpetrated ay prior fraud.
• Hire a real estate consultant in the city where the real estate is for sale. This helps to learn if this deal is sound.
• Perform a background search on the tenants themselves. This helps to see if they are creditworthy and if they would remain in the building once the deal was finalized.

Vincent Parco, private investigator, is a  Certified Fraud Examiner and Certified Forensic Examiner. He is also a member of the American Academy of Forensic Examiners. His professional experience includes terms as senior investigator with the Office of Professional Discipline and as senior investigator in charge of the Office of Professional Medical Conduct.