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, and 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, fluctuations in the real estate market and the loss of some major tenants, the building was up for sale at ten times the rent roll.
The deal was presented to the investor’s group which we will call “Pittsburgh Development Corp.,” to give the building as is and a presentation of the outstanding leases were included in the deal.
The building was solid, structurally sound, with 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 and selling it at market value which then in Pittsburgh was about $18.00 per square foot. There were also some small leases that were due to terminate in the near future and 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 which was a draw for the renting agent to bring in other good tenants. At the time of the closing, this was all presented to the investors at an average of 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 was a debt service to the building, maintenance, taxes, electricity and other expenses which indicated a reasonable return on the investment.
The group invested approximately Eight Million Dollars and were able to get a mortgage for Twelve Million Dollars. The deal went through without a hitch and Pittsburgh Development Corp. had itself a sixteen story office building. The partners decided to keep the existing real estate agent and proceeded to send out notices to all the tenants that there was new management. They set up a computer generated billing system which printed bills according to leases in July 1990. In August 1990 they received half the anticipated rent and were perplexed as to why they did not receive the full amount.
The partners contacted the managing agent and tenants individually, and asked them how much rent they were paying. Many of the tenants produced the same lease the partners had, except that their lease had a rider attached to it. The rider stated if the tenant did any leasehold improvements, their rent would be reduced considerably and that they could automatically take that deduction from their rent. In essence, someone paying $15 a foot, was able to put up a sheetrock wall, paint their office, install some carpeting and they were entitled to deduct $6 or $7 per square foot from their rent.
However, the new owners did not know about this, nor were the tenants aware 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 t the rent so they could pay their mortgage, they knew that they had a big problem. They tried to renegotiate leases with the tenants to no avail and when they did re-negotiate their leases with the major tenants they were forced to give major concessions which 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 and that the buyers did not do a proper due diligence. Further investigation indicated that this group headed by a Rabbi and some of his real estate cronies perpetrated the same fraud in Queens, NY, but were caught by the buyers and were 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 any prior fraud.
- Hire a real estate consultant in the city in which the real estate is for his sale, to learn if this deal is sound.
- Perform a background search on the tenants themselves to see if they are credit worthy and if they would remain in the building once the deal was finalized.
VINCENT PARCO, private investigator, was formerly a senior investigator with the New York State Office of Professional Discipline and senior investigator in charge of the Office of Professional Medical Conduct. He is a Certified Fraud Examiner and a member of the American Academy of Forensic Examiner.