History is bound to repeat itself.
In 2010, just two years removed from the great mortgage market crash, Congress passed the Dodd-Frank Act. The legislation required lenders to get income documentation and verification from borrowers before approving a loan. It fundamentally altered how business was done in the single-family mortgage industry.
But what about the multi-family industry?
In short, multifamily was left relatively unchecked, and it still relies heavily on the honesty (or lack thereof) of borrowers and their mortgage brokers to provide legitimate income figures to lenders.
Suffice it to say, the lure of submitting fraudulent numbers is an enormous risk that should have been addressed decades ago. Nevertheless, most multi-family companies have no real safeguards in place – and now, perhaps predictably, the feds are uncovering some spectacular allegations of fraud.
In the middle of last year, Wall Street Journal reporters Cezary Podkul and Peter Grant reported on an investigation involving four individuals who allegedly conspired to obtain more than $167 million in fraudulent multi-family loans from giant lenders like Fannie Mae, Freddie Mac, Arbor Commercial Mortgage, and Berkadia Commercial Mortgage. The group is accused of faking much of the information that the lenders and government-sponsored enterprises count on when issuing or buying the mortgages.
The WSJ story is fascinating, and not in a good way. The alleged culprits are accused of using false rent rolls to suggest that properties had more occupied units and generated more income than they actually did. Leases were allegedly altered. The group is accused of hiding vacant units by planting blaring radios inside them, and by placing welcome mats and dirty shoes outside their doors. On at least one occasion, a person was hired to be a fake tenant.
How could such a fraud be perpetrated? Because lenders (even the biggest players in the industry) rely on borrower submitted data to ensure that properties earn enough to pay their loans, and they generally do not have the resources they need to examine every lease in detail. In addition, credit-rating firms that grade the securities for investors also generally don’t review loans for fraud.
For some unscrupulous borrowers, there are incentives to engineering these types of schemes. After all, artificially-enhanced income numbers equal larger loans for owners, which allows for rapid business expansion or cash-out. For property managers and leasing agents, better income and occupancy numbers equal increased compensation.
So, the question for lenders: How do I safeguard against this?
One way is to rely on the expertise of Saxony Partners.
Saxony is a data management and technology consulting firm, specializing in real estate and financial services. We can help you identify risks, improve business processes, and leverage technology to increase automation, efficiency and data transparency. By introducing the right technology stack to solve common business problems, Saxony can help eliminate the potential for both human error and fraud. We focus on collaborating with our clients to build practical solutions that provide streamlined usability and encourage user adoption.
Check out this recap of the WSJ report by HousingWire’s Jacob Gaffney.