How Money Launderers Exploit Private Real Estate Investors

From left: Senator Chuck Grassley, Global Financial Integrity’s Lakshmi Kumar, Senator Sheldon Whitehouse, and Eagle’s Brook apartments outside Atlanta

In early March, Lakshmi Kumar got a chance to tell Sens. Chuck Grassley and Sheldon Whitehouse that crooks across the globe were taking the U.S. to the cleaners. She didn’t miss it.

Kumar, the policy director at watchdog group Global Financial Integrity, told the powerful lawmakers that Congress had failed to close the loopholes routinely used by international criminals to convert ill-gotten gains into American real estate.

Testifying before the Senate Caucus on International Narcotics Control, she laid out in striking detail how American property has become a thoroughfare for traffickers, terrorists and kleptocrats to rinse tainted money through the U.S. financial system.

Grassley and Whitehouse have for years led an earnest but sputtering crusade against money laundering. Yet regulators still lack the information and the authority to cut through the webs of shell companies and trusts that hide illicitly obtained assets, Kumar explained.

Right now, it’s like you’re blindfolded in a dark room trying to find a grain of rice,” Kumar told The Real Deal.

In the wake of calls to punish Russian oligarchs, a spotlight has been thrust on the difficulty of identifying property purchased with illicit funds. But those ghost apartments are just the tip of the iceberg.

No one knows that better than Kumar, whose report “Acres of Money Laundering” details how real estate serves as a conduit for dirty money. One of the bigger, and least scrutinized, vulnerabilities in the system is private investment.

It’s hard to overstate the recent growth of private equity, hedge funds, alternative lenders and other private capital in real estate. They have exploded in popularity since the Great Recession, writing bigger checks and raising massive funds overseas with minimal government oversight. They are buying up homes across the country and have raised so much cash so fast that one bought a New York City skydeck — not the building, just the deck — for half a billion dollars.

While institutional banks need to undergo standard anti-money laundering procedures, these private lenders face essentially none of those requirements. That has allowed cartels and oligarchs to clean their money by investing in everything from humble multifamily projects in the Southeast to high-rises in Cleveland. The true scope of their real estate purchases is likely vastly larger than what has been identified.

The Financial Action Task Force, an intergovernmental organization of G7 nations, has called the free pass for investment advisers one of the “most significant” gaps in America’s efforts to stop money laundering.

The government once came tantalizingly close to addressing the problem. In 2015, the Financial Crimes Enforcement Network proposed a new rule that would have forced investment advisers to comply with anti-money laundering programs and report suspicious transactions. As the division of the Treasury Department tasked with combating money laundering, FinCEN called for suggestions on how to implement such sweeping new requirements.

Investment advisers are on the front lines of a multi-trillion-dollar sector of our financial system,” said FinCEN Director Jennifer Shasky Calvery in the announcement. “If a client is trying to move or stash dirty money, we need investment advisers to be vigilant in protecting the integrity of their sector.”

Not surprisingly, the industry was not keen on ratting out its clients. In the face of pushback and insufficient data to support the proposal, it soon disappeared into the bureaucratic ether. But even before Russia’s invasion of Ukraine put oligarchs under the microscope, winds blowing in Washington indicated the proposal was still alive.

In December, President Joe Biden released the White House’s “Strategy on Countering Corruption.” It called on the Treasury to re-examine the 2015 rule and consider adding “minimum reporting standards” for investment advisers and equity funds.

Stopping money laundering, particularly in real estate, is the rare issue that bridges the partisan divide. In October, three Democrats and three Republicans in the House of Representatives introduced a bill to require investment advisers like those at private equity and hedge funds to report suspicious activity to FinCEN and establish anti-money laundering compliance programs. Whitehouse plans to introduce a Senate version.

Even if the government acts, there are still major questions about how implementation would work, and whether the world can ever regulate money laundering out of real estate.

Investing in one of these funds is not the quickest or simplest way to get money into the American financial system, but it’s one of the hardest to stop, according to Kumar.

If I’m a kleptocrat buying a house somewhere in the D.C. area, it’s just me buying the house,” she said. “When you’re investing in private equity and large portfolios, you can own 2 percent of the property through the structure, and you’d still make millions.”

Pesos in Georgia

Eagle’s Brooke is a nondescript, mid-rise multifamily development just outside Atlanta. The 248 modest, blue-shingled apartments are the kind of rentals that alternative investors have targeted as young families relocate to Sun Belt it-cities but are not ready or able to buy. In 2018, Florida-based real estate investor Sefira Capital and Coastal Ridge Real Estate bought Eagle’s Brooke for $34 million.

One problem: The feds were watching. They didn’t like what they saw.

Throughout 2018 and into early 2019, Sefira received millions of dollars from investors who were actually laundering drug money through the Black Market Peso Exchange. 

The exchange has helped criminals pass huge sums of money between Latin America and the United States, but consider the following example: a Mexican cartel that sells drugs for U.S. dollars wants to convert them into pesos for use at home. Meanwhile, a corrupt Mexican official wants to turn his bribes, paid in pesos, into dollars. Both groups want to keep their financial alchemy under the radar of regulators. Enter money-laundering brokers. 

A broker buys the drug dollars with the government official’s pesos and deposits the greenbacks into shell bank accounts controlled by the official. Voila: Clean cash for everyone, in their preferred currencies.

From there, the money could go in a number of directions. Private real estate investors provide a relatively opaque, easy-to-enter repository. As prosecutors laid out in their case against Sefira, a laundering broker directed drug money into several investments in multifamily apartments.

In at least four cases, high-ranking Mexican officials accused of corruption, embezzlement and unexplained wealth acquired real estate worth millions of dollars in the U.S.,” Kumar’s report noted.

In 2018, as part of an investigation into international money laundering, the Drug Enforcement Administration infiltrated the Eagle’s Brooke transaction and transferred millions of dollars at the direction of exchange brokers into Sefira multifamily funds. That money blended in with the $100 million Sefira raised between 2016 and 2019 and helped the firm purchase real estate, including Eagle’s Brooke, across the Southeast.

As a private real estate investor, Sefira had no obligation to ask where the DEA-injected funds came from. But any real property involved in a money-laundering transaction is subject to civil forfeiture, and Sefira found itself in a bind. It ended up paying $6.5 million in a settlement with the Department of Justice and promising to conduct due diligence on future investors.

The Corporate Transparency Act aims to mandate such disclosure. It would require small LLCs, like the special-purpose investment vehicles Sefira created for each building it invested in, to report the names and personal information of all their “beneficial owners” to the Treasury Department. 

But under the act, companies would only need to report information about people who own or control at least 25 percent of the LLC. Given the size of commercial transactions, shady characters could pour millions of dollars into major commercial deals without reaching that threshold.

Commercial real estate poses a particular problem for officials trying to catch launderers. Identifying beneficial ownership is relatively easy in residential transactions but “tends to break down in the commercial realm, because you have all sorts of sources of funding flying around,” said Peter Hardy, an anti-money laundering expert and attorney at Ballard Spahr.

While many of the biggest financing deals in commercial real estate still involve institutional banks, private lenders’ footprint has grown. Last year, real estate debt funds alone raised $32.5 billion, up from $13.7 billion a decade before, according to research firm Preqin.

Real estate’s burden

Industry experts agree that money laundering is a problem in real estate, but argue that implementing anti-money-laundering, or AML, requirements for investment advisers, real estate agents and lawyers would create a lot of burden with scant benefit.

Our view is that very little if anything would be added by imposing AML requirements on investment advisers,” said Gail Bernstein of the Investment Adviser Association. “It sounds very easy: Why don’t you just add this one thing? But each thing that gets added takes up a lot of staff time and monitoring time.”

Processes like suspicious activity reporting, beneficial ownership research and identity verification can be a huge time suck and resources drain for a company. The Government Accountability Office found that up to 2 percent of banks’ operating expenses come from AML compliance. Verifying customers’ identities and reporting suspicious activity made up more than half of that.

In another survey, the American Land Trust Association asked its members about geographic targeting orders, which require title insurance companies to complete AML checks in all-cash deals in counties deemed laundering hotspots. Insurers estimated that compliance runs $45 per transaction.

The amount of money laundered through real estate is unknown, but Kumar’s report estimates at least $2.3 billion in the past five years.

In a vacuum, that’s a qualitatively large number,” said Hardy, “but the industry as a whole handles multiple trillions of dollars a year.”

Some say the problem isn’t big enough to warrant the kind of sweeping regulations making their way through Washington and state capitals. 

The question is whether the benefit outweighs the burden it would impose on the industry,” said Neil Simon, who leads lobbying for the Investment Adviser Association.

The answer is no, according to the association, which also notes that investment advisers make decisions about money but don’t actually hold it. Instead, the actual custodians, the depository institutions, are the ones who should face regulation, advisers argue.

Thinking that there is material risk at the adviser level for AML really misunderstands how advisers work,” said Bernstein.

Money launderers don’t need a team of crooks to help push their funds through the system’s checks and balances. With such a loosely regulated industry, as recent reports about Russian oligarchs investments in the United States show, they just need enough people willing to look the other way. 

Even unintentionally, a real estate fund can become a vehicle for illegally obtained money, especially if it is large, draws investors from around the world and uses “feeder funds” that namelessly compile cash, including from tax havens such as the Cayman Islands.

The Treasury Department’s ultimate definition of a financial institution could mean millions of dollars in compliance costs and untold hours of paperwork. It also figures to send launderers back to the drawing board in their endless quest to evade lawmakers trying to regulate them out of existence.

As we innovate policy, criminals innovate their operations,” said Kumar. 

After the first GTO was issued in 2017, all-cash purchases by shell companies fell by 70 percent, a University of Miami and Federal Reserve Bank of New York study found. But geographic targeting orders initially exempted wire transfers, so some operators began using them instead.

Kumar acknowledged that even with the new measures, regulators would still be searching for grains of rice among billions of dollars in real estate deals. “The hope now,” she said, “is at least you have the lights turned on.”

https://therealdeal.com/2022/04/05/wash-rinse-repeat-how-money-launderers-exploit-real-estate/

Christin Hakim

Next Post

Big Ten women’s basketball scenarios: Michigan’s path to a title

Sun Apr 17 , 2022
Thursday should be one of the most exciting nights in Michigan women’s basketball history. Consider this trifecta: The Wolverines host their rival…while honoring a record-setting senior class…with a shot to get within one victory of a Big Ten title. Yeah, a lot is happening at Crisler Center as Michigan hosts […]