Fed by Trust

Real estate investments are often managed by syndicators, who find and manage deals and gather investors to participate, in return for an acquisition fee (usually a set percentage of the money they bring in), as well as other financial incentives. Syndicators may enlist their buddies to help find investors by promising them commissions — either cash or a piece of the deal. Thus is born the “feeder” system, where people with relatively little knowledge of a deal’s details and risks are incentivized to bring in investors. This setup has always existed, but the recent proliferation of feeders in our community means there are a lot of biased brokers who are accorded real trust.

When these feeders turn to friends, relatives, or fellow shul-goers and offer them the opportunity to invest, there is an assumption that the deal is a reliable one. Instead of asking for second opinions and getting a professional assessment, potential investors often treat the feeders as above all doubt — when in fact they are biased, because their own commission depends on how many people they bring in. And that dynamic has turbo-charged the most recent real estate cycle.

The other game-changer is the prevalence of social media and WhatsApp. These forums changed the landscape of the field by enabling syndicators and feeders to quickly and efficiently build up hype about a deal and easily raise the requisite money.

Back in the old days, a deal had to be built investor by investor, relationship by relationship, meeting by meeting. If a syndicator wanted to raise 20 million dollars, he was in for a long and tedious process, and he had to nurture each contact individually.

The proliferation of so many digital forums, WhatsApp groups, and social media changed all that. It’s now viable to accept smaller sums from multiple investors without heavily investing in relationships or painstakingly building trust.

Fried shares an example: A syndicator seeking to close a deal enlisted a feeder, who told his neighbor about it, who shared it with his chavrusa, who then posted it on his family chat. He wrote something like, “There’s an amazing deal, but the minimum investment is 100K. How about we each give 20K?”

Instead of doing due diligence, some recent investors have grown accustomed to a form of social piggybacking. Many of these investors knew nothing about real estate, but decided to invest because their super successful neighbor “Reuven” had done so. Meanwhile, Reuven was in because he knew “real big leagues Shimon” was in on the deal. But Shimon was giving only because he was trying to help his brother-in-law, so he invested what to him was pocket change. How many people were actually scrutinizing the deal?

The feeders and the distance created by social media communication meant that too many people invested in deals they never corroborated; the further the chain strung away from the ones running the deal, the less knowledge there was. And that lack of knowledge set the stage for many naïve investors to put their trust — and their money — in the wrong hands.

We Lost It All

Trouble began brewing in 2022 with the increase in interest rates. At first, investors were still riding on the high winds of 2021. It took some time until things started falling apart. Several months ago, however, the flimsy structure began to tremble, and since then many investments have begun to sink or implode.

A well-known Lakewood askan who asked to be identified as David has witnessed the devastation up front.

“A young couple had been saving up for a medical procedure,” he says, describing one such case. “The funds were sitting in a bank account when someone approached them with an incredible investment opportunity that would bring in a substantial sum. They still had three months until the procedure, so they figured, Why not make some money in the meantime? Just recently, they learned that the money is gone. After waiting two-and-a-half years, they had to cancel the procedure. It was devastating.”

The repercussions are not just financial, David says. “In another case I dealt with, the husband invested money — he thought he was the greatest guy because he would make money quickly. But then he lost everything and his life fell apart. When the wife found out, it caused immense stress in the home. I’ve seen this destroy marriages.”

A Lakewood yungerman experienced this painful pattern before his marriage had even found its footing.

“During my engagement two years ago, I received a substantial yerushah from a wealthy uncle,” he says. “It was heaven-sent because my wife and I both came from chinuch families, and this was our only hope of affording the down payment for a house in Lakewood. We decided together to put the money into a CD until we were ready to buy a house.”

Then, during sheva brachos, they were approached by the kallah’s business-savvy relative who had heard about the yerushah. “He convinced me that I was mamash stupid and immature to let the money just sit. He then presented me with an elite investment opportunity that would give us 10 to 15 percent yearly returns. As a favor, he would help me get in on it.

“I’m cautious by nature, and I was hesitant,” the yungerman confesses, “but I didn’t want to look stupid in front of my kallah’s family, and I surely didn’t want to lose out on a once–in-a-lifetime opportunity. There was also a time pressure. With only 24 hours to decide, we had no time to discuss the deal with daas Torah or a financial adviser. My wife trusted her brand-new chassan and encouraged me to go ahead.

“Between our third and fourth sheva brachos we signed away our entire yerushah and chasunah money.”

At first the investment seemed like an incredibly wise decision: the checks came in with high interest, a boon to their kollel lifestyle. But then the checks stopped coming.

“At first there were excuses, and then more and more excuses,” he remembers. “It took some time until the truth came out: Our money was gone, and there was nothing to do. The day I found out, I literally couldn’t get out of bed. I was devastated. The worst part is the guilt I feel about my bad decision and the resentment I feel toward the family member who steered us wrong. It’s been a very difficult hurdle and a real blow to our new and fragile marriage.”

Four Lanes of Loss

Joseph Kahn, a third-party realty advisor, says that in the case of crumbling investments, every single story is “completely different,” and it’s important to differentiate them. That said, he’s found that incidents of investments gone bad usually fall into one of four categories.

The first is outright fraud, such as a Ponzi scheme, where a schemer intentionally sets out to trick people without even making an attempt to invest the money properly. “In that case,” says Fried, “he’s clearly a gangster. Ponzi schemes often look amazing until they bust, which can make them difficult to detect.”

Kahn points out that these schemes are rare. For the most part, people start off with what they believe are legitimate deals. When things go awry, there is immense temptation to commit fraud. This leads to category two: fraud due to pressure. It’s hard to comprehend the intense pressure experienced by the guy with a great reputation who is facing a deal that’s about to crumble and ruin his reputation.

Eli Fried, investment advisor, shares an example of this phenomena. “There’s a guy working on several deals at once. Deal A is struggling. So without asking permission from the investors of Deal B, he takes money from Deal B to save Deal A. He may have good intentions, promising to pay back two or three times what he took and make everyone happy.

“But those good intentions lead him to play mind games. He tells himself, ‘Deal A is really a good deal. All I need is a million dollars to bridge everyone over. I don’t have a million dollars, though, and I don’t want to go back and ask for more money — because I can’t publicly admit that there’s trouble. If I let Deal A go down, people will get scared and everyone from Deal B, Deal C, and Deal D will pull out all of their money, everything will crumble, and everyone will lose!’ ”

So he takes the money from Deal B without permission, trying to prop up Deal A. And by so doing, he crosses a line, becoming a fraudster.

“It doesn’t matter what his intentions are,” stresses Fried. “Fraud is fraud. It’s stealing, it’s illegal, and it’s against halachah.”

The third category is recklessness, which often boils down to sloppy bookkeeping and negligence due to growth that the investor can’t keep up with.

Kahn found this to be a common issue after Covid. “Post-Covid, people did very well because of the low interest rate and cap rate depreciation. The money came flying in and all of a sudden a guy without much prior experience owned 75 properties around the country. But the growth happened so quickly that he couldn’t manage them properly, he never grew into the management responsibly, so he began playing games, and things spiraled out of control.”

And once that pattern takes hold, he cautions, it’s very hard to take back the reins. “When properties are mismanaged without a solid infrastructure, nothing works,” he says.

“Sloppy bookkeeping is a serious problem,” Fried agrees. He shares an example: A developer promised his investors that he would put 10 percent of his own money into a deal. That was very important to the investors, because they wanted him to have skin in the game. But the developer had so many deals coming and going, with money flying in and out of multiple doors, that he never got around to investing his own funds in the deal — yet he was taking profits anyway.

“Some real estate investors have a real eye for details, but there are many who are go-getters, big-picture guys with no patience for the nitty-gritty,” Fried explains. “When their business grows quickly, they often lack the proper infrastructure to maintain their back office. Without good bookkeeping, one will almost inevitably come to steal, if inadvertently. And the bookkeeping for many investment structures is not so simple — it takes highly specialized accounting skills. A regular bookkeeper can’t handle the fair distribution of a complex investment waterfall.

“Another example: Consider the overhead of thousands of dollars in travel expenses to oversee properties. Is that included in the management fee, or is it an expense to be taken out of the pot? Everything can be sliced and diced differently. Or take another question: When there is profit, does the principle get returned first? There are many ways to structure a deal.”

Pressure, sloppiness, and negligence may be unintended weaknesses of the business, but they can never be an excuse for losing other people’s money. “Killing someone even without intention is very serious,” Fried says. “If you drive recklessly and hurt someone, that is an offense you go to jail for. Being reckless with other people’s money is a serious crime.”

The fourth category is a simple deal gone bad, with no fraud attached. “There is nothing wrong with doing occasional bad deals — there’s no one out there with a perfect track record, unless he’s Bernie Madoff,” says Kahn.

“Here’s an example of a legitimate deal gone bad,” Kahn continues. “A client bought a property where Class A people lived. They were paying $2,500 a month in rent. Within one week, two different people were killed in domestic disputes on the property. This was a total fluke, and it wasn’t the client’s fault, but now he can’t get insurance and the whole deal may go into default.

“Another case of a legitimate deal gone bad would be anyone who bought Manhattan real estate in 2019, before the change in rent laws. There’s a good chance they are losing money — but they weren’t sloppy, irresponsible, or devious in any way.”

Another example of this category are real estate investors who suffered significantly from the Covid-19 eviction moratorium, which forbade landlords from evicting tenants who couldn’t pay rent. For the duration of the moratorium, it wasn’t uncommon for the courts to allow tenants to live rent-free for years. (One woman whose tenants were withholding rent told me that her family would fervently say Tehillim on the day of these court hearings.) In some cases, the renters were trashing the homes, and the owners ultimately bribed the renters with tens of thousands of dollars to get them to leave. These bad deals cost landlords and investors significant damage — but the losses were completely unintentional and could not have been predicted.

While the four categories of investments gone bad involve different causes, Kahn notes a common thread. “The underlying problem in all of these cases is that too much money was thrown too quickly at too many people. We’ve recently seen people in the business for less than five or ten years raise a quarter billion dollars. And that is a very big problem. Money is being thrown around wildly without enough oversight.”

More Vulnerable

Fraudsters and scammers have been around forever, and the temptation to get rich quick is universal. But the frum community has several characteristics that leave its members more susceptible to scams.

The first is the overlap of vastly different socioeconomic levels. While general society usually segregates according to economic levels, frum communities include many different spending brackets who are united by religious standards.

“We have billionaires and paupers living together,” says Fried. “They daven alongside each other and send their children to the same schools. So those with lesser means develop hasagos, because when the people around us make a lot of money quickly, we see it’s doable and we want in.”

David, the community askan, adds another point. “In our fast-paced world, the younger generation has this tremendous drive to become rich quickly. As wealth in Klal Yisrael has increased, so has that drive, most notably in the ‘in-town’ cities. Today’s societal pressure is higher than it ever was. The generational demands and the available luxuries are blinding, even for smart people. Maybe one out of 100 are blessed with money quickly, but your typical young couple may not realize that it’s not the norm. They see it, and they want it too.”

Due to its tight networks and assumed trust, the frum community is also vulnerable to affinity fraud, in which communal or friendship networks are abused by a schemer looking for money.

“We live in a much tighter network,” says Fried. “You can only scam people if they trust you. This type of fraud happens almost exclusively among tight-knit communities.”

And since real estate is a very common profession in the frum community, opportunities abound. A typical non-Jewish real estate developer from Kansas City likely has a limited social network. In contrast, the frum developer will have mechutanim, shul mates, neighbors, brothers-in-law, and friends, all of whom can be tapped for the next hot deal.

“In frum communities, we have a high level of trust,” says Fried. “We offer rides to complete strangers. We regularly host strangers in our homes without thinking twice. This generally works well. But it’s different when it comes to money. After recent fallouts people asked me, ‘I don’t understand how this guy got caught in fraud! He was such a decent person!’ And I tell them, yes, he may be a wonderful person in general, but when it comes to big money, the temptation is just too great.”

Kahn describes what he calls “the Hatzalah effect.” “The same way you trust the Hatzalah guy to save your life at three a.m., you assume that you can trust him with your money. And he may be the biggest tzaddik in the world — but when it comes to money, you can’t blindly trust anyone. Even if you take the best, most honest person, if you increase the pressure and raise the stakes high enough, it’s impossible to know how he will react. Money can make good people do bad things. That’s why it’s essential to take the proper precautions before any deal.”

“This can be compared to hilchos yichud,” adds Fried. “Human nature is powerful enough that Chazal set boundaries in place to take specific risks off the table. We’re not making any blanket accusations of impropriety, but there are halachos in place, and certain things just can’t happen because of yichud. Non-Jews are often taken aback by these boundaries. They may ask why we suspect two healthy people of doing something wrong — they say it’s demeaning and insulting. But it’s not demeaning, it’s realistic. It’s not that we don’t trust, it’s just the rule. We should have some sort of yichud system for money too, because people are so tempted by it.”

Verify, then Trust

In his commentary on Mesilas Yesharim, the mashgiach Rav Don Segal quotes a story about Rav Yisrael Salanter, who was once in a room with a large sum of money. He learned that the owner had left the money there because he didn’t want to take it with him on his trip, but Rav Yisrael Salanter immediately ran after him and pressed him to take it with him.

He later explained that Chazal instituted the prohibition of yichud as a safeguard against immorality. And Chazal say that many more fall to gezel than to immorality. If Chazal instituted the laws of yichud for a less common transgression, how much more so do we need to set boundaries around other people’s money!

On a practical note, says Fried, systems should be put in place to safeguard investments. This includes good contracts, third-party review and audit, and most importantly, a system of checks and balances.

“A trustworthy guy with a valid operation may still not have proper checks and balances,” Kahn points out. “If there is a real back office with a CFO and an accounting team, it may not be perfect, but at least you know that there are multiple people involved and some level of accountability.”

David, who has witnessed the fallout of too many deals, is passionate about this point.

“The era of the strong handshake — with its assumed trust — is unfortunately over. People should ask questions before going into a deal. They should take the time and effort to research the specifics, rather than relying on the middleman or the syndicator. We have to take away the shame of asking; it should become the norm. We should demand normal reporting across the board. We need transparency upfront, right from the start — not just when things are going awry.

“In general, men don’t like to ask directions,” he notes. “They feel like there is something taboo about asking too many questions, that if they ask for details, they won’t look sophisticated, and they may not be allowed into the deal.

“But if a person doesn’t want to take your money because you ask too many questions, then you don’t want to go into that deal,” he stresses. “It’s not a lost opportunity, but a gained opportunity. We’re not ashamed to ask for extensive information when we look into shidduchim, because we want what is best for our children’s wellbeing. It should be the same thing with our family’s finances.

“I once asked someone why he jumped into a deal and he said to me, ‘If you saw the way the guy davens Shemoneh Esreh, you would trust him too!’ I responded to him in jest, ‘When the guy gets up to Velamalshinim, see how much kavanah he has.’ “You can’t make investments based on the way a guy davens; that doesn’t define the deal. It’s not about if he’s a talmid chacham and an erliche guy — of course you want to invest with good people — but you have to learn what the deal is.

“After a recent fallout that hurt many people, someone commented to me, ‘I just can’t believe it! The guy who runs the portfolio learns three sedorim a day!’ I said to him, ‘Of course I’m machshiv learning, but with all due respect, you said the guy learns all day. How exactly is he watching over your investment?’

“The common denominator in the deals that have gone bad is that people were investing based on trust and they felt it was taboo to ask, either because they wouldn’t look good or because it would show a lack of trust. But that has to change — we have to put the expectation in place that investors will buckle down with more transparency.”

Beware the Red Flags

So how can one distinguish a high-risk but potentially high-opportunity deal from a fraudulent one?

“Once you move away from vanilla — the regular pareve, stable investments — you will be accruing some level of risk,” says Fried. “Anyone can fall into a bad deal. However, there are red flags to watch out for and ways to minimize the risk [see sidebar].”

Mr. Harry Pascal of Monsey, New York, an economics professor in several New Jersey colleges with a background in business and investment banking, was once approached by a friend who asked for his opinion on a deal. “I told my friend that I would review it within the next few days, but he responded that he was under crazy pressure because there were only a few slots left in the deal and he had 24 hours to decide if he was in. The first thing I said was, ‘If you have to give an answer within 24 hours, the answer should be no.’”

But the fellow persisted, claiming this was an incredible opportunity. After careful review, Mr. Pascal found several problems. “Firstly, some of the promoters of the deal had previous violations with the Security Exchange Commission,” he says. “The next thing I found was a conflict of interest. Part of the deal included a lawyer’s opinion about its validity, but it turned out that the lawyer giving his opinion was related to the promoters of the deal. That was a bad sign.

“I then examined the numbers carefully. We were dealing with people who had past violations and they were presenting the deal in a way that was so twisted and complicated, an ordinary person couldn’t spot its weaknesses. You had to be an expert in financial analysis to go through the numbers. On the surface it looked like the deal promised high returns, but after analyzing the numbers, I found that the chance that the investors would come away with a profit was very small and the risk was very large. It took much convincing, but thankfully I talked my friend out of the deal. Ultimately, he was very grateful.”

Just recently, several people approached Joseph Kahn and shared that they had desperately wanted to get in on a certain real estate deal, but when they began asking too many questions, the investors just stopped talking to them — which saved their life-savings from bad deals.

“In retrospect, it’s better to miss out on a deal than to lose money,” Kahn says.

The recent string of deals gone bad has repercussions beyond the investors involved in those immediate stories; the entire field is rocked as a result. One real estate investor with a two decades-long, squeaky-clean reputation admitted that he is currently struggling to raise capital due to the recent losses by many investors in the field.

“To some extent this overall speculation has caused some self-correction,” says Fried. “People are now asking more questions and insisting on more accountability. The problem is that people forget quickly and within a few years, we can go right back into a similar cycle of no accountability.”

“I believe the best opportunity in real estate was not two years ago — it’s actually coming up now,” adds Kahn. “But people will miss out because of a lack of general trust. The recent stories should not stop you from investing in real estate. But they should serve as a warning to do proper diligence, get reports, and insist on real accountability.”

Minimize Your Risk

The returns seem high — but so do the risks. Should you invest in a hot deal or keep your cash in the bank? Joseph Kahn, Eli Fried, and David share important points to consider when analyzing a potential deal.

Fear of Heights. Is the return being promised unusually high? If something is too good to be true, it doesn’t mean no. Just be very careful.

The Limits of Trust. Trusting the partner is very important, but trust alone is not enough. There is an entire industry of middlemen (or feeders) raising equity for syndicators. This means that often the guy raising the money barely knows where it’s going. It is important to understand the actual deal. In many of the cases that went bad, feeders are left feeling terrible for unwittingly misguiding family and friends — and they lost money in the same deal as well.

Do You Understand? It’s important to do due diligence and ask questions. Many people jump into deals because their friends invested with a syndicator and made a lot of money. What happened in the past, however, is no indication or proof for the future.

Due Diligence. The importance of due diligence cannot be stressed enough. Remember that if you don’t do your due diligence, you can’t be shocked when things crumble. You should have an independent third party review the fine print beforehand to make sure the deal is legitimate.

Ask for Advice. Make sure you use a quality advisor and don’t rely on unskilled or biased sources for information. You can hire someone to do the due diligence for you, or make a call to someone more knowledgeable in the industry. There are also many kind and helpful people in Klal Yisrael who can advise you, such as retired professionals who have time on their hands and are happy to help young guys starting out.

Checks and Balances. Look for an infrastructure with checks and balances. Is there a team behind the deal — or is it a guy in his basement that everyone’s trusting? Is there a CFO and accounting firm overseeing what’s going on? This makes it much harder for fraud to fester. (Keep in mind that some of the exclusive private deals don’t have that natural system of checks and balances built in. If you’re considering this type of deal, read the fine print carefully. It often allows the investment manager to do what he wants.)

Seek Transparency. Is there transparency? Some deals state that investors can demand an audit of the books but there’s a negative connotation to that. This is usually only done in hindsight, not foresight, and that’s a bad structure.

CPA Please. Is there an accountant on top of the books, and can you speak to him? That can provide good protection against detecting outright fraud.

Lose to Gain. By doing your due diligence, you may end up losing out on deals, because if you tell certain investors that you’ll want to audit their books every quarter, they may tell you to go jump in the lake! The inherent structure of “hot deals” (when there is a lot of money to be made) is that no one is opening their books and giving time for due diligence. Still, if you are unable to verify the deal, it is better to err on the side of caution and not take big risks.

Diversity Is Key. Even the best syndicators have admitted to regretting some of the deals that they did during the past two years. This is why diversification is key, and investors should never put all of their eggs in one syndicator or one deal. Some bad deals can’t be detected until they blow up. When Rav Moshe Feinstein heard that bnei Torah were financially wiped out (and this was in the 1970s), his response was, “How can that happen? It says in the Gemara that you have to diversify.”

(Originally featured in Mishpacha, Issue 965)