Ponzi Schemes, Property Fraud, and How to NOT Fall for a Real Estate Scam

Dave:
What’s going on, everyone? Welcome to On The Market. I’m your host, Dave Meyer, and we have a really cool two-part show for you today. We came up with the idea for this show unfortunately because two of the panelists and our friends on the show, James and Jamil, have gone through some unfortunate situations recently where they were victims of scams basically. We thought it would be a great opportunity to talk about these two unfortunate situations and learn what we can from them. Hopefully, in that process, we can help all of you who are listening to this avoid working with some of the bad operators that are unfortunately present in pretty much every industry. Unfortunately, real estate is no different.
The way this show’s going to work is we’re going to start by talking about different types of operators in the real estate investing space and how to best vet them. Each one of the panelists is going to talk about one of their expertise and how they vet an operator that they work with frequently. Kathy’s going to talk about vetting syndications, Henry’s going to talk about vetting contractors, James is going to talk about vetting lenders, and Jamil is going to talk about vetting wholesalers when you work with wholesalers. So, there’s tons of great information, really practical, actionable tips that each of them provide.
And then in the second part of the show, we’re going to hear from James and Jamil who are both going to share a lot of details about the scams that they were unfortunately party to and involved in. It sucks. Really, there’s just no other way to say it. They both experienced some tough stuff, but I really admire and respect and am grateful for the fact that they’re willing to share their experiences with all of us, so that we can learn from some of the situations they found themselves in. So, stick around for this episode. It’s a long episode, but that’s because it’s packed with good information. So, you’re definitely going to want to stay to the end.
All right, welcome back everyone. We’re going to be talking about how to vet operators, and again, we’re going to talk about syndications, wholesalers, lenders, and contractors. Kathy, we’re going to start with you and talk about syndications. At least, I invest in syndications and I think the potential for not just necessarily scammers, but just incompetence in this space has been really widespread over the last couple of years. We would love to hear your advice on how you insulate yourself from bad actors or poor actors, how you advise the people in the real wealth network to do the same.

Kathy:
Well, the incompetency thing is what I would often fall for. The lessons I’m going to share today are learned from experience and they’re really hard lessons, and it’s really important to share because there have been scammers or incompetent people in real estate, not just over the last few years. It’s been for centuries. But the last few years is probably where it really accelerated because of the internet. In the last euphoric state, which was 2005, 2006, there weren’t some of these social media outlets where you could learn about things so quickly.
I think this time around, the information would get out faster. You would have internet stars overnight who suddenly were experts and people fall for people that they see in the media. The media now, it’s pretty easy to produce. You do it yourself. The things that I’ve learned, the big one is track record. Now, there’s two sides to this, but I would say when going into a syndication, you want to make sure that somebody in the leadership team, somebody in the general partnership that’s in charge of the investment has experience doing what they say they’re going to do or what the business plan says, that they have experience for not just a few deals and not just a few years.
It’s okay to do that. If you want to invest with someone who did one deal or no deal and you think the business plan looks good and you want to go for it, you just have to know that you’re at higher risk. Doesn’t mean don’t do it. Just know that if someone only has a few years experience, they just don’t have a lot of experience specifically in changing markets and changing economic cycles like we’re in right now. I see people saying, “Wow, if you can’t put your money in a bank, where can you put it?” I’m going, “Were you not around in 2008?” I mean, it wasn’t that long ago that we had bank failures.

Dave:
Literally today, we had bank failures.

Kathy:
Yeah. So, it’s like, “What do you mean?” No, that’s why the government only backs $250,000. That’s why I make my husband run around and put deposits in different banks. You shouldn’t have more than 250,000 in any one bank, because that’s all that’s insured. Well, I guess, that’s changing as of today where I think the government’s going to come bail it out, which is probably great for the depositors. Just track record, if you really want a conservative investment, make sure that they’ve been through a few cycles because then they’ll really know how to handle these different situations and they would know how to underwrite.
A lot of people were underwriting as if we were going to have low interest rates forever, and that was clearly a unique situation, a pandemic-led, low interest rate environment. That was going to change, and if you had a three or four-year deal, you’d better underwrite it with the possibility that interest rates would go up. People didn’t. I mean, that’s what Silicon Valley Bank did. I mean, they were buying bonds thinking that rates were going to always stay low. So, track record is a huge one, but people could put whatever they want on their bio in the PPM, the private placement memorandum, or the operating agreement. They can make a pretty nice looking bio.
What I ask for and what I provide, whenever I offer a syndication, is a resume. Show me everything you’ve done, show me how it went. What are the deals you’ve done? What were the returns? What was your role? It’s easy for me to say, “I’ve syndicated developments,” but do I really know how to develop? I don’t have that experience. My partners do, but could I go out and say that on a resume that I have development experience? Sure. So, make sure you find out how involved they were in that position. What was their role? Were they, I don’t know, the admin on that project, or were they really the lead? Again, get their resume and find their involvement in those positions.
The next I think is to find out the fee structure and their salaries, or in the syndication is somebody getting a salary or taking high fees? Because if the project goes on for a long time, then those salaries and those fees are going to eat up any profit that there might have been. The operators get paid, but you don’t. In fact, you could lose your money. I don’t like to be in deals where there’s salaries or high salaries. Obviously, people need to be paid, but ideally, a syndicator should be well healed. They should have deep pockets that they don’t need to take a salary. Fees, sure. There’s reasonable fees that keep the lights on, but that’s just again my personal opinion.
And then, skin in the game. A deal can go really well where the operator didn’t have their own money in it, but if they have a lot of their own money in it, that helps to know that they are well healed, that they do care. They want to see the investment go well, especially if their money’s on par with yours. If it’s an equity position that gets paid out when you get paid out, that can help. And then finally, it’s just scaling too fast. You can do one deal really well, and we’ve seen this over the years with property managers, with syndicators who maybe they did really well on one deal and then they had to grow and hire more people. They might be good at real estate, but maybe they don’t know business and they don’t know how to hire people. They don’t know how to scale.
But they’re just scaling too fast and then hiring the wrong people and the people they hire do a bad deal. I was just at the Best Ever Conference with, I won’t say who, but a big group that is scaling very quickly and they brought in somebody who just wasn’t as good at due diligence as they expected and they got a bad deal. Anyway, just scaling too fast makes me nervous, especially when people brag about it. “I’ve just got 10,000 doors in the last two years.” Well, Ken McElroy has 10,000 doors, but it took up 20 years. How do you scale like that, unless you’ve owned a business before? I can tell you personally as a business owner, I know my product, I know real estate, but I didn’t know how to hire and manage. That’s a whole nother skillset. Anyway, be aware of that.

Dave:
That’s excellent advice. I think the skill of identifying deals and even underwriting deals and managing them is a very different skillset, especially at the scale most syndications require, because it is more like traditional business operations than it is real estate. I also want to say just from personal experience, when I first started investing in syndication, I felt a little nervous to ask these types of questions. I don’t know if you’ve had that experience, Kathy, asking, “Are you taking a salary?” You’re questioning these people.
But I’ve found over the course of my career that syndicators, the good ones, like when you ask those types of questions. They want people who are going to dig into the numbers and who really understand it. They don’t want people who are just going to throw money and then are going to ask silly questions later. They want people who know what they’re getting themselves into. So, I really encourage people to have a serious conversation with anyone they’re going to invest with. Don’t be afraid. If someone is unwilling to answer those questions for you, that is an enormous red flag.

Kathy:
That’s a huge red flag. I mean, in my syndications, since day one, I didn’t know all the questions to ask because I was fairly new at it 14 years ago. I wouldn’t allow one-on-one conversations. I wanted everything to be in a webinar format or a Zoom format, where smart investors could ask questions that maybe another investor might not even have thought about. I would make it very public and then I’d post those webinars on the investor page, so that everybody could learn what are the questions I should be asking?
One person asked so many questions, I ended up hiring her. I’m like, “Man, you know so much about this.” People don’t have to ask questions because she addresses it right off the bat. She was the one in the audience. I was like, “Oh no, she’s going to ask questions I don’t know. I’m just going to bring her on my team.” Absolutely, I think more and more people are doing that where they’re doing webinar marketing and if you ask a question on that webinar and they don’t answer it, pay attention.

James:
That’s a red flag in itself. We raise capital and we pepper our potential investors with questions because as a investment business, we need people on the same page as us. We have minimum investments that we collect, and if you can’t hit that threshold, you can’t be in there. It’s just because we want a certain caliber investor with us. In case something goes wrong, you want the same like-minded people in the same foxhole as you. The syndicators that will grab any dollar amount from anybody, that’s a red flag because they need the money, whereas, we’re doing an investment because we want to do it as a collective group, not just to make money. We feel good about the deal. We have money in the deal. People like-minded have money in the deal. If someone didn’t ask me a bunch of questions as an investor, that would be a red flag immediately if I wasn’t putting money in a fund.

Dave:
That’s a great point. All right, well, thank you both. This has been super helpful. We should move on.
Henry, I miss you. I feel like I haven’t even heard from you all day. Let’s go and talk about contractors. Can you tell us about how you go about vetting contractors for your business?

Henry:
Absolutely, man. This is one of the topics that I don’t think get talked about enough with especially new real estate investors, because it’s such a key thing to need when you’re buying under market value deals. You’re buying them because there’s some level of distress. You’ve got to go add that value. But it’s one of the things that typically investors don’t learn until they absolutely have to. I have all the same horror stories as all other new investors. I’ve hired contractors that have run off with my money. I’ve hired contractors that wanted a big upfront fee to get started and then didn’t do what they said they were going to do. And so, I’ve learned a lot along my investment journey.
For me, one of the key things that I think new investors should be doing is I don’t think people review existing work enough. A lot of new investors get a contractor name from a real estate investment group. Somebody says, “Oh, you should work with so-and-so’s contracting. Go to Henry’s Contracting. They did my last deal.” And so, they call Henry’s Contracting. Henry’s Contracting comes out and gives them a bid, and then they’re like, “Hey, I like that bid.” And then, they start the work. They didn’t go look at any project that that company did or have any understanding of how they operate. What we like to do is, “Yes, I’ll take recommendations, but I want to go see work.”
So, I’ll ask for addresses of properties and I make sure I don’t schedule it. “I don’t want to meet you there. Just tell me where the addresses are of ongoing projects.” I want to pop in when I want to pop in. I want to do those unscheduled, unannounced visits, because then I can get a true sense for how they keep the job site, how their team works. Are the people there organized? Is the site clean? Are they respectful? How do they treat me when I get there? Because these are people that are going to be managing your expensive renovation. If you’re doing a 40, 50, 60, a hundred thousand dollar renovation, you want to make sure that they are respecting your property. You want to make sure that they’re doing what they say they’re going to do.
And so, some of the things I take note of are just that. Is the job site organized? Is it dirty and disgusting? Because that could be a sign that if they don’t keep the site organized, are they going to keep your money organized? Do they know what’s getting done, what’s not getting done? Do they know what materials are there or not there? So, I keep note of those things. Always try to go look at current jobs. Do not schedule it. Show up when you want to. If they don’t like that, if they seem put off by that, it’s a red flag for me. I just will say, “Well then, that’s not somebody I’m going to work with.” That doesn’t mean that if they don’t want to let me see it, they’re a bad contractor. I’m just going off my best guess. My gut tells me that I should be able to move on and find somebody who’d be willing to let me see their projects.

Dave:
That’s great advice, Henry. Can you give us an example of a time you’ve done that and how you approached it when you were actually talking to the contractor? Are they okay with that?

Henry:
Yeah, absolutely. We’ve done it several times. Both times, I typically will just ask the contractor. I’ll say, “Hey, do you have any jobs going on right now?” Most of the time, they just tell me. They say, “Yeah, I’ve got one at 123 Main Street. I’ve got another one at 456 Main Street. So yeah, go by, check them out and let me know.” I typically don’t even have to ask. Most of them are comfortable with it.
The ones that I have asked have had no problem telling me and the ones that have had a problem, we just moved on. The conversation’s typically pretty easy. I have one contractor that I used for several jobs where I pulled up… I was driving for dumpsters. That’s what they call looking for contractors. When you see a dumpster on the side of the road, pull over and ask them…. Yeah, driving for dumpsters, right?

Dave:
That’s a good one.

Henry:
Pull over and ask them who the contractor is. I pulled over, because I saw a dumpster in front of a really nice looking house, and I said, “Hey, I’m looking for the contractor for this property.” He was like, “Oh yeah, that’s me.” I was like, “That’s great. Is this your project?” He was like, “Yeah, it’s my house.” I was like, “Oh, it’s your personal house?” He was like, “Yeah, but we do contracting as well.” I was like, “That’s awesome. Do you have some work I can see?” He was like, “Yeah, come on inside.” I off the street walked in this guy’s house.

Dave:
That’s awesome.

Henry:
He walked me through all the work he did on his kitchen. I’m shaking hands with his kids.

Dave:
Did you eat dinner over there?

Henry:
It smelled delicious. I should have. I would have. I was open to it. But we did several projects together after that and it all worked out well. Absolutely, the good ones have no problem with you seeing their quality of work and their job site.
The other thing that I like to do is I think oftentimes, as investors we’re trying to get the cheapest bid possible. We’re trying to find the cheapest contractor. Being cheap is expensive. First of all, remember that, but second of all, it’s okay to sometimes pay for bids. Some contractors, when you say, “Hey, can you go out and give me a bid on 123 Main Street?” Some contractors will come back and say, “Yeah, I can give you a bid, but I’m going to charge you 60 bucks, a hundred bucks, whatever it is, a trip charge for me to go out and do that.”
I used to be really put off by that, but what I learned when I actually did decide to pay for that is I got my bids faster than just when a contractor went out there for free. I got a more professional bid because I paid for that bid. I got a more professional-looking, itemized bid. There was less back and forth. In all honesty, who would you rather have managing your 60 to $100,000 renovation? Bob’s Remodeling who showed up late, took notes on a napkin, and then took three weeks to get back to you with a bid and you may like the price?
Or the contractor who charged you to be there, showed up on time, took notes, asked questions, and got you a bid turned around within 24 to 48 hours and you didn’t have to go back and forth about that bid because it was everything that you asked for? I would much rather have that person managing my extensive renovation. And so, don’t be afraid to pay for bids because to me, what that says is, “I value my time. I’m a business person, and I want to give you a quality bid. I don’t just want to throw a number out there, so you hire me.”

Jamil:
Henry, when you’re dealing with contractors, the one thing that I’ve noticed, and it’s interesting that our show is called The Ponzi Scheme episode, is that a lot of contractors actually run mini Ponzis, where they use the money from their next job on to complete the job that they’re working on right now. How do you go about making sure that the contractors aren’t commingling funds between job sites?

Henry:
I dealt with a situation like that recently. When I do my contracts, I typically do a scope of work, which is another tip I was going to give people. I do a very high level scope of work at first, because contractors, or the good ones, are busy and not every contractor is willing to do every job. You could have a job that’s too small for certain contractors. You could have a job that’s too big for certain contractors. And so to save myself a lot of time, I’ll do a scope of work and that scope of work is very high level. It’s just room by room what I want done. So, kitchen, I want new floors, this color paint on the walls. New baseboards, hang new light fixtures, very high level.
So, it’s a room by room thing and then I can send that scope of work to the contractor ahead of time. That way, if the job is too small or too big, I know on the front side we’re not wasting anybody’s time. But once we get that bid back, Jamil, and we know what the line item cost, labor and materials is for each thing, we pay based on work complete. We’ll give a percentage upfront to get materials to get started. But there is essentially a checklist. We take that scope of work and we break it down and we say, “This is what you get to get started, and then these 10 items must be complete and checked off before we release the next draw for the next amount.”
And so, everybody has to agree and it’s signed off that that is complete before we release the funds for phase two. We’ll typically break a job into two to three phases based on how extensive that job is and we all agree on the front side to sign a contract to say, “Okay, we’re not moving on to the next phase, until we all agree that the things in phase one are done and signed off on.” That’s typically how we’re keeping or making sure that at least what we’re giving them is being spent on what’s being done, or if they go spend it somewhere else, it doesn’t matter. They have to complete these line items before we’ll give them anything else.

James:
That was an important thing Henry just pointed out. A contract is not the same as a bid. A construction contract is where the contractor and the owner are on the same page with the same agreed upon terms. A bid does not reference that stuff. That’s very important that you contract every construction project.

Henry:
Absolutely. Yes, another thing is scopes of work. You should do those high level scopes of work. It saves yourself a lot of time. It’ll save the contractors a lot of time. I don’t know how many times I’ve met a contractor at a job that he just didn’t want to take for whatever reason, because I didn’t just send the scope of work on the front side so they could evaluate it, because you don’t know how busy they are or what their crews are at. They could want your job, but their plumber’s six weeks out and you’ve got a heavy plumbing rehab. Just sending that upfront can help you save a lot of time on the back end in picking your contractor.
And then, red flags that I like to look for? Again, when you’re looking at those jobs, take note of the job site and make sure it’s organized and clean. You want to make sure of that. And then, take note of the communication. If you’re struggling to get your contractor to answer the phone, to show up on time, to give you a bid, to answer text messages and you haven’t started a job yet, I promise you that doesn’t get better once you give them some money. If you’re having trouble communicating on the front side, that’s a red flag that that’s how the communication’s going to go for the entirety of your working relationship.
Once you throw some money out there, you sure as heck are going to want that phone to be answered or those text messages to be answered and that communication to be there. And so, I found that the contractors who communicate well on the front side are the best with being open and upfront and communicating on the backside. You don’t want those contractors that never answer the phone or want to talk to you until it’s time to get paid. Then one last thing to think about is a lot of contractors are going to ask for a percentage of that job upfront. It’s sometimes typical, but I’ve been asked for as much as 75% of the total project cost on the first draw.
To me, that’s a huge red flag. Now, most contractors are typically going to ask for some level of cost to get started because they’ve got to go buy materials. Some ways to think about that are just use your gut. If you’ve got a $60,000 rehab and they want 30 to 40,000 of that upfront, that’s a good chance that they may not show up to do the rest of the work. They got half their money for doing nothing. So, use your gut. But if they need a 20, 25% down payment, okay, think through what that is and then ask. Don’t be afraid to ask, “Hey, what do you need the 25,000 for?” Typically, it’s for materials.
So, you have a couple of options there. You can trust that that’s true, or you can say, “Well, what materials do you need? Until we build trust, how about I source the materials, or you get it on my pro account at whatever big box store and then they’ll bill me. We’ll get you all the materials. You get started.” That way, there’s some trust. “I bought the materials, you did a little bit of the work. All right, now, we can release some more funds.” If they’re not open to that, if they’re saying, “No, we need 50, 75% upfront,” then just leave. There’s other contractors, guys.

Dave:
All right, great advice. Thank you, Henry, and everyone for chiming in on that. Couldn’t agree more on the get what you pay for. I think that’s a lesson we all learn very quickly into our investing careers.
Jamil, let’s move on to you. Let’s talk about vetting a wholesaler. Where do you even start with this?

Jamil:
It’s a really good question. Vetting a wholesaler is important. Especially if you’re a fix and flipper, you want to make sure that the person you’re dealing with is giving you what they say they’re giving you in a wholesale deal, in a contract, because that’s what we sell. As wholesalers, we sell contracts, we sell opportunities. And so, is the opportunity really what they say it is? First and foremost, if I’m buying a deal from a wholesaler, I ask for a redacted purchase and sale agreement, which is basically their contract to purchase the house. I will never sign an assignment until I see the original purchase contract.
They can take out a few details. If they want to remove the seller’s phone number and the seller’s name, even the purchase price that they bought the house for, I’m okay not seeing that. Some wholesalers get sensitive. They don’t want you to know how much money they’re making. That’s fine. You can take that off the contract. But I do want to see the redacted contract because what I’m really interested in is the additional terms of the contract. I’ve been in a deal before where I have signed an assignment, and then I found out that I inherited a lease and I didn’t budget for a lease. I didn’t want to have to get rid of this occupant or have to deal with the occupant in itself. There was one where I had gotten into a deal where it was a two-year lease, and so now I’ve got to deal with this whole situation.
The other thing that I would say is before getting into a deal with a wholesaler, always view the property. A lot of wholesalers will try to get you to commit to deals, site unseen. That’s a very common tactic for wholesalers. They create FOMO. They create this, “You got to move on this deal before anybody else gets it. I don’t have a lot of time. I can’t get access to the house. You’re going to have to make a commitment and wire in earnest money before you see the house.” I have been burnt in that same situation. Again, bought a house from somebody that we knew and trusted in town. They claimed the property was a three bed, two bath. We ended up buying it, closing it, and then finding out that it was a two bed, one bath. It completely changed the math. So, we lost-

Kathy:
Wow.

Jamil:
Significant money on that deal. The other thing I would look at is never buy a deal that is being transferred to you on a quitclaim deed. That’s another thing that wholesalers will try to do. They will go and try to do a deal outside of title. Oftentimes, the reason they want to do that is because there’s a lot of clouds on title or there’s just an interesting situation going on with the chain of title and the title’s not insurable. So, they’ll want you to do the deal by quitclaim deed. Never do a wholesale transaction on quitclaim deed. You will get burnt.
The other thing I would ask a wholesaler is, what’s their volume? “How many transactions are you doing on a month-to-month basis? Do you have any people that I can talk to that have bought deals from you?” I would absolutely want to see that. The other thing is I would look at their wholesale list and I would see and check other properties that they had wholesaled and seen, where are those houses now? How do they look? Are their ARVs real? If a wholesaler is sending you a property and they’re over-inflating their ARVs, then you know that they’re not an honest person.
You should be able to know an ARV and be able to understand what your after repair value is and not have to rely on a wholesaler’s after repair value. If you are in this business and you’re relying on a wholesaler’s after repair value, pause and learn how to comp before you start spending money and getting involved. The other thing I would do is ask for a wholesaler’s website. If you’re a legitimate business, you should be online. You should have a website. You can’t just be a flyby night operation and not have any online presence. I want to see that you’re doing business.
The problem is wholesaling is a very early real estate investing technique. People don’t have a ton of money when they get started and they sometimes don’t go and build a website. I think that that’s not cool. You definitely need to have an online presence. I want to see what you’ve got. I want to see your inventory online. And then lastly, I would say Google the company. I know it sounds common sense, but look, if I had Googled the people that I put money in on the Ponzi scheme, I would’ve gotten some red flags ahead of time. I didn’t do it.
I trusted the people and I should have Googled and should have read every page all the way to page four, five, and six because page four, five, and six is where the actual meat and potatoes of their unsavoriness was talked about. Page one, two, and three had all their current social media posts and all the things that were really timely about them and maybe more current information, but you want to see what somebody’s done in the past. You want to understand the skeletons in their closets. And so, Google a company. That’ll give you some great details. You’d be surprised at how many folks will actually go to the internet and voice their concerns and their opinions when they’ve been burnt.

Dave:
Wow, that’s a great piece of advice. When you’re looking over a contract, do you recommend people get lawyers, or did you just learn to read these contracts yourself over time?

Jamil:
Again, I think on the safe side, of course, always seek an attorney’s advice if you are unfamiliar with legalese. It can get a little complicated, but these contracts are pretty standard, especially if it’s a board-approved real estate agent contract, which I love. I love the board-approved real estate agent contracts because they’re very fair. They’re always written quite neutral. I tend not to over-complicate or overthink those ones, but I do read every line. I do make sure that I understand the contract and I do make sure that I understand my obligations.
But yes, the other side of that is if you can’t afford an attorney, one thing that’s really interesting about title companies that a lot of people don’t know is that they always have legal on staff and you can actually ask your title company to get legal involved to help you walk through the contract because you have some questions. They will and it won’t cost you any money.

Dave:
That’s great advice. All right, James, we would love to hear about working with lenders. How do you approach vetting any lenders you work with?

James:
Lenders really aren’t the Ponzi scheme, unless you are the lender brokering the money out. You got to watch out for them for sure. But one thing that has happened dramatically over the last six months is the lending spaces changed rapidly. Rates have gone up, terms have gone up, access to money has gone up. And so, what has happened for a lot of these investors buying property is they get commitment for a loan verbally and then last minute, it changes right before closing and the terms change. It’s been very detrimental to a lot of investors because they have to double their down payment size. Their rates and their points change last minute before your closing, which can dramatically affect your deal and the profitability of your deal.
One thing that investors need to remember is most consumer protection rules don’t apply to us. We’re not protected. This is commercial loans. And so, vetting is so important. Things that I like to do when I’m talking to a new lender is A, what are their contingencies for funding? We own a hard money company in Washington. We fund in our backyard, interest funding. We do not have any subject to appraisal. It is all underwritten in-house. It is myself or my business partner’s call 100%. We have nobody that’s going to trump us. That’s a committed deal. If I’m talking to a different lender and they’re subject to appraisal, because they want to fit inside the box for whoever they’re going to sell their note for, that means whatever they told me can change rapidly.
And so, you want to know what are their actual terms for funding. Does it need to appraise? Is your debt fixed? That is a big deal right now. I’ve been seeing a lot of flippers or I’ll be talking to them, I was actually talking to a lender that loans a lot of money to flippers, and they go, “Yeah, we’re still lending at nine and a half percent right now,” which is low for hard money in today’s space. I go, “Well, how does that work if it doesn’t appraise out?” Because I also know they sell their notes off. They had a clause in there that if it didn’t hit the future market value according to a third party appraisal, their rate went from nine and a half to 13% and two points automatically got charged, because then they have to dispo that loan out to somebody else.
That is detrimental to an investor, and a lot of flippers don’t understand. You got to read through these terms and conditions, because if your deal switches three points on your rate over a six to 12 month period, you can go in the red really fast. The other thing you want to look at is as a lender, a lot of us are doing heavy value add, heavy construction. What is the issuance of their construction funds? Is there verbiage in there? I say there’s two different types of lenders out there for bridge financing. There’s hard money, which are guys that will issue you the money themselves. They’ve controlled that capital. Then, there’s the soft money, which are guys that broker loans out to big note buyers.
They’re two different things. The soft money guys have a little bit lower rate, but they come with all these conditions. And so, you have to watch out for these construction draws. What’s happening right now is these soft moneylenders will say, “Yes, I will give you your $100,000 loan to Jamil and we’re going to issue you this money over this draw schedule.” But there’s a condition in there that if the loan to value drops, they won’t issue any more construction funds, even though they’ve committed that you need that money to stabilize that asset. If the loan to value drops below that, they won’t issue you the money and you got to come out of pocket with those rehab dollars. That is also detrimental to your deal. It can affect your cash on cash return.
You might not have the liquidity. You can get yourself behind on payments, because you got to come up with the funds otherwise. And so really, get these terms specified when you’re talking to lenders. I always want to know who’s actually funding me the money. Is it a shadow company that’s brokering the loan out, or is it guys with the actual capital? Those are two different types of lenders and you can ask those questions. Most of the time, they’re not going to tell you those answers, but you can look at how… Then you go into what are your conditions. Does it need to meet appraisal? How does your construction draws work? What are their processes? Because those things have to be built out and depending on their processes, my red flag always is if they say, “Well, we’ll send out a third party construction team to review it.”
As a hard moneylender in Washington, we review it all ourselves. We have people on staff that go look at this stuff. I don’t want a third party to interpret a construction site. That will tell you who you’re working with, because the thing is, as an investor, hard money costs more than soft money. It’s usually one to two points higher on the rate. But if it can help you get that project done, you want to go with your hard money guy. The thing is, you want to know this upfront. You don’t want to know after you bought the deal because if you know it upfront, you can buy that deal cheaper to offset the debt cost. When you’re interviewing these lenders, really lock in your terms. Is there any variance in those terms? Can they switch things? If they can, you want to lock in those terms. Don’t buy anything on variable rates right now. It is not going to work in your favor.

Dave:
How would you, James, advise people who are new to this, who are trying to get their first loan? What do you even look for? You’re talking to probably a dozen lenders every time you do a deal. How should people even find good lenders to approach in this type of environment?

James:
The best thing you can do is find a backyard lender. Guys that are local like Intrust Funding, our lending company, we only lend in Washington state. That’s all we lend in. That’s why we have full control. If I was lending out in Arizona, that’s going to be an issue for me. I don’t know the market as well. I don’t know construction costs as well. That becomes a riskier loan. So, find people in your backyard is the best thing you can do for a lender.
The second thing is you can also look at private lenders, not just commercial. A lot of these bigger shops, they’re trying to deploy as much money as they can on the street nationwide because it makes their company more value and they’re working on small yields at this point. They’re just trying to spend as much money as possible. Your backyard lenders or your private lenders in your backyard, they’re going to understand you as a business and they’re going to work with you more business to business, rather than just, do you fit in my box to lend you money or not? So, look for the guys that are local.

Dave:
All right, well, thank you to Jamil, Henry, Kathy, and James for sharing their expertise on how they vet those operators. We’re now going to go to the second part of our show where we’re going to hear from first, Jamil, and then from James about how they found themselves involved with scams and what they learned from those experiences.

Jamil:
I just learned that the perpetrators in my investment have now been charged by the CFTC.

Dave:
Sorry, what is the CFTC?

Jamil:
Oh, it’s a regulatory body, much like the FTC or the SCC. They’re a governmental agency that basically is set up to protect consumers against fraud.

Dave:
Right.

Jamil:
Their job is to make sure that people aren’t selling illegal securities, that they’re regulated, that they have licenses, and that if they’re raising funds from the general public that they do it in the appropriate manner. This situation happened, I would call this more of an affinity Ponzi scheme. How it went down is Pace Morby and I were at a Mastermind of very well-known people in our industry. After the Mastermind, one of the attendees called Pace and I over and told us about this incredible investment that they were in that was generating one to 2% returns a day. Right away, when you hear stuff like that, the red flags go right up, but we’re talking about people that we know very well.
Again, it was framed to us in a way that we were almost being shamed for not realizing that there were better returns available in the world, but we had been just so mindset. Our mindsets were so broken that we didn’t believe that anything better than 10 or 15% a year… Or 12 to 15% a year was actually real. And so because of that, our initial spidey-senses were let down and we listened to the rest of the pitch. This individual shows us an account with $650 million, and he said, “This is the account that money has been placed in to buy my trading bot.” The scam or whatever was there was this savant trader who was trading US dollars against gold and was incredibly gifted at timing the market.
He called it front running, which is a very legal thing to do. How it works is these high frequency traders have these computers that are able to monitor when large institutions are placing orders for or selling gold. Because they’re able to know when these orders are happening, they can place their orders and follow whichever direction these institutions are in. It’s completely legal and there’s nothing wrong with that. If you have a computer that’s able to monitor that and track it, then good for you. And so, we thought we were getting involved in something like this and also that there was some technology or an AI that was involved in timing the market.
We get in and I started to the tune of $500,000 and immediately start seeing… I wasn’t able to realize any of the returns. I hadn’t pulled any money out. But I was getting emailed daily statements and the one to 2% was happening. And so, I’m getting really excited because I’m seeing that a $500,000 investment at the end of 30 days, that’s… I mean, it’s 20 trading days. So, we’re talking 20% in a month. That’s phenomenal. I’ve never seen a return like that. As a real estate investor, I’m making 20% a year, but I’m doing the work and I’m breaking my back to do it. So, I’m thinking, “Wow, I can get the returns that I’m getting in a year on my money in a month. This is fantastic.”
So, I double down and I send in another $500,000. Pace does the same. We’re both into this thing for a million bucks now, and that’s where everything starts going wrong. A couple of months later, I put in a withdrawal request. I wanted to test a hundred thousand dollar withdrawal. I have a million dollars in. It says now that my million dollars has grown to 3 million, and now I want to pull my principle out. I submit a withdrawal request to take out a hundred thousand, and then I submit subsequent withdrawal request to take out the rest of the million dollars that I have in. I’ve never seen a dime and none of those withdrawals have been redeemed.
And then just recently, about a week ago, in fact when we were in Denver actually, I received an email that the CFTC had charged the individuals that were involved in this as a Ponzi scheme, and all of their accounts have been frozen. This is going to not end well for Pace or I and other friends. We have other friends, who I won’t name, one who has an additional three and a half million. Another who has 3 million in it. These are sophisticated people. They were able to make millions of dollars. I mean, I don’t consider myself a dummy, but I do feel dumb. I do feel very dumb, because I should have done more due diligence.
I allowed myself to get sucked in based off the relationships that I had. I thought that everybody that was involved… When you think of somebody that has a large influence and is well-known, you almost feel like they’re too big to screw you. That’s never the case. I am just completely ashamed. I feel terrible that I put myself and my family in this situation where I lost a million dollars of our nest egg and I learned a valuable lesson. It’s do a lot more due diligence and never to trust anything that seems too good to be true, because at the end of the day, it very likely is.

Kathy:
I just want to give you a hug.

Jamil:
Thank you, Kathy.

Dave:
Now, I’m very sorry to hear that, Jamil. It’s really unfortunate. Sorry to hear that you’re going through that. We appreciate you telling this story to help raise awareness to people about what is going on. I mean, frankly, unfortunately, this is not the first story about a Ponzi scheme or a scam impacting real estate investors I’ve heard over the last, I don’t know, two or three years. Have you heard anything else like this, or did this really come as a surprise to you because you hadn’t heard of similar scams before?

Jamil:
I’ve heard of scams. I mean, I’m a fan of watching American Greed. I watch the show just because it’s interesting to see and hear all these people who would gamble their lives away for a quick buck. And so, I watch it just out of curiosity. So, I know scams exist. It’s just that I didn’t think that they were that close to me, and I didn’t think that the people that I knew and that I liked and that I trusted would be involved in them. That to me is the part that’s the most hurtful because I trusted the people involved. I truly did. I truly believed that they had my best interests at heart, that they were friends. And then I come to find out that these individuals, they all profited off the million dollars that I sent in. Everyone was paid referral fees on my money.

Dave:
Wow.

Jamil:
It’s like, “Gosh.” Now, I can sue everybody. I’m definitely going to go to law enforcement and I’m not going to stay quiet about it. I’m not naming names right now, but if anyone has or wants to know any more information, by all means send me a message offline and I’m happy to share details in greater detail. But until this situation is completely resolved, I have to be mindful of the legalities involved and the sensitivity of the situation. I won’t stay quiet. I’m not going to be a silent victim.
I think that’s one of the things that these people are banking on is that the majority of people, they feel so ashamed for being duped that they don’t say anything, that they don’t come out, that they don’t share. I think also that they looked at Pace and I as having such big profiles that they thought these two would never share with the general public that they were duped for a million dollars each, because that’ll just make them look dumb. So I think these guys would be a great target. But I’m not. You know what? I’m happy. Call me dumb, but you know what you’re not going to call me? You’re not going to call me a victim.

Kathy:
Jamil, your friends, do you think they knew it was a Ponzi, or do you think they were-

Jamil:
Yes.

Kathy:
They did not.

Jamil:
A hundred percent they knew-

Kathy:
Ouch.

Jamil:
It was a Ponzi scheme. Absolutely, they knew it was a Ponzi scheme. Everybody involved knew it was a Ponzi scheme. They were all taking fees. If you’re taking fees off of my money and there’s been no returns generated… I heard that the fees were upwards of 20%. So, if I send in a million dollars and you get 200 grand of that and nothing has been generated in profit yet, how is it not a Ponzi scheme?

James:
Oh, that’s coming back though.

Kathy:
Yeah.

James:
Anybody that made money on this will be giving it back.

Kathy:
They’ll be forced to pay it back.

Dave:
Well, it sounds like you know that from experience, James. Jamil, sorry to hear that. Again, Jamil is being wise because this is an ongoing investigation and not publicly discussing some of the details. But as he said, if you want to ask him about it, he’s been very open about that and we appreciate that. James, I know you’ve also unfortunately been a part of a Ponzi scheme unknowingly. Can you tell us a little bit about that?

James:
Yeah. I guess, it starts very similar to what Jamil said in I was approached. I had a good friend of mine meet somebody down in California, Beverly Hills, and actually I can talk about this guy because he just got sentenced to 20 years in prison.

Dave:
Let’s name some names. Who do you got?

James:
We’ll get to that. He calls me up and he says, “Hey, I met this awesome entrepreneur.” He just sold his business to Howard Schultz, and he’s been relocated out to Beverly Hills and they are in the film business. Their business is locking up… After movies get produced, they get released. Then they go onto the secondary market and they would go secure the rights for these contracts and then sell them off to Netflix, Sony, whatever all the streaming channels were. They had a group of channels that they were working with. At the time when my buddy approached me, I actually told him I just wasn’t interested because we were flipping homes. We make pretty high returns and I like making money on stuff that I control. I don’t like giving up a lot of control on these things. But he really gave me a hard press and not because he was trying to get money out of me or trying to manipulate, he just really believed in it. And so, I flew down.
Well, the first red flag was this guy named Zach Horwitz, they took me out and they flew me down to Vegas on a private jet. He rented this huge suite and they took us out all weekend. He never asked for money at this time, but it was about setting the presence. He was a very personable person. Actually, I really liked him when I got to hang out with him. He seemed down to earth, was engaged, had all the right story. I got his whole background story because I really like to get to know people before I invest any money with them. But the issue I was having was the collateral. I didn’t like the collateral. I was going to give them money on a rights to a movie. I don’t know what to do with that contract. And so anytime I’m investing in anything, I’m looking at what’s the collateral and if something goes wrong, what can I do with it? The only thing I knew what to do with rights to a movie was really use the bathroom with it. I was like, “What do I do with this?”

Dave:
You weren’t going to make your own movie and star in it?

James:
Yeah. Well, and these were all in Spanish too and I don’t speak Spanish. The whole setup was you would come in, you’d fund the right to the movies as a bridge lender. Then once HBO and Sony would buy this movie off you, they were going to kick you a 20 to 25% return in a 90-day window, which is very high. That is exceptionally high. Just like Jamil said, we’re fighting to make 20, 30% on an annual basis and to break our backs. And so, what I did is because I knew the person that was involved, they guilted me a little bit like, “Hey, can you help us get this going?” That was the first mistake. Never do an investment based on friendship. You make an investment based on what you’re trying to accomplish and verifying the information.
The other thing is I don’t like to invest in stuff where people are asking me for money and I don’t understand it. When I go invest in things, I’m going out and looking in industries that I’m interested in, and then I will find the operators in there. About a two-year period, I end up doing about five deals with them, and I make about $252,000 in this Ponzi scheme. I probably put up 250, and I made 250. So, I made a hundred percent of my money on these deals that I had done, which was great. But the red flags kept coming to me and it was really sold to me on a friendship like, “Hey, these are great people.”But where I was seeing the mechanical breakdown was I started noticing their paperwork wasn’t in line for the amount of money these guys were saying they were doing, because this Ponzi scheme ended up getting shut down for $650 million-

Henry:
Wow.

James:
Is how much this thing raised. When I got their paperwork, it was elementary. It was not done by attorneys. You could tell it was not. They didn’t have their securities, the Reg D filed. There were all these red flags. My buddy was just like, “Well, he’s just busy. He’s an entrepreneur.” No business runs that way. If you’re raising $650 million, you better expect to be able to talk to a securities attorney. I asked to talk to their securities attorney and I got the push around at that point.
And so the paperwork was bad, the timelines were a little weird, and then in addition, they had switched the format a couple of times because he was trying to figure it out. The biggest red flag I saw was when this guy asked me for an example, because we have a debt fund up in Washington, or an equity fund. It’s a hard money fund. We’ve ran it for 18 years. They asked me for an example of how I structured that because they were going to do debt and they wanted an equity example. So, I sent them off my fund docs. When I received my investor docs back, guess which documents they were? They were my own documents.

Dave:
Wow.

James:
Soon as I got that, I was like, “This is a joke.” How I ended up getting out of that was I baited them. Because the deals would pay off after four to six months and once it paid off, I committed verbally I was going to do the next deal. But I said, “Hey, just get it back in my account. I need to do it for accounting purposes.” Money came back in my account, I was done. I said, “Hey guys, sorry, something came up. I have to invest over here. I’ll come back later.” I never came back.

Dave:
Wait, just to clarify, did you get a profit or you just pulled your principal?

James:
I made a profit. I made 240,000 on that. But in the back of my mind for five years, I was like, “Someday, I’m going to have to give that money back because it just didn’t seem right.” And then what had happened is four years later, all of a sudden, my phone burns up with news articles, Fox News, CNN, American Greed. All these things come out about this guy and he had just been arrested for $650 million Ponzi scheme. The crazy thing is everyone was investing in this person because of who he was and the image that he put out. This guy never invested one single dollar. He had emails and contracts from Netflix to buy your contract off you. They were all fabricated. Fake email addresses-

Henry:
Wow.

James:
Fake contracts. No one at Netflix even knows who this person is. Not only that, I saw an article where Howard Schultz is like, “I have no idea who this person is.” So, he was dropping Howard Schultz’s name everywhere. It’s that whole act as if-

Dave:
Howard Schultz, by the way, is the CEO of Starbucks, if people don’t know.

James:
He’s got a little bit of coin on him. And so, that was my thing because the red flags for me was the returns were too high, it was too easy, their paperwork and structure was incorrect, and I could not verify the collateral. All four of those things made me pull my money out at that point. That doesn’t mean that I’m really smart. It was just a risk thing for me. I’m like, “This is so risky and I can flip properties and make nearly the same return and have full control.” I didn’t pull it out because I thought it was a Ponzi scheme. I thought there was a lot of red flags there. I thought he had those relationships though. But it was just more of a, “Hey, this is safer for me. I’m going to control the money.”
Now fast-forward, after he got arrested, there’s something called a clawback period. That was not enjoyable. I got calls from federal trustees to go over A, why I pulled my money out because I was one of the only people that actually did that. Just like Jamil said, a lot of very intelligent people had invested millions and millions of dollars in this company and they left it. It’s not because they weren’t smart. They just trusted this guy and unfortunately, it was too much trust. And so, they were looking at me like, “Why did you pull your money out?” We went over that of why. But fast-forward, it was not an enjoyable experience then because these guys, how they ran their accounting was so off, there was wires flying all around.
It actually made it look like I made more money because the guy would wire me money and then have me wire back and then he would have me wire them more. So, there was all these weird wires going out. And then, they tried to hit me for double and I had to fight them for 90 days. They said I owed them $580,000 because they included my principal and everything in there, which is not how clawbacks work. For the last 90 days, I’ve been fighting with this federal trustee, getting it down to the $248,000 that I actually made. Now, for me, I was good paying that money back because that’s not my money at that point. I don’t want to take anybody’s money. I mean, that’s stolen money. All that profit is stolen.
And so, I was good giving that back. I had to pay a lawyer about 20 grand and negotiate this to what the actual amount was, show all the verification that that’s what I actually made, because they wanted double. I think right now, I’m the only person that has wired back in money because I was the only person that actually took it out. I actually am sending the wire tomorrow for 248,000, which isn’t great. That was money that I’ve already invested in other projects and did these things. Now, I got to come up with this liquidity. With these Ponzi schemes, it’s hard because you meet these people and they have so much charisma. They seem like such great people, and that’s really what it comes down to.
You’re not investing always in the people. You need to verify the process too. Great people can be great people for a short amount of time, but if they’re not great people and you can’t verify the paperwork and process, stay clear because it is a total headache. It’s a total mess. A lot of people that I know very important to me have lost a lot of money in this deal. It’s a sad thing to see, but it was completely reckless. If anyone wants to see more, they can check out American Greed. They just ran an episode on him. It’s called One in a Million Capital Zack Horowitz, and it talks about how he wants to be an actor. Basically, this Ponzi scheme funded his whole acting career-

Kathy:
Oh, gosh.

James:
Which he was not good at, by the way.

Dave:
Wow.

James:
He was not good.

Kathy:
I totally agree with you. I’ve seen so many Ponzi schemes and have personally known people. I didn’t invest in those deals, but I saw them at different events. I’ve been to events where the SEC would escort people off the stage even. The general I think that they have in common is they are very charismatic and they come across as just really good people. When I started to study it, I actually did a show on it once on, what is this type of personality that can just rip you off and not feel bad about it? It could be that it’s sociopathic behavior, where a sociopath knows how to get what they want want and they use all the things that they know that work, which is charm and taking you on private jets and so forth. But they don’t have any compassion, zero, or empathy, none. So, they don’t feel bad at all about taking your money. In this case, it could be that he really felt like, “But I need to fund my acting career. The world needs to see me on stage.”

James:
This kid was so bad at acting.

Kathy:
Who knows?

James:
He was terrible. Absolutely terrible. He’d be telling me, he’s like, “Oh, I’m flying over.” That was another red flag. He’s like, “Yeah, I’m going overseas to Cannes and now we’re producing movies.” I’m like, “So, let me get this straight. The fund that you’re raising money for is now producing the movies that you’re the lead actor in?” I was like, “I wonder how this is all going.”

Dave:
All right, well, thank you all. This has been super helpful to understand. Unfortunately, we do have to get out of here because this show is already running long, but you packed it with full of great information. So, thank you all. I appreciate you sharing all your stories and especially the losses. A lot of people aren’t as willing to share some of their unfortunate situations where they’ve lost money. But as you’ve all shared, those are some of the best learning experiences. So, thank you for sharing those all with our audience. If anyone wants to connect with you, Henry, where should they do that?

Henry:
The best place to find me is on Instagram. I’m @thehenrywashington on Instagram or go to henrywashington.com.

Dave:
All right. Jamil?

Jamil:
You can find me on IG as well, @jdamji. Also, YouTube. Just youtube.com/jamildamji.

Dave:
Awesome. Kathy?

Kathy:
On Instagram, it’s kathyfettke. That’s with two Ts. There’s somebody trying to pretend they’re me, and that’s one T. Don’t listen to them. And then of course, at realwealth.com.

Dave:
All right, great. James?

James:
Easiest way is probably Instagram, jdainflips or jamesdainard.com.

Dave:
All right, great. I am @thedatadeli on Instagram, or you can always find me on Bigger Pockets. Thank you all so much for listening. We appreciate you. Hopefully, you learned something great here. Just remember, real estate is exciting. You want to get into it. Take a beat, vet who you’re working with, and make sure that you’re working with reputable people. It will help your investing career more than you know.
On The Market is created by me, Dave Meyer, and Caitlin Bennett, produced by Caitlin Bennett, editing by Joel Esparza and Onyx Media, researched by Pooja Jindal, and a big thanks to the entire Bigger Pockets team. The content on the show On The Market are our opinions only. All listeners should independently verify data points, opinions, and investment strategies.