When Does the Charade Become Outright Fraud?
When Does the Charade Become Outright Fraud?
New Development Closing Credits
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When Does the Charade Become Outright Fraud?
New Development Closing Credits
Real estate developers and their brokers aren’t shy when it comes to rounding the corners of the truth. With a glut of new luxury condominium units available in Boston, are developers so desperate to unload unsold inventory that they are willing to commit outright fraud? We think the answer is yes.
We’ve been vocal about the glut of high price condominium units in the downtown Boston market (see “Ready or Not, Here They Come”). The inventory problem is compounded by the fact that there’s been a lot of speculative investment activity in these projects. New units in these buildings are generally subject to 12-month re-sale lockups. With those lockups expiring, speculators are now free to cut their losses and dump their units.
With their backs up against the wall, developers are getting promotional to sell unsold inventory. Over at the new 317-unit Winthrop Center project, the developer is waiving condominium fees for a year and offering to pay real estate agents inflated commissions to steer customers to their project – that’s just for starters.
Closing Credits – Smoke and Mirrors
In a sign of how sluggish the new development luxury condominium market is in downtown Boston, many developers have resorted to offering substantial “closing credits.” In the context of new development, closing credits are basically hidden discounts. To make sure that these discounts stay hush-hush, developers often require buyers and their agents to sign non-disclosure agreements.
By way of background, closing credits (also referred to as selling credits) are commonly used by cash strapped buyers, typically first-time home buyers. They generally cover the buyers’ closing expenses and sometimes the cost of repairs, i.e., a new roof, septic system, etc. It’s effectively a way of mortgaging transaction expenses.
It should be noted that mortgage lenders have very strict limitations on the use of closing credits, which keeps a lid on their use. However, when it comes to all cash transactions, the sky is the limit on the use of closing credits.
How Much Did They Really Pay?
The scheme works like this. The developer (seller) and the buyer agree on a discounted transaction price – the actual price the buyer pays. The parties further agree that the deed, which is a matter of public record, will show a higher price. The difference between the discounted price and the higher price recorded with the Registry of Deeds is the closing credit.
Since the published price doesn’t reflect the discount, these transactions artificially inflate valuations. When buyer credits are used, the reported price is basically fictitious. As we see it, it’s an intentional deception.
Recently there was a full-on publicity blitz over a transaction at the St. Regis development in Boston’s Seaport neighborhood - press releases, social media grandstanding, etc. Digging a little deeper, it looks more like a marketing stunt to us.
Smoke and Mirrors in the Seaport?
For starters, grandstanding the $20,348,000 transaction at the St. Regis as a “record-breaking sale” is a bit disingenuous as the transaction involves the sale of two separate condominium units. The two units sold for about $10 million each, run of the mill stuff in the Boston luxury market, certainly not record-breaking and not worthy of a press release.
The real question is, did the developer actually receive just over $20 million ($3,682/sf) for the two units? According to a spokesperson for The Collaborative Companies, the broker who represented the developer in the transactions, closing credits were used. So, the short answer seems like no.
Sources with knowledge of the transaction who have asked to remain anonymous told us that the actual sale price of the two units was closer to $16 million net of closing credits. While we can’t confirm the actual sale price, $16 million +/- for the pair of units equates to a far more realistic $2,895/sf. and implies a closing credit of roughly $4 million.
Recent sales in the building suggest that $16 million is market correct. According to MLS data, over the last 12 months the average selling price at the building is $2,100/sf (excluding the two units in question).
Additionally, just a few floors down, unit 16E has been on the market for nearly a year with a current asking price of $7.795 million, $3,053/sf. Unit 16E was bought from the developer in early 2023 for a “reported” price of $9.45 million, $3,702/sf. With closing credits in play, it’s anyone’s guess what the real purchase price was.
When pressed, The Collaborative Companies spokesperson wouldn’t confirm or deny that the actual price was closer to $16 million, but repeatedly stated that it will cost the new owner “millions of dollars” to combine the two units. That may be true, but the value is determined by what you can convert the asset into cash, today. Future improvements don’t give you license to fabricate valuations.
When Does the Charade Become Outright Fraud?
There are many reasons that developers want to maintain the appearance of high prices in new condominium developments. At the top of the list is market perception. Cutting prices sends a signal to the marketplace that the project may be in trouble and that can trigger a downward price spiral.
More importantly, most large developments are highly leveraged, and the lenders get very nervous when their collateral is losing value. In some cases, declining financial performance of a development can violate loan covenants and trigger defaults.
All this begs the question, when does price manipulation cross the line and become outright fraud? Merriam-Webster defines fraud as:
Fraud (noun)
Deceit, Trickery
a) Intentional perversion of truth in order to induce another to part with something of value or to surrender a legal right
b) An act of deceiving or misrepresenting: Trick
In our opinion, that’s exactly what it is – consumer fraud, and maybe even bank fraud. The use of closing credits deceives other buyers and maybe lenders, too. Since residential real estate valuations are largely determined by comparable sales, recording fictional prices distorts price data which in turn causes widespread consumer harm.
To be clear, we don’t know the exact amount of the closing credits involved in the St Regis transaction; that’s entirely the point - to keep the marketplace in the dark. The exact amount of the discount is less important. What matters is that when closing credits are used, the published valuation data is totally unreliable. Garbage in, garbage out. Buyers, you’ve been warned.
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About Batterymarch Group LLC – Batterymarch Group is an independent full service real estate brokerage and advisory firm focused on the downtown Boston high-end residential market. We represent buyers with a sharp focus on valuation. We also offer sub-advisory and owner’s representation services to financial institutions, family offices, and trustees.
About Andrew Haigney – A 25-year Wall Street veteran, Andrew held senior positions at leading global investment banking institutions where he routinely valued and negotiated complex securities transactions on behalf of institutional clients. Andrew has been an outspoken advocate of a universal fiduciary standard. In founding Batterymarch Group, Andrew brings that same discipline and passion to real estate brokerage.
One of the potential winners in this story: the city, assessments are informed by market value (including prior recorded sale prices) leading to higher assessments and thus additional tax revenues. Paying taxes on $20m assessment vs $16m assessment is a big difference, now apply that over a large number of inflated lux properties. City benefits from lack of transparency.