When one considers illegal activities like money laundering and fraud, commercial real estate typically doesn’t come to mind. That’s not the case though, and the Financial Crimes Enforcement Network (FinCEN) is taking immediate steps to combat vulnerabilities in the U.S. real estate market.
Around 20 percent of real estate transactions in the U.S. are cash-only. They’re also ripe for fraud.
In December 2021, FinCEN issued an Advance Notice of Proposed Rulemaking (ANPRM) to seek public comment on a potential rule to address these vulnerabilities. All-cash transactions for both residential and commercial real estate could be affected.
Why Real Estate?
In the past, FinCEN has targeted all-cash residential real estate purchases by shell companies. Now, regulatory attention has shifted to the entire sector.
Banks and financial institutions, which are already required to report suspicious activity, are less often targets for criminal activity. Real estate has no such requirement and is not subject to federal anti-money laundering rules. If the transaction doesn’t require a financed mortgage, it can be relatively easy to commit certain types of fraud with real estate.
Real estate is also a relatively stable investment. Not often does it lose money or change hands, so it’s a safe bet for legitimate investors – and criminals or corrupt officials – to use real estate to store and accumulate wealth. It’s not a heavily regulated market nor are transactions especially transparent, making real estate an attractive target for fraudsters.
The risk of money laundering via real estate has gotten the attention of FinCEN. A U.S. Treasury 2020 report emphasized how serious of a threat this issue has become, noting that real estate at all price points is a common method to “store, launder, or benefit from illicit funds.” It’s no wonder, given that real estate purchases can easily be done without revealing the true owner’s identity.
In the previous five years, it’s estimated that $2.3 billion has been laundered through the U.S. real estate market.
Says Acting Director Himamauli Das, “Addressing this risk will strengthen U.S. national security and help protect the integrity of the U.S. financial system. We urge stakeholders to provide input to assist us in developing an approach that enhances transparency while minimizing burden on business.”
Fraud in Commercial Real Estate
All-cash commercial real estate transactions are trickier than residential. The terms of what can be considered “all cash” are different and can involve bonds, several transactions spread out over months or years, and different entities. Further complicating matters is that there are many stakeholders and advisors throughout the process, each with varying levels of knowledge about the transaction and with little regulatory oversight.
Historically, commercial real estate has been a vehicle for tax evasion, money laundering (especially to corrupt officials), international transfers, and structuring. The fraud cases have increased in recent years.
Overview of the Bank Secrecy Act
The Bank Secrecy Act (BSA), which is what FinCEN’s rule is expected to be based on, requires recordkeeping for financial transactions that may involve criminal, tax, or regulatory investigations as well as risk assessments and intelligence or counterintelligence activities.
Under the current rule, financial institutions are required to submit Suspicious Activity Reports (SARs) for any transaction that could be a possible violation to the law or regulation. Banks and financial institutions are also required to:
- Establish appropriate policies, procedures, and controls to combat fraud and criminal activity
- Designate a compliance officer
- Train and educate staff, and
- Regularly test their programs with an independent audit.
And while financial institutions are already subject to the BSA, including financed real estate transactions, and high-value residential real estate transactions are covered by GTOs, certain other cash transactions have missed oversight. Until now.
FinCEN Proposed Rule
The proposed rule, which is meant to curb money laundering in the U.S. real estate sector, falls under the BSA. If passed, it would mandate recordkeeping for all non-financed real estate transactions. The public commenting period, which ended on February 7, 2022, sought input into how much of a burden certain types of recordkeeping requirements would be on businesses or individuals.
More specifically, FinCEN wanted to better understand:
- Who should be subject to recordkeeping requirements
- Which real estate transactions should be covered
- What information should be kept and reported
- Geographic scope of the requirement
- A dollar threshold reporting requirement
Title insurance companies are already subject to recordkeeping requirements under the BSA. The Geographic Targeting Orders (GTOs) require title companies to file reports and maintain records for all-cash residential real estate transactions above a certain threshold in select cities and metro areas, like Manhattan and Miami, for example. The current purchase threshold for GTOs is $300,000.
GTOs require title companies to report the:
- Price and address of the purchased property and
- Ownership information including but not limited to name, social security number, ID number, and type.
If FinCEN passes a similar rule for all real estate transactions, it’s likely it would follow suit with a similar and expanded requirement as the BSA and GTOs.
Industry groups, like the National Association of Realtors and the American Bar Association, have already issued voluntary guidelines to help increase transparency in real estate transactions. While these are good first steps, it’s becoming clearer that more specific action may be needed.
PBMares is continuing to monitor developments around this issue and will inform real estate clients as FinCEN’s rulemaking process moves along. In the meantime, commercial real estate developers, owners, and investors need to be on alert: for fraud and for additional recordkeeping requirements in the near-term.