How to Spot a Ponzi Scheme in Commercial Real Estate

By Published On: August 5, 20213.2 min read

A Ponzi scheme is a type of investment fraud that pays earlier investors with money taken from new investments, promising high rates of return with little risk. Ponzi schemes, a type of white collar crime, are similar to pyramid schemes in that they both use new investors’ money to pay back older investors. The key difference is that a pyramid scheme usually offers investors the opportunity to earn money by recruiting more people into the scam.

Eventually, Ponzi schemes bottom out when there are no longer new investors coming in and there isn’t enough money to pay back existing investors. When that happens, the scheme falls apart entirely.

A company that engages in a Ponzi scheme usually puts most of its resources into finding new investors. Without a constant influx of new investors, the company is at risk of collapsing.

The History of Ponzi Schemes

The “Ponzi Scheme” was named after Charles Ponzi in 1919, even though this type of scheme can be traced back to the 1860s. Charles Ponzi’s scheme had to do with the U.S. Postal Service. He started out legitimately, offering “international reply coupons” at post offices, which allowed senders to pre-purchase postage they could send with their letter. The recipient of that letter would then be able to exchange those coupons for postage and send a response.

The idea was so successful that he immediately attracted a number of investors. Soon, however, Ponzi began to divert investors’ money into payments to himself and earlier investors, calling that money a “profit,” until eventually the entire scheme collapsed. Ponzi was then arrested and charged with mail fraud. This was such a notorious incident in America that the entire style of scheme was named after him.

A Modern-Day Example

In 2008, Bernie Madoff was convicted of Ponzi scheme fraud. At the time, Madoff falsified trading reports to show investment profits that didn’t exist. Madoff was attracting new investors through his falsified numbers and using that money to pay back earlier investors, who assumed they were getting a portion of profits — profits that didn’t actually exist. Eventually, the money ran out, and Madoff was arrested. He died in prison in April, 2021.

Characteristics of a Ponzi Scheme

Most Ponzi schemes all share similar attributes to look out for:

  • A guarantee of high returns and little risk
  • Consistent returns no matter what the market is like
  • Investments that are kept a secret
  • Investments described as “complex” or “hard to explain”
  • Investments that have not been registered with the Securities and Exchange Commission (SEC)
  • Secret or complex investment strategies
  • A lack of official paperwork for the investments or issues with paperwork
  • Difficulty removing one’s money from the investment
  • Unlicensed sellers

If you’re ever faced with an investment opportunity that comes with any of these characteristics, it is an immediate red flag and possible indication of a Ponzi scheme.

Ponzi Schemes in Commercial Real Estate

Ponzi schemes are used in almost every industry, and commercial real estate is no exception. In 2018 Gerson Barkany pleaded guilty to running a real estate scheme that defrauded investors out of $62 million dollars.

Barkany promised “risk-free” investments in commercial real estate to more than 10 people, encouraging them to purchase and immediately sell the real estate at a profit. However, those deals did not actually exist, and Barkany created fake real estate documents and agreements.

When investors gave Barkany the money for a commercial real estate investment, he pocketed some and used the rest to pay back earlier investors — a key characteristic of a such a scheme. Eventually, however, Barkany ran out of money, and the Ponzi scheme fell apart, leaving investors with nothing.

These schemes are common, and it’s important to pay attention to the red flags — in this case, the promise of a “risk-free” investment.

Also keep an eye out for wire fraud, money laundering, and illegal kickbacks.

Related Articles

Related Articles