Big Changes For Canadian Real Estate After Prominent Developers Charged With Fraud

Big Changes For Canadian Real Estate After Prominent Developers Charged With Fraud

Canadian real estate has already seen a shift behind the scenes after a regulatory failure resulted in changes to the way markets will operate. This week, the RCMP charged two prominent real estate professionals with fraud. It comes after a half-decade investigation, and a regulatory failure nearly 10-years ago. The allegations haven’t been proven, but the embarrassment already has regulators scrambling. It’s expected to have a big impact on a process that helped fuel Canada’s real estate boom.

A notice sent out by the RCMP this week notifies the public that two principles of Fortress Real Developments were been charged:   

Jawad Rathore (Markham):

  • Fraud, contrary to Section 380(1)(a) of the Criminal Code
  • Secret Commissions, contrary to Section 426(1)(a) of the Criminal Code.

Vince Petrozza (Richmond Hill):

  • Fraud, contrary to Section 380(1)(a) of the Criminal Code; and
  • Secret Commissions, contrary to Section 426(1)(a) of the Criminal Code. 

“The investigation, dubbed Project Dynasty, began in 2016 after police received a public complaint related to the business activities of Fortress Real Developments. In particular, allegations were received that the company was fraudulently obtaining investments in a syndicated mortgage investment scheme,” explains the RCMP. 

What The Heck Are Syndicated Mortgages?

Syndicated mortgage investments (“syndicated mortgages”) are mortgages with co-lenders. A group of investors pool their money and act as one big lender, for hard to finance deals. It’s essentially private lending, and has the promise of those sweet high interest payments. It’s easy to assume investors incurring losses were greedy and knew the risks, but that’s not the case. 

Syndicated mortgages sound like a scam but they actually have a legitimate purpose. Large developments require more capital than single lenders are often comfortable lending. This gets more complicated since land valuations can be based on future potential, not current value. If the lender has nothing securing the loan, it becomes too risky to justify. That’s where syndicated mortgages can come in. The issue is investors are sometimes mislead about the risks involved. Since the industry was largely unregulated, there weren’t many standards. 

FSRA, Ontario’s investment regulator, warns syndicated mortgages aren’t for the average investor. They’re often promoted as high yielding, low risk, and “fully secured.” 

“It is true that your investment will be used to create a mortgage that is registered and secured directly with the land or building associated with that mortgage. But remember, if something goes wrong with the project – and the value of the security is limited to the value of the land – you may rank behind other lenders and investors and may not get your money back. This is because the value of the land may be only enough to pay these prior-ranking lenders,” warns the FSRA. 

Canada’s Real Estate Boom Helped Fuel Fortress, and Investors Missed Red Flags

Canada’s real estate boom also led to a boom of syndicated mortgages. Fortress Developments was a big player, attracting nearly a $1 billion in investments. There were signs investors should be exercising more scrutiny, but they were muffled.

The response to a tweet from prominent analyst Ben Rabidoux was one of those red flags. Most of us would have read his comments, and likely forgotten about them in a few days. Apparently not this firm. His 2015 tweet resulted in Fortress slapping Rabidoux with a defamation suit

If you’re familiar with investments, you know analysts criticize companies. Companies that think analysts are way off either ignore or prove them wrong. Those that chose to silence critics tend to set off more alarms than those that brush off claims.

By 2016, a lawsuit was filed against Fortress by investors alleging they were misled. By 2017, an Ontario court dismissed the suit against Rabidoux as having no merit, under anti-Strategic Lawsuits Against Public Participation (SLAPP) laws.

Anti-SLAPP legislation dismisses meritless lawsuits designed to silence public criticism. A great tool if you have the money. Last I heard, Rabidoux still hasn’t been paid back.

That same year, heads were rolling at Ontario’s securities regulator for dismissing the issue. Not only had investors been demanding an investigation, but Canada’s tax authority also did. It was revealed in 2013, nearly a decade ago, the CRA asked the regulator to look into Fortress.

An investigation found documentation stating “[the CRA] suspected Fortress to be Ponzi in nature” scheme. The regulator was even scrutinized by its own compliance officer, for closing the case 1-month later. Stop laughing, Gerald.

Charges Were The Result of A Half-Decade Long RCMP Investigation

Fast forward to the charges this week, with the RCMP attributing them to the work of “Project Dynasty. ” The operation began in 2016 (!) but didn’t become public until the raids of the firm’s offices in 2018. After the raid, Canada’s national police force alleged Fortress had inflated property values and misled investors about project risks.

“It is alleged that the founders of Fortress Real Developments engaged in fraud by orchestrating an ongoing scheme whereby they did not disclose the various risks to brokers and investors,” reads this week’s charge notice from the RCMP. 

Petrozza, one of the two charged this week, came out of a 3+ year hiatus on Twitter to proclaim their innocence. 

Regardless of the outcome, Canada’s real estate industry will change drastically. The CSA, which facilitates harmonized regulation across provinces, began a syndicated mortgage framework. This has resulted in the first steps of regulating an industry that had been the Wild West.

Provincial regulators are also openly warning investors not to participate in syndicated mortgages. In Ontario, they were called unsuitable and risky for the average person. They’re currently seeking input on further regulation of the industry. Similarly, Nova Scotia warned investors that syndicated mortgages are “extremely risky.” 

Your friendly local regulator warning against an investment product isn’t great for business. This is likely to throttle capital to the industry, which might not be immediately obvious. Low rates would have helped to conceal the issue, allowing more leverage. However, as interest rates rise and markets pull back — would you, as an average person, put cash into an industry regulators warned you to stay out of?