New proposed regulations by the Financial Crimes Enforcement Network (FinCEN) of the U.S. Department of Treasury might put more pressure on U.S. commercial real estate professionals, including fund managers, to address money laundering in the industry.
Starting in December 2021, FinCEN solicited input from industry professionals on how best to address the issue of excessive secrecy and limited transparency in commercial real estate transactions, focusing on non-financed, or “all-cash,” deals. The organization hasn’t yet given a timeline for when the proposed new rules might be releases to the public, but proponents of stricter regulation say the rules could be introduced as soon as this month, or sometime over this summer, with enactment slated for 2024. FinCEN declined to make any additional comments on the matter, other than a statement that it intends to issue a notice of proposed rules to address money laundering threats in the U.S. real estate sector.
Currently, a lack of financial transparency enables bad actors to use U.S. real estate to launder their money, hiding the true source of their finances, as well as jeopardizing U.S. national security and financial system, according to those backing the measure. These bad actors include domestic and international criminal organizations, such as drug cartels and human traffickers, international terrorists, as well as sanctioned foreign oligarchs and kleptocrats.
According to a study published in August 2021 by Global Financial Integrity (GFI), a Washington, D.C.-headquartered think tank, based on a database of more than 100 international real estate money laundering cases, between 2015 and 2020 more than $2.3 billion in illegal funds had been laundered through U.S. real estate. Even that figure is considered to be “the tip of the iceberg,” since money laundering is so difficult to track.
GFI research found that about 30% of the cases it looked at involved commercial real estate and “the use of anonymous shell companies and complex corporate structures” appeared to be the number one preferred method for money laundering schemes. An overwhelming majority of the U.S. cases (82%) involved the use of a legal entity to conceals true ownership of property.
The think tank, along with other backers of stricter regulation, have centered the discussion around the fact that the U.S. trails behind other developed countries by exempting its real estate professionals from having to follow anti-money laundering regulations. When an investor buys property in the U.S., there’s currently no requirement for real estate professionals, starting from fund managers and ending with title agents, to do any background checks on whom they are selling real estate to. On the other hand, the E.U. has regulated real estate transactions to prevent money laundering since 2001.
At the same time, the stable performance of U.S. real estate relative to other asset classes, such as stocks and bonds, for example, and the country’s strong protections of private property make it a particularly attractive option for criminals and corrupt foreign officials to hide their money.
For example, earlier this year, FinCEN issued an alert to banking and commercial real estate professionals to be on the lookout for sanctions Russian elites, oligarchs and their family members who might have been attempting to evade sanctions by exploiting the vulnerabilities in U.S. commercial real estate regulations.
Among measures FinCEN was evaluating to curb such abuses was requiring people involved in all-cash commercial real estate closings to follow the requirements of its AML/CFT program and SAR reporting; ensuring that a record-keeping and reporting requirement be attached to at least one entity involved in every all-cash real estate transaction; expanding anti-money laundering regulations for the real estate industry from a number of targeted geographic locations to a nationwide status for transactions over a certain amount; and extending reporting requirements to trusts.
Any proposed new rules for U.S. real estate professionals and fund managers should require them to do their due diligence by getting to know who their customers are and the source of their money, and to report anything suspicious, noted Gary Kalman, executive director of Transparency International U.S., part of a global coalition against corruption. The rules need to apply to both residential and commercial real estate, he added.
“We have been pushing FinCEN to do both commercial and residential real estate,” Kalman said. “My sense is that they’re moving towards comprehensive rules around residential real estate, and I still think they’re trying to figure out if they have enough information because commercial transactions are much more complicated.”
FinCEN’s December 2021 request for input in part sought to address the question of how much commercial real estate transactions can be regulated without imposing undue burdens on the professionals involved, given the wider array of methods for investing in commercial real estate—for example, through CMBS bonds.
Yet if stricter regulations are imposed on investment in residential real estate, but not commercial transactions, money launderers would just “play a game of whack-a-mole” and switch their hiding places from one sector to the other, according to Zoe Reiter, co-founder of the advocacy group Anti-Corruption Data Collective. “We need to strike while the fire is hot and the attention is there,” she noted.
Right now, residential real estate is getting the bulk of illicit money, in spite of the fact that there are a few more regulations surrounding it, such as a Geographic Targeting Order requiring U.S. title insurers to identify the natural persons behind the shell companies used in all-cash residential purchases, according to Kalman.
Jyotswaroop Bawa, chief of organizing and campaigns with the California Reinvestment Coalition, noted that it was suspicious when during a period of ultra-low interest rates, 75% of limited liability corporations purchasing homes across the country were using all cash. “If these were small investors it would be silly not to borrow money when interest rates were low,” Bawa said. “I think it raised some red flags of who these people are who are buying property with all cash.”
Kalman and other supports of stricture regulations for both commercial and residential real estate transactions noted that the rules FinCEN was considering should be easy for fund managers and others to implement and won’t hinder companies from finding legitimate investors for their ventures. They come down to doing basic checks on who the potential investors are rather than asking for full-scale investigations to prove wrongdoing, he noted.
While there’s always a learning curve with new regulations, the rules being reviewed for adoption by FinCEN don’t appear onerous from either a time or financial standpoint, according to Tom Cardamone, president and CEO of GFI. In fact, partnerships and funds that have been raising money for their ventures from reputable sources won’t be negatively affected by them at all, he said. The rules will only “adversely affect” real estate professionals who take investments from shady characters who are opaque about where their money comes from while funneling it through corporate entities, LLCs and trusts, so their true beneficial owners aren’t known, Cardamone noted.
As it stands today, private equity, hedge funds and other entities that specialize in alternative investments have no responsibility to know who they are raising capital from, according to Kalman.
“Maybe I’m naive, but while there’s a lot of dirty money in a multi-trillion-dollar system, it’s still not a majority of the money,” he said. “I don’t think that either the real estate market or private investment market are suddenly going to see a downturn because they’re losing dirty money. I do think it’s going to remove some of the money from the system, and that’s critically important because we’re making it harder for these bad actors to steal, hide and launder and live off the proceeds of illicit funds. But we’re not going to see a downturn in investment returns with these rules.”
“I would like to think fund managers are getting most of their money from people who don’t have ill-gotten gains and haven’t gotten their money from trafficking, corruption or embezzlement,” echoed Reiter. “I think most are doing the right thing, but I think we need to make it a lot harder for the corrupt and criminals to launder money through private investment and real estate.”