Money laundering is shaping US cities

The Washington Examiner - Pete Kasperowicz - 30 March 2017

In a little-noticed statement, the Treasury bureau responsible for investigating financial crimes shared a remarkable money laundering statistic last month.

Thirty percent of the cash purchases of high-end real estate by shell companies in six major cities involved a suspicious buyer, according to an investigation conducted by the Financial Crimes Enforcement Network to find out who was behind the deals.

In other words, money laundering plays a significant role in shaping U.S. cities.

But money laundering is only one reason that foreign investors might pour money into luxury condos and exclusive addresses. Foreigners also prize expensive real estate because it allows them to evade taxes in their home countries or escape government restrictions on using their own money.

All that money being poured into U.S. real estate is contributing to affordability difficulties for middle-class families and to the loss of vitality in many of the country's richest neighborhoods, which have seen an influx of cash but not necessarily actual residents. Even so, the U.S is mostly in the dark about the quantity of such investment or the investors behind it.

The Treasury effort

The best hope for transparency in luxury real estate markets is the probe undertaken by the Financial Crimes Enforcement Network, commonly referred to as FinCEN.

FinCEN was created in 1990 by President George H.W. Bush's Treasury to manage anti-money laundering efforts, and the Patriot Act gave it bureau status. Over the years, FinCEN has entered the spotlight for efforts such as investigating money laundering by drug dealers and probing possible terrorist use of bitcoin, at times earning criticism from privacy advocates.

Early last year, the bureau announced that it would begin investigating money laundering through real estate in New York City and Miami. Under authority given to the bureau by the Patriot Act, it can require all financial institutions in an area to report on big transactions, for a limited period of time.

For real estate money laundering, however, requiring reports from banks wouldn't help. The prevalence of all-cash purchases, carried out by shell companies on behalf of buyers, means that banks are often not involved.

So FinCEN instead placed the reporting requirement on title insurers, who are involved in almost every transaction.

The bureau began with shell company purchases of high-end real estate in New York City and Miami, two popular destinations for foreign investment. After initial success getting new information about the actual buyers, they expanded the requirements last summer to include four other cities: Los Angeles, San Francisco and Silicon Valley, San Diego and San Antonio.

Currently, a "handful" of FinCen's 325 employees pore over the data provided by the title insurers, according to a spokesman for the bureau. The program is authorized through late August, and title insurers expect that FinCEN will seek to turn it into a permanent regulation.

The prevalence of shady investors came as a surprise. The 30 percent figure was "certainly higher than we thought we were going to see when the industry first had to do this," said Steve Gottheim, senior counsel for the American Land Title Association.

Previously, authorities could only guess about who was buying what.

No reliable public dataset on the foreign share of real estate purchases is available, because the widespread use of local shell companies makes those statistics meaningless.

A more reliable estimate might come directly from industry sources, such as real estate agents or title insurers. The New York Times estimated in 2015, based on figures from the property data service First American Data Tree, that nearly half of purchases of residential real estate over $5 million in past years were made by shell companies.

But that figure doesn't break down how many shell companies are working on behalf of foreign owners. After all, Americans might have their own reasons for using shell companies. Even in the case of an identifiable foreign owner, it's not possible to know that owner's reason for buying anonymously — whether it's a legitimate purpose or something illegal.


The FinCEN statistic, however, is one clear datapoint. It covers some of the markets of greatest interest to the public, including the very high ends of the markets in Manhattan (sales above $3 million), Miami (sales above $1 million) and elsewhere.

And it covers cash transactions, which are a major slice of the deals in some of the markets. For properties priced above $2 million in Manhattan, for instance, about four-fifths of sales have been made in cash in recent years, said Jonathan Miller, president and CEO of Miller Samuel Inc., a real estate appraisal and consulting firm.

Those are the most rarefied real estate transactions, but also the ones viewed most suspiciously by law enforcement. "There's an automatic assumption that it's the potential fruit of criminal activity or terrorist activity," said Konrad Motyka, a former FBI agent who worked on money laundering cases and who has advocated legislation to mandate more transparency. Actually, Motyka said, cash transactions are more likely to represent tax evasion or capital controls evasion.

Safe Deposit boxes

A perfect storm of events led to a boom in ultra-expensive real estate as an investment in the wake of the financial crisis, Miller said.

All over the world, investors rocked by the crisis sought safe real estate assets they could pour money into. At the same time, wealthy individuals in countries such as Russia and Venezuela increasingly faced the threat that they would lose the ability to move money out of the country because of controls imposed by their own government or sanctions levied by other governments.

"They were building the world's most expensive safe deposit boxes," Miller said.

Investors' motivations for buying those safe deposit boxes vary from city to city. For example, in Silicon Valley and the West Coast generally, the buyers are more likely to be wealthy Chinese individuals aiming to stay one step ahead of authorities who could appropriate their funds. In Miami, buyers are more likely to be from South America.

Michael Repka, the CEO of DeLeon Realty in Silicon Valley, said that over the years he has seen an influx of Chinese investors seeking to move money out of China before the government imposed rules meant to curb inflation. He also saw an uptick in Russian buyers following the collapse of the ruble in 2014 as Russia was hit with new sanctions for its actions in the Ukraine.

Cities such as New York and Vancouver could supply assets that couldn't be taken away in the form of buildings and condos. Higher prices meant more money protected in each transaction. (AP Photo)

Those investors don't necessarily have a particular interest on where they're buying property. "We need to sell them on the Bay area," he said. His firm has bought a plane to fly prospective buyers over the Golden Gate Bridge and the Santa Cruz Mountains to show them the region's beauty and convince them to buy there rather than in Vancouver or Los Angeles.

More recently, Repka noted, he has seen that even white, American buyers are reluctant to buy properties that would be culturally disfavored in China. Worried about resale value, those buyers don't want homes with an address number ending in the number four or with a street perpendicular to the house, which are viewed as unlucky in China or harmful for Feng Shui.

The trends of international speculation in U.S. markets can be seen, at a high level, in the investment flows between countries such as China and the U.S. for commercial properties. And the varying preferences by country of origin can be seen in online searches. Ralph McGlaughlin, the chief economist for the real estate site Trulia, noted that searches on the site from foreign countries allow Trulia to see "foreign interest wax and wane over the years."

On a granular level, however, it is difficult to know who is behind the shell company purchase of any given property.

Even for investigators at the FBI, figuring out the true owners of a property is difficult. Over the years, however, a few cases have provided a window into the shady world of shell company real estate transactions.

One came last year, as part of the major leak of corporate information from the Panama-based law firm Mossack Fonseca, which maintained hundreds of thousands of shell companies for clients. That leak, commonly referred to as the "Panama Papers," revealed the individual behind a $3 million purchase of a Miami oceanfront condo in 2011. The owner was Paulo Octavio Alves Pereira, a Brazilian politician facing corruption charges in his home country, the Miami Herald reported last year.

In 2015, the New York Times published the results of an exhaustive investigation undertaken by its journalists that traced a Russian banker suspected of ties to gangs to the purchase of a nearly $16 million condo in Manhattan's Time Warner Center. Other owners in the same building included a Greek businessman arrested for corruption in his home country and a Chinese contractor penalized for labor violations in the U.S.

Problems with foreign ownership

Generally, the U.S. tries to encourage foreign investment, rather than discourage it. But shell company purchases of real estate are different, for two main reasons.

The first is that they tend to raise housing prices.

If a party official in China or businessman in Brazil decides to park his money in a condo in Manhattan, that "represents additional demand for property," McGlaughlin said. Without a corresponding increase in the supply of housing, that "means that prices are going to rise."

So money driven into the U.S. for money laundering or tax evasion purposes raises prices in supply-constrained cities, putting affordability out of reach for some people.

And unlike domestic demand, which usually grows slowly and predictably with the population and demographics, foreign investment can change a city quickly. A looming crackdown on money leaving the country in China, for instance, could spur a rush of funds into Bay Area housing.

Matthew Pointon, the property economist for the economic research consulting firm Capital Economics, concluded in early 2016 that forcing disclosures of owners would drive down property prices in markets targeted by FinCEN — the flip side of those privacy-seeking investors driving up prices in the first place.

That means that U.S. high-end real estate's attraction as a safe haven for shady investors contributes to the country's affordability problem.

The problem is acute in places such as New York City, where the median rent rose 20 percent over the past five years, according to the most recent data from the Census Bureau. That easily outstrips inflation. In New York, the typical renter can expect to spend about 44 percent of his or her income on the median rent, according to Zillow, much more than the 30 percent viewed as affordable by the Department of Housing and Urban Development. In San Francisco, the figure is 55 percent.

Another problem, separate from affordability, is that foreign investor ownership of properties in pricey neighborhoods tends to turn those neighborhoods into museums.

In some neighborhoods, the condos may be sold out — but empty. In Manhattan, for example, the blocks between Lenox Hill and Central Park, between 63rd and 70th Streets, are nearly 40 percent unoccupied, according to the Census Bureau. On the Upper East Side's most exclusive tract, along Fifth Avenue, more than a quarter of properties are vacant.

The reality is similar in other exclusive neighborhoods throughout the country. More than half of the beachfront properties in the neighborhoods at the ends of Miami Beach, Bal Harbour and the southern tip of South Beach are unoccupied. Because of unoccupied downtown condos, the South Beach neighborhood of San Francisco is one-fifth unoccupied, in the middle of one of the tightest housing markets in U.S. history.

In certain neighborhoods overlooking the beach in Los Angeles and San Diego, the story is the same — a third of properties in Malibu are vacant, as are half of the homes in San Diego's Oceanside neighborhood.

The broader trend of investors buying luxury properties as investment vehicles rather than as homes is illustrated by comparing rental prices against sale prices.

In Manhattan, for instance, luxury sale prices — defined narrowly for the purposes of this comparison as the top 10 percent of the market — have risen out of line with luxury rentals. Between the beginning of 2000 and the end of 2016, rental prices were up 1.2 times, but sale prices were up three times, according to data provided by Miller Samuel. The split reflects the outsize demand for investments rather than residences.

Stopping it

Another obvious reason for concern about shell company purchases of real estate is that they may facilitate terrorist activity.

Last year, Sen. Sheldon Whitehouse, D-R.I., introduced legislation that would require companies to file information to the Treasury about their "beneficial owners" — the actual individuals standing to benefit from the company. Without such legislation, the U.S. "is a preferred destination for terrorists, drug traffickers, tax cheats and other criminals," Whitehouse said.

In past years, Democratic Rep. Carolyn Maloney and Republican Rep. Peter King have backed the legislation. Both represent New York City, the top terrorist target in the U.S.

Last year, the Obama Treasury published a rule requiring banks to collect information about the true owners of shell companies when they open accounts. The agency, however, noted that the requirement wouldn't catch much money laundering or illicit transactions. All-cash real estate transactions, for instance, would evade that transparency rule.

Both the Obama and Bush Treasury departments favored legislation requiring companies to list beneficial owners when they form. The Trump Treasury, still being staffed, did not respond to an inquiry about its views on the subject.

Nevertheless, Motyka, the former FBI agent, said that listing the beneficial owners of shell companies would only be the first step in preventing money laundering and terrorist financing from the perspective of law enforcement officers tasked with tracking down bad actors. It would provide only a "sign post in the investigation."

For the purposes of aiding housing markets, however, a more direct approach might suffice, without learning the true owners of a property: taxing unoccupied units.

Vancouver, one of the cities most exposed to foreign investment, this year introduced an "Empty Homes Tax" of 1 percent of the value of under-occupied properties. In 2013, the United Kingdom enacted a similar tax of up to about 1 percent, but with a twist: The tax applied to residential properties owned by shell companies, creating an incentive for the owners to take direct ownership, thereby increasing transparency.

The early reaction to the U.K. tax, however, has been for far fewer owners than expected to reveal themselves, Capital Economics' Pointon noted, indicating just how much investors prize privacy.

The Financial Action Task Force, a group of several dozen governments created to set rules to combat money laundering, dinged the U.S. in a December report for allowing the relatively free operation of anonymous shell companies.

The flip side is that companies in the U.S. enjoy strong privacy rights to go along with the rule of law, strong property rights and other features that make the country attractive to invest in.

Motyka, however, warned that the problem of illicit or criminal activity facilitated by shell companies could eventually hurt "our brand," which is that money is clean.

Of course, the U.S. brand is also that it is the best place in the world to invest. The trade-off between transparency and investment from shadowy sources has long been made more difficult to assess because of the lack of information about shell companies and real estate.