If someone’s looking for a playbook on the risks involved in investing in real estate abroad through a broker, Central District Court Judge Jacob Shienman recently produced a 70-page volume that makes for perfect reading.
It came in the form of the judicial ruling he handed down in a case involving a suit by 22 investors against the overseas real estate marketing firm TGI and its executives.
“TGI provided deceptive data, misrepresentations and didn’t provide investors with information it was required to provide – and based on this, the investors entered into contracts,” the judge said in summary. He ordered the contracts the Israeli investors had signed with the company to be rescinded, on the grounds that there were major discrepancies between what was written in the contracts and the marketing material the investors received.
The Israeli investors who filed the suit initially approached TGI in 2006 and 2007, after seeing advertisements in the local media or after being recruited through a system in which one friend brings in another. Waiting for them at the company’s stylish offices were a sales staff that offered professional-looking material about the company, the real estate assets it had available in its portfolio and past successes, giving the investors the impression that it had an established track record and reputation.
TGI’s marketing pitch was the same toward all potential clients, giving them the impression that they were buying quality real estate assets at less than their market value. Clients were left with the idea that by buying at below-market prices, they could flip their assets quickly and turn a profit. The investors weren’t sold whole properties but small stakes in large, income-producing pieces of real estate that could be purchased for a few tens of thousands of dollars – within the budgets of small investors. The property was represented by TGI as rented to full occupancy at relatively high rental rates, on long-term leases of at least five years.
In the case before Shienman, the investors who sued had put money into five residential rental projects in Canada. For the first two years, they enjoyed the income stream they had been promised every quarter. But after that, the amounts began to decline until the payments from TGI stopped altogether.
In 2009, TGI representatives informed investors that the properties needed to be renovated, and this would require the investors to put more money into the properties. That aroused suspicion among some investors, since this was not how things were represented to them when TGI was marketing the properties. Relations with TGI soured and, in 2010, the investors sued.
The defendants named in the litigation included Yossi Tuviyahu, the CEO and driving force behind TGI, and Sharon Shati, a shareholder of one of the companies. Most of the companies were trusts set up by TGI. Another one was Ontario Limited, a company controlled and run by Tuviyahu, which investors were told was a real estate development firm that would manage their properties. Ontario Limited was depicted as a Canadian company, with no mention of the fact that it was controlled by Tuviyahu.
In their suit, the plaintiffs asked for the contracts with TGI to be voided and for 6.7 million shekels ($1.7 million) to be returned to them. In its response, TGI claimed that investment in overseas real estate by its very nature entails both benefits and risks, and the contracts prominently stated that the company was not guaranteeing a return on investment. TGI’s lawyers pointed to the bursting of the real estate bubble in 2008, which affected Canada as well as the United States, as the main reason real estate didn’t continue earning income as it had in the first years.
The main issue facing Shienman was whether the economic crisis was the real reason for the investors’ problem, or whether, unconnected to the crisis, the investors were deliberately misled by TGI’s representatives and therefore overpaid for the real estate.
By the end, the judge clearly felt the investors had been deliberately misled and in a premeditated fashion, beginning at the sales-promotion stage and during negotiations with the plaintiffs.
“Based on the data presented to the investors by TGI and the promises [of the company representatives], the investments appeared solid, reasonable, rational and saleable,” the judge concluded. “Even if there is substance to the defendants’ argument that, by its nature, investing involves possible risks and rewards, and does not provide a fixed return like a bank deposit, such an argument does not justify legitimizing misrepresentations and deception of the other side.”
Shienman related to the concept of a “promised return,” which many real estate firms use to dispel the concerns of potential investors and to convince them that what is being offered is a solid investment. In the case of TGI, the plaintiffs were told that the property they were buying an interest in was fully occupied by tenants paying relatively high rents. Detailed information on returns on investment were provided, showing that the properties’ rental income covered mortgage payments and other costs.
In reality, though, the contracts the investors signed with TGI contained very different terms. Among other things, all the guarantees in the sales pitches were absent. The judge ruled that a customary clause – that any terms made prior to signing a contract but not included in the contract itself were void – was insufficient to negate the representations made in the sales pitches.
“TGI, Ontario [Limited] and the other defendants conducted negotiations that were not in good faith and deceived the purchasers to whom material facts were not provided,” the judge ruled, adding that, absent these representations, the plaintiffs would not have entered into the transactions.
Although Shienman voided the contracts, he didn’t absolve the investors of negligence. In the end, though, he said it was no excuse for deception and exploiting an investor’s lack of knowledge.
The trial revealed that there were discrepancies of tens of percent between the value of the properties when they were being pitched to investors and their actual market price at the time. In addition, TGI and Ontario Limited were represented as two unrelated companies, when in fact Tuviyahu actually controlled them both. A false property registration report in the name of the investors was found at the Land Registry as well.
The prices TGI had supposedly paid for the properties were presented to the investors in writing by TGI sales representatives and at various stages of the sales promotion process. But the real market prices, it turns out, were quite different.
The judge said he accepted the defendants’ argument that a business is not required to sell property to investors at the price at which it was bought, which could deprive the seller of any profits. “But to the extent that the defendants made false representations, through which they sought to conceal the real purchase price from the plaintiffs or to deceive them with regard to the purchase price, then it involves deception,” the judge ruled.
Most of the properties were represented as being worth between 22% and 40% more than TGI had paid for them. But in some cases, the discrepancies were as much as 65% to 78%.
And what about the promise regarding returns? “From the evidence presented to me,” said Shienman, “it clearly appears that the subject of returns, which were part of the pre-contract presentations and the basis for the contract, were in practice an inseparable part of TGI’s contractual obligations.”
The returns that were promised were not guaranteed, the judge noted. “To hide this fact, for the first two years after the purchase, TGI continued to send the investors the promised returns – even though in practice the rents received from tenants at the time were not sufficient to cover such a return. There is some basis to the investors’ belief that full payment of the return was made from proceeds of new purchasers who joined in the first two years.”
The judge noted also that the original residential tenants were people with limited financial means who had sold their homes to Ontario Limited and remained in them as tenants. Ontario Limited immediately turned around and sold the properties to the plaintiffs for a considerable amount more, while TGI received a broker’s fee in the process.
The global financial crisis may have hurt the value of the investments as well, but at the trial it became clear that the properties were problematic regardless of the crisis. TGI claimed the investors assumed a risk that ultimately became a reality. But Shienman rejected this argument, saying that deception of the plaintiffs went beyond the business feasibility of the venture.
A representative of TGI declined to comment for this article.