How the Fraud Technique of “Irrational Ratios” Is Used in Reg D Multifamily Real Estate

By Barry Minkow

There are compelling accounting examples from the carpet cleaning industry that illustrate how fraud can be detected through irrational ratios. Consider ZZZZ Best Co. Inc. In 1984 and much to my shame, I reported gross profit margins of 30–40% on our largest sales. To support that narrative and satisfy auditor scrutiny, I employed three deceptive tactics:

1. Overstating Receivables: Receivables were inflated to boost the appearance of profitability.
2. Hiding Debt Obligations: Numerous undisclosed debt obligations were disguised as “income” or sales, and the debt kept “off books,” effectively concealing our true liabilities.
3. Inflating Revenue via Percentage-of-Completion: The percentage-of-completion method was manipulated to fraudulently recognize revenue.

Had the auditors made a phone call (the primary method of communication in 1984) to the Society of Cleaning Technicians, they would have learned that the industry’s gross profit margins were closer to 20%—a glaring discrepancy and red flag.

Accountants and fraud investigators refer to this kind of manipulation as generating “irrational ratios.” By comparing key financial ratios—such as gross profit margins and liquidity measures—to industry norms, one can identify anomalies that may indicate fraudulent activity.

Keeping these irrational ratios in mind, consider the findings from a 2024 report on private real estate investments and public REITs. Over a 25-year period, private multifamily investments produced an average net return of 7.66%, which is more than 200 basis points lower than the returns generated by public REITs. In November 2024, CEM Benchmarking released a study comparing annual returns from 1998 to 2022 for private multifamily investments (unlisted real estate) versus public REITs (listed equity REITs). Two important points from this study are:

1. Study Period Nuances: The analysis includes the years of escalating property values and low interest rates (2018–2021) but omits perhaps the worst year (2023) when inflation and rising interest rates significantly cut into returns.
2. Consistency with Other Studies: The report’s conclusions are consistent—though slightly higher—with those in “Further on the Returns of Non-Traded REITs, May 2022,” by industry expert Craig McCann of SLCG. Collectively, these studies establish a clear, time-tested average annual return for the private multifamily real estate sector.

According to the chart below, public REITs averaged annual returns of 9.74%, while unlisted multifamily investments averaged 7.66%. Essentially, public REITs outperformed private multifamily investments by about 200 basis points. More importantly, the established 25-year average for private multifamily is 7.66%.

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So, how do syndicators regularly advertise annual returns ranging from 15% to 25% (or even higher) on social media? For example, Viking Capital’s Peoria Gateway in Phoenix, Arizona boldly targets returns of 22–26%, while Bam Capital’s Funds III and IV offer 15–20%. Ashcroft Capital, with its Braxton Waterleigh project in Winter Garden, Florida, even advertises targeted returns ranging from 19–26%, with the promise that higher investments yield higher returns.

These advertised returns fly in the face of 25 years of track record data. In effect, these companies appear to be guilty of what can only be described as irrational ratio accounting fraud—the very technique I once employed at ZZZZ Best to deceive investors. In reality, multifamily syndicators typically generate returns that are about 200 basis points lower than their well-funded public REIT competitors. The average annual return of 7.66% is three to four times less than the figures touted to new investors in social media ads.

Worse still, the banks and lenders—who are well aware of these statistics—also see the discrepancy. These financial institutions during underwriting due diligence of the syndicators’ fund marketing materials (always in color) reveal targeted returns that promise percentages to investors which contradict 25 years of industry data. Lenders seem to have forgotten that financial fraud is never compartmentalized. Fraudulent promoters do not operate in isolation; when economic pressures arise, they apply deceptive methods across the board. Consequently, why would a lending committee at a major institution view an entity applying for a loan differently if it’s also running ads promising returns three times higher than its long-term track record? If a promoter is willing to lie to secure investor funds, why wouldn’t they lie to a financial institution as well? Perhaps this is why multibillion-dollar loan portfolios are now keeping board members up at night.

It's one thing to compare the “targeted” annual returns touted by Reg D promoters to those achieved by industry giants like Vanguard or Warren Buffett, and to argue that it's untenable to expect undercapitalized, over-leveraged syndicators to consistently outperform such benchmarks by twofold or more. However, it's an entirely different matter to juxtapose the returns advertised on social media with specific, time-tested industry data—and when weighed against that data, these promises are found wanting.