Compliance and fraud have occurred frequently in the real estate industry. Surprising about cases, such as the current one at Vonovia, is the fact that they are not detected earlier or avoided in principle.

As a DAX Group, Vonovia maintains a state-of-the-art and audited management system. An effective controlling system is the first firewall – it is a necessary but not a sufficient tool to avoid fraud. For investors it is difficult to tell if a scam is at hand. However, consistently excessive monthly repair services provide an indication that something is wrong. As the largest player in this industry, Vonovia is of course not an isolated case.

What are the possibilities of fraud?

Fraud cannot be ruled out in any business model - but there are essential factors that make it very difficult for fraudsters to implement their scam. At Vonovia, internal confidants or helpers have also benefited from the fraud system. Such a sophisticated fraud system requires internal and external accomplices of the company who are in collusion with each other.

Larger companies, with group structures that also have capital management companies controlled by banking supervision as subsidiaries, seek and find value-creation opportunities in a wide variety of places. In some cases, smaller group subsidiaries are supplied with lucrative contracts, in other cases, there are individual capital management companies, whose management of the properties can be well paid for by other companies under the same corporate umbrella.

Fake invoices for repair widely used

In particular, services that are attributable to the repair of the building, and not to the increase in value of the building, offer many possibilities for fraudulent influences. These activities mostly include repair and renovation work. If the original condition is not documented, any work (quality & quantity) cannot be reliably traced. Fraudsters feel safe as this grey area can be exploited by service providers in the real estate industry if asset management is not sufficiently vigilant.

Effective real estate controlling helps to identify potential opportunities and at the same time avoids risks such as fraud. In the real estate industry, there are best practice values for repairs, which are largely based on the type of building and the condition. At the same time, investment companies, and even Vonovia, create business plans for repairs. If these are taken as a basis, deviations can already arise in the analysis, which indicate either opportunities or fraud.

Certainly, common sense also helps in detecting fraud. An investor and profit-oriented real estate company has a self-interest in avoiding unnecessary services at inflated prices.

Cleaning of oil and paint stains in parking lots or cleaning of bird droppings must remain the exception when awarding contracts. In Germany, the power supply is disrupted very rarely, so that the interference suppression of power lines is rather an exception.

Compliance Management System (CMS) can protect against fraud

If controlling or common-sense fails, a Compliance Management System (CMS) should protect against fraud – however, this also seems to have failed at Vonovia. The Compliance Management System consists of different elements. Essential for the function of a CMS are the values of a company and the goals derived from them. If, for example, employees determine that suspicious activity reports submitted in good conscience do not result in any consequences for management, then the compliance system is undermined.

In today's world, companies must ensure an open and value-oriented culture in their company. Whistleblowers must be protected. Whilst hierarchical and patriarchal structures provide a breeding ground for corruption and fraud, a culture of openness and integrity provides optimal conditions.

When looking at other cases of fraud such as Wirecard, in addition to the auditors, the supervisory boards in particular did not understand or carry out their job correctly. The respective supervisory bodies play a very important role in the implementation of the aforementioned elements and conditions. Supervisory boards have the task of actively monitoring the activities in a company, and the effect on corporate culture must not be underestimated. The more committed supervisory boards are to education, the easier it is to avoid fraud – in other words, they protect the open corporate culture.

Relationships with service providers and suppliers must remain professional. For example, Christmas parties or social evenings in hookah bars sponsored by contractors are to be strictly avoided.

Susceptibility to fraud remains high for the last 20 years

Lawyers who are familiar with such cases know immediately where to check and how to uncover the large and small scams with which complex structures, corporations, but also medium-sized companies illegally optimize their profits at the expense of employees, customers, investors or suppliers. Such instances happen again and again. Vonovia's predecessor, Veba Immobilien, was the target of a raid 20 years ago. At that time the raid was also based on suspicion of corruption.

Raid at Vonovia makes investors from other providers and investigators alike take notice

When intending to invest capital in fund units, it is advisable to first obtain information from the respective supervisory authority or a specialized lawyer about the company in question to avoid falling for fraudsters.

Since the raid on Vonovia became publicly known, unsuspecting investors in other unlisted real estate houses have also become worried. Since this is most likely not an isolated case, many are now more attentive and aware of the susceptibility to fraud in the real estate industry. In case of concern, investors can always contact a specialized lawyer, and of course the supervisory authorities directly. The Federal Financial Supervisory Authority (BaFin) is responsible for capital management companies, whether located in Bochum, Munich, Wiesbaden or Kiel.

Benjamin Hasan is a Board-certified specialist lawyer for banking law and capital markets law and partner in the Frankfurt office of international law firm Michael Kyprianou – Advocates & Legal Consultants. Over the years, he has analyzed a large number of presentations of real estate funds and conducted many trials in these and similar matters. He has also reviewed the effectiveness of various compliance systems in his employment as Chief Compliance Officer of a bank. He regularly receives inquiries from investors who invest in various corporate groups that offer the development, design and management of alternative investment funds (AIFs) with an investment focus on residential real estate.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.