Why property investment schemes are best avoided

The practice of conveyancing can be complicated, with the conveyancer having to deal with a wide range of issues as part of their due diligence when examining and reporting on title. This article looks at the issue of property investment schemes and hopefully offers some guidance as to why these are best avoided.

What are they?

Examples of such schemes can involve (a) the acquisition of a site to be developed as a car park, with individual spaces being owned by investors then leased back to the developer who would then sublease individual spaces to third parties; and (b) developments involving the acquisition of a site to be developed as either an hotel or student accommodation, with individual rooms being owned by investors and sublet as mentioned above. In each case, a firm of solicitors is retained to act for the developer and purchasers/investors are offered the services of a nominated firm of solicitors to advise them, with fees being payable by the developer.

The position in England & Wales

In England & Wales, the Solicitors’ Regulation Authority (“SRA”) is a regulatory body which protects and helps the public by making sure that solicitors and law firms meet the SRA standards. It has no locus in Scotland. That having been said, there are a number of guidance notes issued by the SRA which are worth looking at. One such guidance note in the form of a “warning notice” on this topic was first published in 2017 and amended in 2020.

It is an open publication which contains very good guidance and risk management awareness points for solicitors when faced with an invitation to advise either a buyer or a seller in a property investment scheme. The Law Society of Scotland has never issued a similar warning notice in Scotland but, in my experience, solicitors are aware of the issues surrounding such schemes. Nevertheless, there is an increasing trend for solicitors to be asked to get involved in such schemes.

The dangers

In my opinion, such schemes can be described from a risk management perspective as speculative at best and downright dangerous at worst. They are “high risk”. As a result of sometimes dubious or questionable investment schemes being clothed in legal language, they can lead to solicitors and law firms giving credibility thereto. As such, warning bells should be ringing in the head of any solicitor who has agreed to act for prospective purchasers – especially when these purchasers are being directed to the same firm of solicitors as part of the deal with the developer. 

In such circumstances, human nature being what it is, many prospective purchasers will choose that option as it looks as if it should save them an outlay – as the said solicitors would be acting for parties with a common interest, so “everyone should benefit”. That does not make it the correct decision, however. In essence, the inherent risk involved in such a transaction is that the buyer carries all the risk, especially with funds being released to the developer, the said funds being used to buy and then develop the property – or maybe not, if the developer was possessed of a fraudulent intention.

The SRA warning notice is an excellent example of its type – especially since it is made clear that the advice therein is for solicitors, their managers and employees and for members of the public. It is, in my opinion, unfortunate that the Law Society of Scotland has never issued such a detailed notice to member firms and the public in Scotland.

The warning notice makes a good point about the level of deposit commonly encountered in commercial property transactions (10%) and the level of deposit often encountered in such investment schemes – up to 50%. The SRA is quite correct to state that it views such investment schemes as being “collective investment schemes” or, in worst cases, what are referred to as “Ponzi” schemes. Such transactions are examples of what the SRA describes as “red flag” transactions. 

There are examples of schemes having failed for a variety of reasons. These include:

• insufficient capital had been raised from deposits;
• developers going into administration (after having received substantial deposits from investors);
• the development has simply not progressed; and
• the money invested has been used by the developers for purposes not connected with the scheme.

The net effect of such failures can be a claim against the professional indemnity policy of the legal firm that has given advice to the investors.

What to do when asked to be involved in such schemes?

Where a solicitor is acting for the buyers in these types of transactions, you must advise your clients fully about the transaction and how it significantly differs from the simple conveyance of an existing property (if appropriate, advising against entering into the transaction). In addition to the issues outlined above you should explain that:

• buying a property not yet built or completed, i.e. a transaction which is buyer-led or where the property is subject to significant refurbishment, involves a substantial risk that the developer or seller could fail, and money will be lost;
• promises of substantial returns can be misleading. Standard warnings in publicity to prospective investors about the risk of capital loss are not enough to make sure that you have properly advised your client on the risks of the transaction.

In conclusion, the best advice if asked to advise anyone in such a scheme may be to say no. Risk management should always be to the forefront of a solicitor’s mind. To that end, in the absence of anything akin to the SRA warning notice in Scotland, solicitors should review the terms of the warning notice and, in particular, the red flag issues and practical tips about the nature and range of such schemes which are often encountered in practice. We would also do well to remember the old adage that “All that glitters is not necessarily gold”.