Fraud in the Real Estate and Construction Industry: Recognize, Prevent, Detect, Respond

November 18, 2014

Recognize, Prevent, Detect, Respond

Globally, the real estate and construction industry ranks among the highest in both the number of fraud cases reported and the average amount of loss due to fraud. The benefits of understanding types of frauds facing your industry, having the know how to identify early warning signals, knowing how to reduce fraud exposure, and how to react when faced with fraud goes far beyond avoiding immediate monetary losses.

The Canadian real estate and construction industries continue to prosper despite the naysayers. As key stakeholders in the industry, property development companies, contractors, real estate investors, property management companies, construction firms, lawyers and accountants, the opportunities and challenges we face today are unique and some would say the industry is in unchartered territory. While the challenges are many, the one many organizations fall victim to is thinking “fraud could never happen to us”. The fact of the matter is that companies with good systems to reduce fraud exposure generally have been victims of fraud in the past.

Most organizations react to fraud rather than take proactive measures to prevent it from occurring. Studies indicate proactively handling potential fraud exposure is far less stressful, easier on the wallet, and keeps businesses focused on what they do best, which is running their business. To be effective in managing fraud risk, companies must understand the types of frauds prevalent in their industry, take measures to reduce exposure to fraud as it cannot be eliminated, implement systems that assist in detecting red flags indicative of fraud, and prepare a course of action in the circumstance that fraud occurs.


Understanding who perpetrators of fraud are, how they commit fraud and why fraud may be committed will provide great insight to any organization that has the desire to proactively control fraud risk. Studies show companies on average lose approximately 5% of their annual revenue to fraud, and this figure is twice as much in the construction industry.

Given the complexity of the procurement process in real estate and construction projects, fraudulent activities are commonly identified during procurement. The potential culprits can be many including suppliers, contractors, employees (purchasing, accounting, sales), joint venture partners, third party agents, and property managers. Interestingly, motivation to commit fraud is not always personal greed but may be personal or business related, and financial or emotional. Examples of motivating factors include greed to support lifestyle outside one’s financial means, personal financial distress, economic pressures, and/ or satisfying commitments to business partners.

A fraud susceptible environment in the real estate and construction industry is generally fostered by weak/lack of internal controls, use of related parties, use of joint venture parties, especially in unfamiliar jurisdictions, poorly designed project scope, poorly worded contracts, employee/supplier collusion, use of undocumented workers, and use of cash, among others.

Most common fraud schemes noted in the real estate and construction industry include bribery and corruption, bid rigging, billing schemes, cheque tampering, expense account abuse, stealing non-cash assets, material switching, falsifying payments, use of phantom suppliers and payroll schemes. Examples of many of these have been reported in the Canadian media in the recent past.


The best fraud prevention strategies begin with knowing your weaknesses, the areas of operations susceptible to fraud and implementing appropriate internal controls. A thorough risk assessment of a company’s operations is the first step. This risk assessment should include identification of risks, review of existing controls, policies and procedures. Some of the red flags indicative of potential fraudulent behaviour in the industry include use of sole source awards on construction projects, unusual bid patterns, unsuccessful bidders being hired as subcontractors, use of related parties, common ownership, poor job costing, excessive use of change orders, and lack of segregation of duties.

Specific prevention steps companies should consider include implementing a strong anti-fraud regime including creating a fraud policy, conducting fraud risk assessment, internal controls such as conducting due diligence on suppliers, agents and employees, and a whistle blower hotline. All of this should be completed as part of an organization’s overriding governance program and its effectiveness should be tested via regular monitoring and oversight.


A good prevention program will certainly reduce exposure to fraud, however, despite best intentions no prevention program will be able to guarantee fraud will not take place. This is a function of the human factor and the trust that is necessarily inherent to assume employees will carry out their fiduciary duties to the company. Individuals can circumvent controls, override controls and most of all collude with others. Studies have shown that a substantial number of frauds have been detected via tips. A fair number have been detected via management review, internal audit, performance of account reconciliations or by accident. Some specific detection procedures relevant to the real estate and construction industry include:

  • Detailed comparison of budgeted costs to actual costs, including all budget revisions
  • Scope change order analysis — comparison between original scope and budget and reasons for the change orders, i.e. change in specifications/drawings
  • Review the bid selection process to ensure compliance with policies
  • Review support provided as proof of reimbursable charges being claimed
  • Detailed analysis of any general/soft accounts such as “contingencies”
  • Random checks of payments being made to suppliers to identify phantom suppliers, fictitious invoices and/or inflated billing rates.

Based on the company’s size and transactions, these checks may be conducted on ad hoc basis or as part of a formal continuous monitoring program.


When faced with fraud, having a well thought out contingency plan is invaluable to allow the company to seamlessly handle this adversity. The response plan should give consideration to the parties suspected of fraud, internal and/or external; internal/external communications; professionals to call to seek advice on issues such as legal, insurance, evidence preservation, human resources, quantification of loss and so on.

The benefits of implementing a strong fraud prevention, detection and response strategy will not only help organizations better prepare for the unknown, but also set high expectations for anyone wanting to do business with them in the future.

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Contact us:
Chetan Sehgal, CPA, CA•IFA, CFF, CFI, CAMS, MAcc
Senior Manager
416 775 7812 Ext 4093