Sunday, October 10, 2004

One neighbor sued another over placement of this backyard swimming pool at the Bluffs at Mauna Kea, an exclusive subdivision along the Kohala Coast of the Big Island. The case has since focused attention on the 1990s practice of developers providing confidential discounts to buyers to stimulate sales, a practice some say is misleading and distorts public records.

Price break
generates legal fight
on Big Island

Part of a land lawsuit hinges
on the practice of hush-hush
discounts to encourage selling

A legal fight between two neighbors in an exclusive Big Island subdivision has shed light on a little-known practice from the 1990s in which developers gave buyers huge discounts -- sometimes in six figures -- to stimulate sales of upscale properties but required that the price breaks be kept confidential.

The nondiscounted amounts were reported to the state as the purchase prices, leading some to criticize the practice as a way to mislead prospective buyers into believing properties sold for full asking prices. Critics also said reporting the higher prices distorted public records commonly used when people buy and sell property.

But proponents defended use of the confidential credits, saying it was legitimate, legal and a way to boost initial sales in a new project, especially in a depressed market.

Several buyers, who in the late 1990s received what were called landscaping credits at the Bluffs at Mauna Kea, were required by the developer, Mauna Kea Development Corp., to sign confidentiality agreements to prevent the credits from becoming public, according to documents filed in the court case.

The buyers were allowed to disclose such information only to their lawyers, tax and accounting advisers, tax authorities and otherwise as required by law.

Even though the buyers got the credits for landscaping, they weren't required to spend that amount on landscaping.

In one 1999 deal in which a California couple paid $2.55 million for a vacant lot at the Bluffs, they received a credit of $450,000 -- the difference between the $3 million Mauna Kea sought for the oceanfront parcel and what the buyer actually paid.

When the couple reported the completed transaction to the state for conveyance tax purposes, they listed the purchase price as $3 million, according to the court documents.

If other would-be buyers, real estate agents or others subsequently checked the state's Bureau of Conveyances or other frequently used databases, which often rely on bureau records, to learn how much that lot sold for, they got the same answer: $3 million.

But when the couple, Irwin and Concepcion Federman, received a property tax assessment based on the $3 million price, they appealed. The Federmans told the County of Hawaii, which handles property taxes on the Big Island, that they had negotiated the $3 million list price down to $2.55 million and that the discount was reflected in the landscaping credit.

"This credit is only an accounting artifice to enable Mauna Kea Realty to maintain the recorded sales price at the amount originally listed," Irwin Federman, a nationally renowned venture capitalist, wrote in an appeal letter to the county in 1999. His appeal was approved.

At least three other buyers received similar confidential credits in the late 1990s at the Bluffs, and their purchase prices likewise were recorded with the state as the full list prices, according to the sales contracts, other developer documents and real estate industry data.

In one transaction, Mauna Kea granted a $1.3 million landscaping credit to a buyer of two lots, and the confidentiality agreement required him to pay the developer the full credit amount upon demand if the discount information became public through his actions, according to the agreement.

The Federmans and Mauna Kea have been sued by Guy and Julia Hands, an English couple who in 2000 purchased a vacant lot next to the Federmans' for $3.25 million, the full asking price.

The Hands and the company they manage, Western Sunview Properties, originally sued over the placement of the Federmans' backyard swimming pool, spa and deck, which are under construction, and whether the couple received the required approvals. Custom homes on both lots also are under construction.

The charges related to the swimming pool dispute against the Federmans recently were dismissed by federal Judge David Ezra, who is hearing the case.

But the original complaint has mushroomed to include fraud and other charges related to use of the confidential credits, and the bulk of those charges are scheduled for trial in April.

In court documents, the Hands claimed that the Federmans and Mauna Kea engaged in "a devious Enron-like scheme" to manipulate the market value of parcels at the 22-lot Bluffs, using the Bureau of Conveyances to pull off the fraud. Believing that the Federmans and other previous buyers paid full list prices for their respective lots, the Hands said they relied on that information to craft their offer, resulting in an inflated purchase price.

The Federmans and Mauna Kea have denied the Hands' allegations. In court documents, Mauna Kea said the Hands got an incredible deal and noted that two months later they received an offer for double what they paid.

The company also denied that false purchase prices were reported to the state and defended use of the landscaping credits.

"The credit provided incentive because purchasers, if they wished, could use the credit to pay for at least a portion, if not all, of their landscaping and grading," Mauna Kea said in a court filing. "The fact that landscaping credits, in effect, might act as post-closing discounts to the purchase price does not change the nature of the credit."

Andrew Beaman, the Honolulu attorney representing the Federmans, likewise disputed the Hands' allegations.

"The Federmans believe that the charges made against them in the lawsuit are unfounded," he said.

Beaman said his clients were pleased Ezra dismissed the original basis of the lawsuit, but he declined further comment, citing the pending litigation.

Attorney Douglas Ing, who represents Mauna Kea, also declined comment.

Asked in a sworn deposition in 2003 why Mauna Kea granted a $500,000 landscaping credit in a previous lot sale rather than simply discount the price, company executive Yoichi Asari said, "The reason was we didn't want to change the sales price."

Yet he acknowledged that the credit changed the amount the buyer paid, according to a transcript of the deposition taken for a previous lawsuit involving another plaintiff.

In another 2003 deposition for that case, Mauna Kea broker Kathrin Kohler was asked if the reason for using the confidential credits was so prospective buyers could be told the lots had sold at full price.

"Well, after a sale closes, it becomes public knowledge what the lot sold for, and this credit obviously was not reflective in the tax records," Kohler replied.

She agreed that the credit "was basically a discount."

Both depositions are cited in the Hands' case.

In his written ruling on which charges would be dismissed and which would go to trial, Judge Ezra referred to the reporting of the Federmans' purchase price as an intentional misrepresentation.

Citing the 1999 letter Irwin Federman wrote to appeal his property-tax assessment, Ezra wrote that Federman's statement "indicates that he agreed to under-report the price of his home to maintain the fiction that individuals at the Bluffs were purchasing lots at the list price."

But whether the Hands relied on the misrepresentation or were harmed by it is in dispute, requiring the fraud and other related charges to be argued at trial, Ezra ruled.

The practice of offering incentives or discounts to lure buyers is common in the real estate industry, especially in slow times. Some sellers advertise their offerings.

What makes the Mauna Kea case unusual is that a formal system was established to keep the discounting confidential, real estate experts say.

Most of the experts the Star-Bulletin contacted said they were surprised that buyers were required to sign confidentiality agreements.

"I have never heard of anything like this before," said Raphael Bostic, a professor at the University of Southern California's Lusk Center for Real Estate.

Nick Ordway, a University of Hawaii professor with expertise in real estate issues, said the practice appears to be an effort to distort public records.

He said the incentive to use confidential discounts to maintain high purchase prices exists even in a healthy market but didn't know whether such a practice is occurring today. "If you have a good market, the incentive is there to push prices even higher."

Bob Hastings, a Honolulu real estate appraiser, said giving confidential credits was a "completely legitimate" practice used occasionally at luxury projects during Hawaii's bust years in the 1990s. It is not being used now, he said.

Asked why developers insisted on confidentiality, Hastings said they were intent on not sending any signals to the market that values were falling.

"What they were really trying to do was fool the appraisers," he said.

A more common and effective way to accomplish the same objective was to have the developer agree to pay for future association fees or other "off-site" costs "so you don't create a red flag," Hastings said. "It's an easier way to hide the fact that you're giving discounts."

At the Bureau of Conveyances, registrar Carl Watanabe said his office doesn't get involved in determining how purchase prices are reported to the bureau and therefore couldn't address questions of legality. His agency simply processes the information, he said.

But Terrance Revere, Western Sunview's Honolulu attorney, said confidence in the bureau's records will be undermined if such schemes are allowed to persist, resulting in consumers paying artificially inflated prices.

"If developers are allowed to get away with something like this, consumers lose out," Revere said.

Apart from the confidential credits issue, the Hands' lawsuit presents an unusual peek into the normally private world of wealthy out-of-state buyers acquiring prime isle real estate.

The two principal litigants in this case are big-time players in the world of business and finance.

Irwin Federman is chairman of SanDisk Corp., a roughly $1.5 billion publicly traded company based in Sunnyvale, Calif. He also is general partner for U.S. Venture Partners, one of the leading venture capital firms in the country.

Forbes magazine once described Federman as one of the country's top venture capitalists. The San Jose Mercury News called him "the most honest man in Silicon Valley."

Guy Hands has major league credentials as well.

A London newspaper once described him as the city's "golden boy and kingpin dealmaker."

Last month he became Europe's biggest cinema owner, and media reports also have chronicled his company's recent attempts to acquire several major landfill businesses in Britain, prompting one newspaper to refer to him as the country's potential "rubbish dump king."

The two feuding executives are now spending some of their wealth in a Honolulu courtroom.

At a recent hearing, Judge Ezra took note of the costly dispute and wondered why it hadn't been resolved long ago.

"I can tell you that it looks to me like these are a lot of people, on both sides, who have far too much money and far too much time on their hands," Ezra said. "There's been a tremendous amount of assets spent here. I mean, you could build a very nice home, I am sure, for what has been spent in terms of attorneys' fees in this case."



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