Was California House-Flipping Business a Ponzi Scheme?

Yet another “scheme” has reared its ugly head in the real estate industry. A seemingly successful apartment-flipping business based out of Irvine looks like it turned into a Ponzi scheme when things got financially tough for the company and its two owners.

In November, John Packard, co-owner of a real estate firm based in Irvine and Long Beach, pleaded guilty to setting up a Ponzi scheme to pay off old investors while continuing to recruit new ones for a plan to flip distressed apartment buildings during the Great Recession’s housing collapse. Co-defendant and former co-owner of Pacific Property Assets, Michael J. Stewart stands behind an attorney who has told jurors that Stewart is innocent and his plan was a financially prudent one because homeowners who lost their property in foreclosure would have to turn to renting apartments.

According to prosecutors, just before Stewart and Packard declared bankruptcy in June 2009 and the company’s 647 investors lost $91.6 million and the executives owed about $96 million in outstanding principal to banks, Stewart was telling every potential investor that he had an opportunity for the investors to make money because the business was thriving. Assistant U.S. Attorney Brett Sagel pointed out that, in fact, the company was failing, but Stewart’s plan was to have investors snatch up apartment buildings at “rock bottom prices” and refurbish them to fill the void in housing when evicted homeowners look for a place to live. He told investors they would be able to reap 15 to 30 percent interest a month.

Sagel goes on to say that Stewart’s and Packard’s business plan worked when they founded their company in 1999. Packard’s job was to acquire property, deal with the banks, get loans and manage the apartments. Stewart, an attorney and real estate broker, was in charge of recruiting investors. They would borrow money from banks and individual investors while acquiring apartment buildings and renting out units and selling or refinancing the properties. However, the rental income was never enough to pay the bills, but as long as property values continued to thrive, the model worked as they sold off and refinanced the buildings.

Come 2006, when the housing industry began its collapse, Pacific Property Assets found it more difficult to make a profit. By the end of 2007, the company had gotten its last refinancing deal, and the income from sales and loans had diminished. This left new investors as the only source of income. The decision was made to “step on the gas with investors,” Sagel said. Sagel also alleged that Stewart was giving a “rosy” account of the company’s future despite its struggles and his actions of drawing a substantial salary while pulling his investments out of the company. The money from new investors was supposed to be spent on acquiring apartment buildings, but it instead went to pay off old debts, amounting to a Ponzi scheme.

Attorney Kenneth Miller defends that Stewart could not have anticipated that the collapse of the housing industry would spread to apartments as well. Stewart and Packard’s company had a solid track record and had earned praise for its business model before the economy cratered and up until April 2009, Pacific Property Assets had never failed to make a payment on a loan or to an investor.

What do you think? Was this a full-blown Ponzi scheme? Are Stewart and Packard guilty?

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