The Effects of the Inflation Reduction Act on Real Estate Investment Strategy | Think about real estate
It’s best to be alert and prepared when considering your next real estate investment.
Wall Street and lenders are expected to be on high alert since the Inflation Reduction Act of 2022 (IRA) was passed, with $46.5 billion earmarked for enforcement activities. The question on everyone’s mind given the allocation of funds to the Internal Revenue Service is, “Will IRS audit rates go up?” The answer is “yes”, but what impact will this have on private lending?
Over the past few months, we have all watched closely as the Federal Reserve’s actions to control inflation have affected the housing market. Rising interest rates have slowed home sales and homes on the market are much less affordable than they were just three to six months ago.
As a result, housing affordability was reported as the worst in 37 years. The struggling market has caused home values to decelerate, leaving homeowners and real estate investors uncertain about the best time to consider a cash sale or refinance. The good news for some investors is that rental applications are still at an all-time high due to the already existing housing shortage.
Direct and indirect impacts
Real estate investors are seeing both the direct and indirect impacts of these market shifts, including shrinking profit margins, less cash available through refinancing, and tighter lending criteria on both short-term and long-term loans. Investors are challenged to balance cash liquidity options (i.e. selling or refinancing with decelerating values equates to less outflow) or refinancing and continuing to lease with higher monthly payments high. The flip side is that rental rates are increasing across the board, making those higher monthly payments possible.
The fact remains, however, that lenders and investors cannot forget that stated income loans (eg loans without verified income) contributed to the housing crash and financial crisis of 2007-2008. The tightening of lending criteria and underwriting guidelines is there for one purpose: to protect both the lender and the borrower.
The implications of these new rules may affect you as an investor, so it is best to be vigilant and prepared when considering your next real estate investment. New IRS auditors hired to improve the tax monitoring system will seek to enforce the law if you are late or commit fraud in paying your taxes, which could result in a lien on your properties and any properties you subsequently purchase. Anecdotally, we have seen an increase in the number of REIs who have become accustomed to loans without income verification and have been slower to pay taxes, and some have not filed taxes at all.
Check the boxes
Since the last report in 2018, only 32% of self-employed borrowers under-report their taxes and 36% choose not to file at all. You will need to be able to provide tax returns and show income/cash flow consistent with those returns in order to be approved for a real estate investment loan. Below is a checklist of what to keep in mind:
- Stated income is still a very popular route, but lenders will be much more conservative with the items listed below. Some lenders that require tax returns, proof of income, or cash flow will offer more aggressive terms. At the end of the day, most lenders aren’t as concerned about your declared income as the ones you deposited.
- Credit score will always be the most important indicator of whether you can afford your next real estate investment. You can be sure lenders will be stricter on minimum FICO scores and defaults.
- Many lenders will say that the second most crucial requirement besides credit rating is experience. Lenders want to see that you have already invested successfully. Lenders offering loans to inexperienced individuals may require proof of income or cash flow and more equity in the transaction (ie, lower ARV/LTV).
- Lenders want to play nice. Most lenders will increase what you need for your down payment or required cash at closing and other reserve requirements.
- LTV, or ARV, will continue to be reduced. Ultimately, lenders are hedging or anticipating lower market values, demanding more cash at close to further protect them.
When choosing a private lender, weigh your options. Look for a partner who keeps your success in balance with theirs and who has the flexibility to customize a product that’s right for you. Find the lender that can help you navigate the post-IRA inflationary environment we are currently experiencing.
Susan Naftulin founded RFG with her partner Jeffery Goldberg in 2009. In addition to being president of RFG, Naftulin serves on the Ethics Advisory Board of the American Association of Private Lenders, where she continually champions the values of the real estate industry and supports professional conduct in private lending. .
Prior to becoming RFG’s Chairman, Naftulin held several senior positions in the mortgage industry, including General Counsel, General Counsel, Chief Operating Officer and Senior Vice President for Private and Public Mortgage Lenders. . Prior to entering the mortgage industry, Naftulin was a creditor rights attorney with the Philadelphia law firm Fox Rothschild LLP.