Freddie Mac (FRE) is set to tighten its underwriting standards to finance apartment rental buildings, a hit that comes as the multifamily sector shows increasing strain from the crumbling economy.

The changes apply to loan applications effective Monday, with stricter controls on net operating income, boosted-debt-to-coverage ratios and required maintenance reserves.

"We've tightened our multifamily credit parameters to ensure that they reflect the risk associated with current market conditions, such as declining property values, changing credit quality and lack of property sales activity," said Ed Hussey, vice president of terms of business for Freddie Mac's multifamily division. The sector is a small part of Freddie's business - its multifamily loan portfolio was $84 billion, compared with a residential portfolio of $1.8 trillion as of Sept. 30. But it's a big deal to apartment operators that count on Freddie and Fannie Mae (FNM), dubbed GSEs or government-sponsored enterprises, purchasing or guaranteeing individual and pools of loans from another lender, providing key access to capital in an otherwise frozen market.

The access has helped the sector shine within the battered world of REITs, which distribute the bulk of income to investors as dividends. So far this year, apartment REITs have shed 12.14%, compared with a 23.41% plunge for industrial and a 19.83% drop for self storage, according to the National Association of Real Estate Investment Trusts.

But, as the unemployment rate climbs, apartment operators are predicting a weak year, warning vacancies will likely rise, making rent increases difficult. BRE Properties (BRE) expects annual same-store net operating income to decline between 1% and 3.5%. Earlier this week, Aimco (AIV) announced an $85.4 million impairment charge related to land and developments, its second such announcement this month, according to UBS. Five other REITs have taken charges, with more expected.

Freddie's move "demonstrates that there's fundamental stresses and that they want to protect themselves, as they should," said Richard Anderson, an analyst with BMO Capital Markets. "Fundamentals are weakening, and they want to be compensated for taking on that risk."

The imminent Freddie changes, along with continued negative economic headlines, helped drag down the sector Friday afternoon. AvalonBay (AVB) shaved nearly 4%, while Home Properties (HME) fell more than 3%. BRE slipped about 1%.

Starting Monday, when forecasting NOI, Freddie is placing greater emphasis on the past 12 months of operations. "The emphasis is on what is happening right now because this is in a market that we've never faced before economically," Hussey said.

The minimum debt-to-coverage ratios, measuring a property's ability to cover mortgage payments, have also been tightened, while the maximum loan to values, or LTV, are smaller, UBS said.

For loans less than a decade, that is 70%-75%, Freddie said, confirming information UBS analyst Michelle Ko distributed earlier Friday. Requirements for assets in underperforming markets and those older than 15 years are tighter.

During the heat of the market in 2005, borrowers could have an LTV "well into the 90% range, if not 100%," Anderson said.

Freddie will also require maintenance capital expenditure reserves set aside from property's cash flow, proving operators have funds to keep up a property. Finally, it is placing more focus on the ability of loans to be refinanced at maturity based on a future view of increasing interest rates and cap rates.

UBS's Ko doesn't think that the multifamily sector is in jeopardy of losing its valuable GSE connection.

"We believe that the GSEs will continue to lend to multi-family, which has been the minority of their lending but their most profitable business," Ko wrote. "That said, the GSEs are becoming stricter on their underwriting criteria and we believe could decide to lend less to multi-family given the declining fundamentals."

She's right. "We expect to have lower multifamily lending volumes in 2009 than in 2008 due to the current market environment," Hussey said Friday afternoon.

Last year's volumes haven't been released, and the agency can't yet predict for this year.

-Dawn Wotapka; Dow Jones Newswires; 201-938-5248; dawn.wotapka@dowjones.com

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