Fannie Mae and Freddie Mac are getting tough on cash-out refinancings for multifamily borrowers.

The government-sponsored enterprises (GSEs) are changing the way they underwrite cash-out refis, with Freddie Mac announcing stricter terms in January and Fannie Mae expected to tighten up in the coming days.

A cash-out refinancing—when a property is refinanced for more than it owes, and the owner pockets the difference—is a critical strategy for many multifamily owners. They’ll often take the equity from a refi of a strong property and balance their portfolio by investing the cash in a weaker one. 

This is especially crucial now. At a time when many markets have seen declines in rent and upticks in vacancy, owners are looking to the GSEs to provide just that kind of strategic liquidity to help prop up underperforming assets.

But 10-year cash-out refis from Freddie Mac now offer 75 percent loan-to-value (LTV) ratios and a 1.30x debt service coverage ratio (DSCR), and it gets even tougher for five- and seven-year loans. Previously, 80 percent LTVs and 1.25 DSCRs were the norm.

While tighter underwriting standards is the prudent thing to do in bad times, the changes could have unintended consequences. “You wonder if this will crimp some potential opportunities for developers to tap into places that can help them ride through this downturn,” says Phil Melton, a senior vice president at Grandbridge Real Estate Capital. “Now, you’re trapping the equity within a specific transaction.”

One of Freddie Mac’s strengths is its ability to assess individual transactions and make adjustments to its credit parameters when the deal merits it. But to what extent will the company adhere to its new rulebook?

“It’s still a little early to see how Freddie is going to apply these standards,” says Don King, head of GSE production at CWCapital. “Early indications are that they are sticking pretty hard to these new credit and pricing standards.”

The changes to Freddie’s cash-out refis were part of a larger move toward more conservative credit standards. The company also announced stricter terms for conventional five- and seven-year loans in January.

In general, the concern on these tighter standards is that it will make a bad market worse. It’s a delicate balancing act for the GSEs, who have become the last men standing in the multifamily debt market.

“If we’re cutting back the amount of money we can lend to an acquisition, we are increasing the pressure on real estate values, which makes the problem worse,” says King. “You risk falling into the death spiral.”

Fannie Mae is expected to announce similar changes in early March. Fannie will likely institute underwriting floors for sizing five- and seven-year loans. For top deals, the underwriting floor will likely be 6.25 percent on a five-year deal and 6 percent for a seven-year deal. Lower-tier deals would be underwritten at even tougher standards.