(Read more on the debt and equitymarkets.)

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NEW YORK CITY-Through the end of June, Ernst & Youngcollected information from a group of more than 285 private equityfund sponsors. Asked what keeps them up at night, the majority ofrespondents cited the ability to find and deploy capital in assetsthat will meet their return expectations. Then the credit crunchcame knocking.

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A follow-up straw poll to a number of respondents this summerproduced slightly different results. The ability to find and deploycapital was still a concern, but what mostly keeps fund sponsors upat night now is the fear of an economic recession and the impact offundamentals. “Why?” Mike Syers, partner in Ernst & Young's NewYork City office, asked at the firm's release of its Real EstatePrivate Equity Funds: Market Outlook. “We've had weak job reports,although the latest one was not as bad as expected, and housevalues are falling.”

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The woes in the credit market have had an effect on the realestate industry as a whole, and private equity funds did not escapethe pinch. “The seller mind set has changed,” Syers adds. “Debt isvery scarce and there is a significant increase in borrowingcosts.”

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As a result, prices–theoretically–should be falling, heexplains, but there hasn't been enough market activity to get agood sense of that. “The transactions that are closing now were onthe table before the credit problems,” Syers says. “We need moretransactions to see where we are.”

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But private equity funds are seeing opportunity in the creditcrunch. “It is interesting, because you are now seeing a number ofdistressed debt funds forming to take advantage of theopportunities where others are having problems,” explains DavidZiegler, an assurance partner in the Real Estate Group in New YorkCity.

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The next few months will tell what impact the woes have on theexpectations fund sponsors harbored in the first half of 2007.According to Gary Koster, Americas leader for Ernst & Young'sReal Estate Fund Services, the firm's recent survey found thatresponding private equity funds raised $23.5 billion in the firsthalf of the year, with the expectation that new funds would raiseanother $35 billion through the end of 2007. That figure puts 2007on target to exceed the $38.7 billion raised in 2006, he adds.

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Overall, fund sizes are increasing, Ziegler says. The averagesize of funds raised from 2005 to 2007 was $84.4 million, up 79.5%from 2001 to 2004. And more than a third of the funds started overthe past 18 months were raised by new fund sponsors, he pointsout.

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