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(Read more on the debt and equity markets.)

NEW YORK CITY-Through the end of June, Ernst & Young collected information from a group of more than 285 private equity fund sponsors. Asked what keeps them up at night, the majority of respondents cited the ability to find and deploy capital in assets that will meet their return expectations. Then the credit crunch came knocking.

A follow-up straw poll to a number of respondents this summer produced slightly different results. The ability to find and deploy capital was still a concern, but what mostly keeps fund sponsors up at night now is the fear of an economic recession and the impact of fundamentals. “Why?” Mike Syers, partner in Ernst & Young’s New York City office, asked at the firm’s release of its Real Estate Private Equity Funds: Market Outlook. “We’ve had weak job reports, although the latest one was not as bad as expected, and house values are falling.”

The woes in the credit market have had an effect on the real estate industry as a whole, and private equity funds did not escape the pinch. “The seller mind set has changed,” Syers adds. “Debt is very scarce and there is a significant increase in borrowing costs.”

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

But private equity funds are seeing opportunity in the credit crunch. “It is interesting, because you are now seeing a number of distressed debt funds forming to take advantage of the opportunities where others are having problems,” explains David Ziegler, an assurance partner in the Real Estate Group in New York City.

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

Overall, fund sizes are increasing, Ziegler says. The average size 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 over the past 18 months were raised by new fund sponsors, he points out.

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