For Private Equity Industry, Mortgage Financing Main Challenge on Horizon

With the economy in the tank and credit markets frozen, fund sponsors have plenty to worry about, but as Ernst & Young L.L.P. concludes in a new report, their greatest issue is mortgage financing and the capacity to refinance maturing debt on commercial assets over the next 12 to 18 months. “Maturity default, that’s what everyone’s worried about, not interim default,” Gary Koster, head of E&Y’s Real Estate Fund Services Practice, told CPN. In the report, entitled 2009Market Outlook – Trends in the Real Estate Private Equity Industry, three debt-related issues were cited among the top five leading strategic priorities for 2009 by heads of the 40 major funds E&Y surveyed. While refinancing risk topped the list, the ability to attain acquisition financing and the overall deleveraging of fund portfolios ranked a respective fourth and fifth on the list. Outside of financing issues, the remainder of the top-five strategic priorities includes raising capital for new funds, which ranked as the second highest priority, followed by valuations; 41 percent of the respondents expect cap rates to increase by as many as 100 basis points and 33 percent believe that cap rates will increase by over 100 basis points. The highly anticipated surge of properties hitting the market with bargain basement price tags has yet to come to fruition. “Nothing’s trading now,” Koster noted. “Everybody’s talking about distress but there’s not enough distress to go around.” For the time being, fund sponsors are in “work out” mode. “They are all working out their existing investments–they’re in work out phase and it’s going to be a tough period as real estate fundamentals decline,” said Koster. “The differentiator will be those who can re-tenant, re-lease and refinance existing assets; they will have a leg up on those who can’t. So, as a result of the differential period, the better operators are going to emerge as survivors and the others will fade into the annals of history.” The main goal for fund sponsors is to “survive to thrive again in 2010,” according to Koster. “The vast majority will survive, but what percentage will survive and be able to thrive is the harder question.”