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All Those Private Equity Funds Will Have To Spend On Worse And Worse Deals

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All Those Private Equity Funds Will Have To Spend On Worse And Worse Deals

Private equity real estate funds continue to raise prodigious amounts of capital, but they may not be the producers they once were.

A combination of factors is driving down the potential yield in commercial real estate investment sales, according to a new report from research and analysis firm Preqin and reported by National Real Estate Investor. As a result, funds launching today are likely promising their investors lower returns, Preqin real estate head Tom Carr told NREI.

As of last June, private equity firms had about $900B in assets under management and the number of funds actively seeking capital was at an all-time high, the Preqin report found. Since then, fundraising has hardly seemed to slow, with Blackstone Group announcing a new fund with a goal of $18B in September and Brookfield approach the $10B goal of its latest fund.

Equity funds continue to recruit capital because the economy has continued to grow, approaching its second decade of recovery since the Great Recession. Real estate prices are now higher than they were in 2007, corresponding with compressed cap rates across markets and sectors, the report finds. The industry is hitting such peaks as the economy's growth is finally slowing (and that is before accounting for the escalating trade war between the U.S. and China).

If returns drop below acceptable levels for fund managers, the resulting buildup in dry powder could throw a wrench in their timelines for closing out such funds and even result in sending money back to investors.

To keep hitting their thresholds, funds are expanding into more types of real estate and more markets, chasing yields in areas that could be less proven. Other funds could extend their life spans beyond initial plans or seek more defensive investments as geopolitical uncertainty continues.