We talked to 14 private-equity insiders about how they’re planning to play the coronavirus turmoil. They identified 2 huge opportunities. Market chaos is creating crises and opportunities. Private-equity firms are scrambling to manage both.

As the stock market crashes, and the global spread of coronavirus delivers a blow to sales from plane tickets to draft beer, private-equity firms — the giant managers of companies such as the bookseller Barnes & Noble and the dating app Bumble — are scoping out new investments.

But they’re looking to ramp up in just about everything but actual private-equity stakes.

Firms like Apollo Global Management, Oaktree Capital, Blackstone, and Ares Management are staffed to buy debt in troubled companies. Others like KKR and Silver Lake have divisions focused on something not as closely associated with private investing: minority stakes in public companies.

These two areas of investing are expected to play a crucial role in deciding who owns what when the dust settles. And private-equity shops, which are equipped with hundreds of billions in unused investor dollars, are well-positioned to snap up their selection of distressed assets while also offering liquidity to companies in need of support, according to bankers, lawyers, and consultants.

But with deals paused because of economic turmoil, a near-term challenge for private-equity firms is putting out fires at their own businesses.

Private-equity firms are busy communicating with their existing portfolio companies about how to maneuver the fluid situation, assessing business repercussions and suggesting when they should draw down on credit lines, private-equity execs, consultants, and bankers said.

“The pandemic has spurred a period of greater focus by PE firms on portfolio companies — partly because of the challenges they’re facing of both supply and demand and partly because the current uncertainty has caused many deal and fundraising processes to stumble or pause,” Bryce Klempner, a partner with McKinsey & Co. who advises private-equity firms, said.

Peter Martenson, a partner at the fund-placement firm Eaton Partners, said private-equity firms, along with growth-equity and venture-capital companies, were “triaging their portfolio aggressively” and that he expected private-equity shops to hold their assets longer to ride out the downturn.

The comments came from conversations Business Insider had with more than a dozen bankers, lawyers, private-equity execs, and consultants since Monday to better understand how private-equity shops are planning their next moves.

The coming weeks and months will demonstrate how businesses weather the downturn, but private-equity shops are already scrambling to aid companies in industries such as travel, leisure, and hospitality, creating loans directed at carrying them through the period with their employee bases relatively intact and without a bankruptcy filing.

On the investing front, one private-equity executive told Business Insider there wasn’t much available to invest in at the moment outside public equities — and that his firm, which is one of the largest, was increasingly focused on liquid investments like loans, bonds, and public stock. He spoke on condition of anonymity because he was not authorized to speak publicly, but Business Insider confirmed his identity.

Meanwhile, one sponsor banker said private-equity execs were busy managing their portfolio companies and advising them on new policies in light of the coronavirus. But he said they expected to be called upon in the near future to provide creative liquidity solutions for large, including public, companies grappling with a slowdown as a result of the coronavirus.

This person, whose identity Business Insider confirmed, spoke on condition of anonymity to preserve private-equity relationships.

Firms positioned for the downturn

Preqin data, along with bankers and lawyers, pointed to a handful of firms, such as Apollo Global Management, Oaktree Capital, Blackstone GSO Partners, and Ares Management, as players whose distressed-debt divisions are positioned to pounce on the downturn.

These firms have not yet made big announcements about distressed investments related to the recent downturn. In the 2008 financial crisis, Apollo deployed more than $50 billion in four months, according to Leon Black’s comments at a private-equity conference in February.

“A downturn would not be a bad thing for Apollo,” he said at the SuperReturn conference, which was held while the spread of the coronavirus was just starting to ramp up and it was still unclear how it would affect the global economy.

Now senior credit professionals are seeking out lending opportunities in businesses directly affected by the downturn, though they would not share specific deals or companies.

Cruise lines, bars and restaurants, live-entertainment companies, and airlines have all seen revenue plunge as a result of the coronavirus and are considered some of the most obvious areas of opportunity, private-equity executives and bankers said.

At the same time, portfolio companies under management of some of the same firms are taking a beating as a result of the coronavirus.
Hospitality names are taking a big hit

For one, Blackstone has poured billions of investment dollars into businesses that are now getting slammed by the coronavirus.

One deal was the copurchase of Merlin Entertainment, the large visitor-attraction operator that controls the amusement park Legoland in Florida. Legoland said on Friday that it would join other amusement parks in shutting down its theme and water parks through the end of the month to ride out the coronavirus.

Blackstone also bought a controlling stake in Great Wolf Resorts, the owner and operator of family-oriented entertainment resorts such as Great Wolf Lodge, in October. On Monday, Great Wolf announced it had closed all of its 19 resorts in 13 states because of coronavirus concerns, with plans to reopen on April 2.

Two other large investments it made in 2019 were the purchases of the Bellagio from MGM Resorts International and US warehouse properties from the logistics company GLP in an $18.7 billion deal.

MGM announced Sunday it would close all of its resorts, including the Bellagio, because of the coronavirus. The effect of the coronavirus on Blackstone’s US warehouse properties could not be immediately determined.

A Blackstone spokesman on Tuesday said the firm’s investors “are and always have been long-term investors.”

He also said the firm had successfully weathered many crises in the past, including 9/11 and the 2007-09 global financial crisis, and still delivered outstanding performance for clients. “Our confidence in this approach remains stronger than ever,” the spokesman said.

A private-equity firm typically holds on to investments for five or so years, so a monthslong slowdown doesn’t necessarily translate to a financial loss for private-equity firms, but it will likely cause firms to change up how they manage their assets, including recapitalizing investments by selling stakes, experts said.

Fundraising put on pause

The uncertainty in the market, coupled with the inability to conduct on-site meetings, put a pause on some fundraising for private-equity shops, according to placement agents.

At the same time, some investors no longer have the appetite to put their money in illiquid investments this year, they said.

Alan Pardee, a placement agent with Mercury Capital, said it was still early to predict how investors would react to the coronavirus and resulting market volatility. But from what he has seen so far, there are a number of investors who are adjusting by scheduling video and regular conference calls as a substitute.

“We are aware of a couple [investors] that have said things along the lines of, ‘I’m not doing any more illiquid strategies for the balance of the year,’” he said. “We’ll see how the market sorts out, given the continuing downdraft in the public markets.”

The coronavirus could also make more attractive areas of private-equity investing that are not as correlated with the markets, like litigation finance, life settlements, music royalties, and needs-based real estate, such as self-storage, rental homes, and medical offices, placement agents said.

Demand for high-yield-debt funds appears to have softened in the past year.

The amount of equity raised by active closed-end vehicles is down for the first time since 2013, according to an annual review of high-yield real estate funds by sister pub­lication Real Estate Alert. Of the 533 funds identified by the survey, 74 invest pri­marily in debt — the most ever. But the number of fund operators in the mar­ket dropped to 65, from a record 70 last year (see list­ing on Pages 9-11).

After peaking at $54.9 billion a year ago, the aggregate equity held by debt funds plummeted 18% to $45 billion. The total amount invested by those vehicles also fell — to $11.4 billion, from $14 billion.

To be sure, the universe of debt funds is still large from an historical perspective. Before 2017, the total amount of equity raised never exceeded $40 billion. But after seven years of steady growth, the market clearly has slowed — and the coro­navirus pandemic could further suppress investor demand.

“There has been a massive proliferation of debt funds over the previous three years,” said Bill Thompson, senior managing director in Evercore’s private-capital advisory group. “So even before the coronavirus, LP interest was slowing. ‘Not another debt fund’ was the refrain.”

Thompson predicted, however, that investors will continue to back managers offering differentiated strategies, whether defensive or opportunistic.

Since the financial crisis, nonbank lenders have come to account for an increasing share of the commercial-mortgage sector. Originations by nonbanks amounted to 41% of the mar­ket in the fourth quarter, up from 29% a year earlier, according to CBRE.

Among high-yield vehicles, the total amount of dry powder they have to invest dropped 18%, to $33.7 billion from $40.9 billion a year earlier. That’s a potentially worrisome sign for borrowers at a time when commercial MBS lenders have retreated to the sidelines and balance-sheet lenders are proceed­ing with extreme caution.

Market pros expect debt funds that use leverage sparingly will remain active and even thrive amid an economic downturn, while highly leveraged vehicles will struggle.

“No investment committee has underwritten this kind of shock — none,” said Walter Stackler, founder of New York placement agent Shelter Rock Capital. “The groups that do well in this environment will be well-capitalized and have multi-disciplinary teams that can effectively manage the restructur­ings that are bound to happen. Managers with in-house direct equity expertise will have an advantage.”

Kevin Miller, chief executive of Los Angeles-based fund manager Thorofare Capital, said operators that borrow heav­ily to boost their returns or rely on CMBS programs to recycle capital will suffer in the months ahead. “Those groups that are overleveraged, they’re the ones who are going to get hurt. And being under-levered is finally going to pay off for groups like ours,” Miller said.

Multiple sources said banks that offer warehouse lines or repurchase-agreement financing to debt funds soon may pull back — either by freezing the facilities or raising rates to unworkable levels.

Real Estate Alert’s review found that just 17 debt funds held a final close last year — the lowest number since 2016. The peak was 28 in 2017.

Alan Pardee, co-founder of New York placement agent Mer­cury Capital, said foreign investors lately have been deterred by the high cost of currency hedging. “The one thing that has been different was that hedging costs to the dollar made U.S. debt funds a bit harder for international investors to invest in last year,” he said.

Real Estate Alert tracks active closed-end funds that invest in properties, debt, or both, and shoot for returns of at least 10%. The 533 vehicles identified in this year’s review are seek­ing to raise $411 billion of total equity. The debt-fund compo­nent has an aggregate equity goal of $66.1 billion, or 16% of the total — the lowest level since 2014.

Vehicles are considered active if they are still raising capital or if they have already held final closes but have invested less than 75% of their equity. So each year, a rotating group of funds is counted. Twenty-six debt funds were added this year and 25 fell off the list.

One that dropped off was a $4.8 billion Blackstone vehicle, Blackstone Real Estate Debt Strategies 3. The removal of that fund is part of the reason that the total amount of equity held by high-yield debt funds fell by as much as it did.

The review classifies funds as debt vehicles if they intend to invest at least half of their equity in the origination of loans or in the acquisition of loans or debt securities. The other 459 high-yield real estate funds primarily target property pur­chases, but 224 of them also can buy or originate debt. So 42% of the fund universe overall can invest in debt to some extent.

Funds are included if they raise capital at least partly from U.S. investors or invest mostly in U.S. commercial real estate. Joint ventures, separate accounts and open-end funds are excluded.

After several years of explosive growth, the market for high-yield real estate funds is slowing.

The total amount of equity managed in closed-end funds fell for the first time since 2013, according to Real Estate Alert’s 24th annual review of the fund industry. Other key metrics including the number of fund operators in the market and number of vehicles that held a final close also dipped.

“It does feel a little slower out there,” said Alan Pardee, co-founder of New York placement agent Mercury Capital. The market is “still healthy — it’s still one of the strongest years we’ve had overall — but it’s got a slightly different tone.”

The big question now is to what extent economic damage from the corona- virus pandemic dampens fund performance and suppresses investor appetite. “The prognosis for the near term is extremely challenging,” said Bill Thompson, senior managing director in Evercore’s private-capital advisory group. “The market hasn’t stopped, but with limited face-to-face meetings, expect long capital-raise periods.”

To be sure, the size of the fund universe remains in record territory — by any measure, substantially larger than it was at the last cyclical peak. The number of commingled vehicles seeking 10%-plus net returns ticked up to 533, from 528 a year earlier. And the total amount of equity being sought by managers increased 1.6% to a high of $411 billion.

But the number of fund sponsors dropped to 418, from a high of 426 a year ago. And fewer of them reached the finish line for vehicles they were marketing. The number of funds that held a final equity close fell to 123 in 2019, from 140 the year before and a high of 146 in 2017.

Perhaps the most telling indicator of a market slowdown is that the aggregate amount of equity raised by active vehicles declined 2.4% to $307 billion. During the previous four years, that figure had climbed an average of 16% annually.

Even as fund raising fell for the first time in seven years, the amount of uninvested capital continued to rise, lion. As a percentage of equity raised, the amount of dry powder increased to 74.9% — the highest level since 2009 and a clear sign that managers have been finding it increasingly difficult to put money to work. “Everyone has been struggling to find deals,” said Walter Stackler, founder of New York placement agent. Shelter Rock Capital.

That reality is reflected in the return target of the average high-yield real estate fund, which fell to 14.4%, after fees, from 15.1% a year earlier. That’s the sharpest drop in more than 10 years, though the figure has been drifting lower for almost two decades.

It’s no wonder that the number of opportunity funds, which seek net returns of 16% or more, has been on the decline, while managers have been teeing up more value-added and core-plus vehicles, which target lower returns. The count for opportunity funds has plummeted to 113, from 184 in 2014. During the same period, the number of value-added funds has shot up to 264, from 142. For core-plus funds, the number has nearly doubled to 69, from 36.

The industry’s rapid growth in recent years largely was driven by institutional investors, which began ratcheting up their real estate allocations in the wake of the global financial crisis. While fund returns may still appear attractive on a risk- adjusted basis, there are indications that investor demand may be peaking.

An annual investor survey by Cornell University’s Baker Pro- gram in Real Estate and advisory shop Hodes Weill & Associates found the average target allocation for real estate is projected to rise to 10.6% this year, from 10.5%. That’s the smallest increase since the survey’s inception in 2013. “The rate of increase has been in the range of 20-40 bp over the past five years,” according to the latest survey report.

Douglas Weill, founder and co- managing partner of New York- based Hodes

Weill, said institutional investors turned more cautious in the past year. “Investors were moving more slowly in terms of making investment decisions,” he said.

Weill noted that the sharp drop in stock and bond prices in recent weeks could prompt investors to slow the pace of their real estate investments due to the so-called denominator effect. As the values of their securities portfolios decline, institutions’ real estate holdings suddenly account for a larger per- centage of total assets.

“How many institutions are going to find themselves over-allocated to real estate?” Weill wondered. “We’re starting to see that the past couple of weeks.”

Real Estate Alert’s review high- lights a bright spot for small and mid-size fund managers: The combined market share of the big- gest operators dipped in the past year after climbing steadily for several years. The top 10 managers accounted for 33% of the total equity raised, down from a record 37% a year earlier. The top 25 firms corralled 47% of the total, down from 50% a year earlier.

Blackstone remains the industry’s undisputed champ. The investment behemoth finished marketing the largest-ever real estate fund last year, closing on $20.6 billion of equity. Other managers of megafunds that held final closes since the start of 2019 are Brookfield ($15 billion), Lone Star Funds ($4.6 billion), TPG ($3.7 billion), Angelo, Gordon & Co. ($2.75 billion), KSL Capital ($2.7 billion), Westbrook Capital ($2.5 billion), Gaw Capital ($2.2 billion), Ares Manage- ment ($2 billion) and Greystar Real Estate ($2 billion).

The prevalence of $1 billion-plus vehicles lifted the average fund to a record $771 million. The average size has risen for seven consecutive years.

While the concentration of capital among the largest man- agers is at a five-year low, fund-raising conditions for smaller shops remain challenging.

“If you’re an incumbent and you’re on Fund 4 or 5 or 6, you get your money raised,” said Shelter Rock’s Stackler. “If you’re a new guy, it’s really hard. That’s not going to change.”

And the coronavirus outbreak has added a new wrinkle for fund marketers.

“There are certainly LPs that are being very measured about their own travel, who they’re letting into their offices and all the rest,” said Pardee, of Mercury Capital. “We really don’t know what to make of the future.”

Assuming the pandemic is short-lived, the impact on the real estate market could be minimal, Pardee added. “We’re still dealing with a buoyant market in the context of transactional activity . . . with the asterisk of coronarvirus,” he said. “But overall, the market is healthy. If it’s slowed down a little, it feels like it has the ability to ramp back a lot.”

Real Estate Alert’s review tracks property and debt funds that raise capital at least partly from U.S. investors, that invest mostly in U.S. commercial real estate, or both. Of the 533 active funds, 363 invest only in the U.S., 122 invest only outside the U.S. and 48 invest globally. Vehicles are considered active if they are still raising capital or have already held final closes but have invested less than 75% of their equity.

That means a rotating group of funds is counted each year. Most of the departing funds were removed because they sur- passed the 75% threshold, but five were dropped because they were put on hold or canceled. Overall, 186 vehicles were added to the list and 181 were removed.

Vehicles must be seeking to raise or have closed on at least $50 million of discretionary equity. Excluded are joint ventures, separate accounts, nontraded REITs and club funds (typically with fewer than a half-dozen limited partners).