While the manager of the sector-leading First State Global Property Securities fund remains upbeat about the long-term prospects for his portfolio, he says commercial property lacks a catalyst for strong performance in the short-term.
"The negative economic backdrop is undermining rental growth, banks are reluctant to provide finance and real estate markets are generally sluggish," said Nicholas, who also heads up the First State Asian Property Securities fund.
"City markets like Paris, Brussels and Amsterdam are under pressure. In the UK, London’s commercial property sector is still in relatively good health, although demand is slipping in the office market because of job losses in the financial services industry."
"On the positive side though, development pipelines are limited and in some markets rents are increasing slightly."
The manager also sees strong headwinds for Chinese property, which has been hit by concerns about oversupply in the residential market and government tightening measures.
However, he is more optimistic about German residential, US apartments and shopping centres, and the Swiss market in general.
The £60.1m First State Global Property Securities fund is currently overweight Australia and Brazil and underweight Japan, Europe and the US.
At a stock level, Nicholas is particularly positive about the prospects for Simon Property, the largest real estate investment trust in the US; Mirvac Group, Australia’s leading integrated real estate group; and Digital Realty Trust, a US-based provider of IT data centres. Simon Property is currently the manager’s largest holding, with a weighting of 7.8 per cent.
Performance of fund vs sector over 5-yrs
Source: FE Analytics
The portfolio is the best-performing vehicle in its IMA Property sector over three- and five-year periods, with returns of 67.9 and 6.47 per cent respectively. It currently has a one-year historic yield of 2.74 per cent.
The most recent RICS UK Commercial Market Survey supports Nicholas’s fears in the short-term.
Research revealed that falling occupier demand and increasing availability drove down commercial property rental expectations in the final quarter of 2011. Notably, the survey showed that demand for commercial space in the capital was in negative territory for the first time in over a year.
Commenting on the results, Simon Rubinsohn, chief economist at RICS, said: "Rental expectations have predictably become a little more negative in the face of the recent run of grim economic news."
"While this seems to be the case across almost all of the UK, the one area that continues to buck the trend is prime London offices. However even here our indicators suggest that demand for space is a little less strong than it was."
"Meanwhile the on-going shortage of mortgage finance is set to dampen investment activity. Confidence is key to a sustained recovery in the sector and this is going to be hard to bolster until the key issues surrounding the European sovereign debt crisis are resolved.''
In an interview with FE Trustnet back in December, star manager Martin Gray said he was starting to reconsider prime property as a source of income for his multi-asset portfolios.