Executive summary
Back to the future
We feel like we were in the recovery cycle of 2004-05. On the expectation of a strongeconomic recovery from the depressed SARS period, residential prices jumped 34% in 2004followed by 6% in 2005. In view of the sharp increase in residential prices, NAV discount formajor developer stocks narrowed to 4-22% in 2004 but widened to 18-30% in 2005 when theresidential market stabilized. Similar to the previous recovery cycle, we forecast residentiaprices will rise 20% in 2009, followed by a relatively steady 5-10% in 2010. We initiatecoverage on the developer sector with an Underweight ranking.
Overshot the economic fundamentals
In our view, both residential prices and stock prices have moved ahead of economic fundamentals. Statistically, residential prices and GDP are moving in tandem. While Hong Kongsuffered from the sharpest slowdown since the World War II, with negative GDP growth of 7.8% in 1Q09, residential prices jumped 21% YTD and developer stocks rebounded 74-189%from their lows. Our regression analysis indicates developer stocks have discounted a 25.2%rise in residential prices. Based on 2010 NAV at a 2005 discount, we have assign HOLD ratings on CK, Henderson Land, SHKP and Kerry Props, and REDUCE on Sino Land and Hang Lung Props.
Impact of liquidity moderating
The biggest risk to both the residential market and developer stocks is the flow of liquidity. The HK$211bn in aggregate balance and HK$6,166bn in total deposits have been suppressing interest rates and, hence, mortgage rates. In our view, liquidity in the system will remain relatively steady. There will be no huge outflow of liquidity on the back of excellent investment opportunities in China through Hong Kong and the confidence in the strength and the stability of our banking system. We do not expect any material impact from incremental rises in aggregate balance and deposits given the large base.
Demand reviving with risks
The economy will bottom before the end of the year, which should help stabilize unemployment, household income and, hence, end-user demand. However, affordability is becoming stretched after the sharp rise in residential prices since the beginning of 2009. Ouaffordability index currently stands at 42.2 or 9.7x medium household income. Investment demand for residential properties is set to slowdown on the back of a narrow yield gap (3.0and cost of carry (0.9-2.1%). Speculative demand may come back on the r
Slight undersupply in the near term Completions will remain low at 14,740 units in 2009, and 12,600 units in 2010, compared witthe long-run average of 25,148 units. However, the problem should be less serious gi5-year average completion of 15,838 units. We are probably under supply the normal demand by 20-30% given the 5-year average take-up of 18,398 units. During 1999-0housing stock jumped 25.8% to 2.19mn units versus a rise of 14.2% in the number of

Executive summary 2
Back to the future 2
Overshot the economic fundamentals 2
Impact of liquidity moderating 2
Demand reviving with risks 2
Slight undersupply in the near term 2
Overshot the economic fundamentals 4
Skating a rollercoaster 4
Volume up, value up 4
Big divergence between residential prices and GDP 5
Repeat of the 2004-05 cycle? 6
Stock prices have already rebounded 6
25% rise in residential prices in the bag 7
Impact of liquidity moderating 8
Currency Board System 8
HK$211bn aggregate balance
8HK$6,166bn total deposits9
RMB7,367bn new loan growth in China10
Demand reviving with risks11
Economy sees signs of bottoming
11Unemployment and household income stabilizing
12
13
Investment demand to slow 13
14
Land supply will remain low 16
Housing completion m16
Inventory on the rise 17
Take-up has also come d18
A slight de-rating in 2010 19
Underweight on19
Cheung Kong 24
Henderson Land 29
Sun Hung K34
Sino Land 39
Hang Lung Prope44
Kerry Properties 49
Analyst team profile