Despite the potential downside to residential property prices over the next 6-12 months, we believe the property developers deserve better valuation due to the improvement in their operating environment. With abundant land supply from the government resulting in land price retreat, developers are now capable of replenishing land bank at more attractive profit margins. Consequently, we expect the developers with solid financial position to achieve sustainable growth and deliver better return on equity despite the softening in housing prices.

We initiate coverage on the Hong Kong property developers with an OUTPERFORM rating. While we expect the physical property prices to consolidate with a downside bias, we are positive towards developers' share price performance due to their improving operating environment. In terms of valuation, the sector is now trading at an average discount of 33% to appraised NAV. With rather resilient property prices, and opportunity to replenish cheaper land banks, we expect the sector to command a valuation closer to their long term historical average of 18%.

Eoin Treacy's view Hong Kong property prices peaked more than a year ago. Historic P/Es for the major property developers remain in the 5 to 7 region but estimated P/Es are double those figures suggesting earnings are expected to deteriorate quite considerably this year.

The Hang Seng Property Index spent much of last year discounting this news and plotted a progression of lower rally highs from late 2010 until late January. While still within the confines of an almost three-year range, the Index has rallied to break the yearlong downtrend. It will need to hold above the 25000 region on the current pullback if the medium-term upside is to be given the benefit of the doubt.

Cheung Kong Holdings (yield 2.83%) has also rallied to break its yearlong downtrend and needs to find support above or in the region of the 100 area to confirm a return to medium-term demand dominance. Sun Hung Kai (yield 2.96%) and Sino Land (yield 3.26%) share a similar pattern.