We downgrade HKL to Underperform from Neutral given its recent priceperformance, based on an unchanged target price of US$2.32. We are justtwo months into an office market downcycle that may last two years. Webelieve it is too early for a sustained recovery in landlord listed prices.

Short-term recovery only: The HK landlords have bounced 30% off theirNovember lows outperforming the HSI by 16%. This is a typical short-termrally before a sustainable recovery in listed prices that will probably start sometime in 2009. In past cycles, we saw a short rally occur once before the truebottom was reached in the 1994/95 down cycle, twice during 1997/98 andonce during the 2001 to 2003 period. Our Microstrategy team also believeswe are in a typical bear market rally – see their report of 17 December,Settling the debate of “P” over “E”.

Office downcycle likely to last up to two years: We are just two monthsinto an office market downcycle that may last two years if past cycles are anyguide. Yes, new supply is limited this cycle, but future net absorption growth isalso very uncertain. There is significant space in Central to backfill oncefinancial firms move to ICC. The 1994/95 downcycle lasted two years andspot rents fell 40%; the 1996/98 downcycle lasted two years and spot rentsfell 60% while the 2001 to 2003 downcycle lasted three years and spot rentsfell 66%. So far in this cycle, spot rents have probably fallen around 10–15%from their 3Q08 highs.

HKL will look to retain cash – dividend to come down: We expect HKL tokeep its dividend flat (at best) as it enters this downcycle. While this is a betteroutcome than during the Asian Financial crisis where its 1997 dividend wasnot reached again until 2007, we have cut our dividend forecast for 2008 by13%, 2009 by 22% and 2010 by 33%.