Following our upgrade of the sector to Overweight in April, the physical market and property shares have gone from strength to strength. Sales not only held up on a m-o-m basis, but prices have moved up from Mar/Apr lows. Since our upgrade, property stocks (FSTREH +29%) have outperformed the STI’s 20% gain. Despite this, we believe the sector still offers upside, as RNAV reflation arising from upward ASP adjustments goes underway. We adjust ASPs up by 20% from 1H09 lows, in line with our economist’s view of a V-shaped recovery. Further improvement in the physical market in line with the economy could provide a catalyst for higher valuations.

Tackling Two Thorny Issues. On the concern of impending residential supply, such numbers were known way in advance and such fear did not put the brakes on the recovery we have seen in the past six months. We believe that yield compression could still result in continued price appreciation even as rents continue to soften. On whether we are heading to a ‘false dawn’, we believe we should not see a short-lived spike unless prices rise beyond economic fundamentals.

Switch from Big-Caps to Mid/Small-Caps. We advocate switching from big-caps to mid/small-caps, which have a higher RNAV exposure to the residential sector, as we continue to remain bearish on the office sector. Our top picks are Allgreen and Ho Bee, though we continue to like CDL for big-cap exposure. Investors with higher risk appetite could accumulate high-end players like Wing Tai and SC Global, on expectation that the physical market recovery will soon filter through.