The rising tide of yesterday's stock market rally floated a lot of boats, some of which may be in severe danger of springing leaks next year. The beneficiaries of yesterday's run-up in Hong Kong-listed stocks included a number of mainland property developers. Soho China, for example, rose a robust 7.7 per cent, while Guangzhou R&F Properties shot up a startling 20.8 per cent. The sharp rise in developers' share prices was bolstered by data showing that property transaction volumes were beginning to recover in some mainland cities. According to figures from JP Morgan, sales of new homes in Shanghai climbed 36 per cent last month, compared with October's level, while purchases of existing homes jumped 68 per cent. With mortgage interest rates now falling, prices down heavily from last year's highs and some local governments offering incentives, including income tax rebates for first-time buyers, hopes are growing that the property market may have passed the worst. After falls in developers' share prices of between 60 and 80 per cent this year, and with stocks in the sector typically trading at valuations between 5 and 8 times estimated earnings for next year, some investors clearly reason this is a good time to go bargain hunting. They should be careful. Many mainland developers are highly leveraged and are sitting on large inventories of unsold apartments, which are steadily draining their cash reserves (see the charts below). With revenues down steeply, debt to be serviced, year-end taxes to be paid and construction workers' back pay to be settled before the Lunar New Year, those reserves are likely to come under still more pressure in coming months. Even worse, many of the same developers seized the opportunity to tap the Hong Kong market for funding during the boom of 2006-07. A lot of those debts will mature next year, and in the current environment it is likely that refinancing will prove difficult, if not impossible to obtain. 'If there's a black hole, it's refinancing,' says Stephen Blank of the Washington-based Urban Land Institute. In a survey published yesterday, the institute notes that property market participants universally expect debt finance to get even more scarce next year. 'There are probably many outstanding deals that will not be refinanced at any price,' it warns. As a result, there will be consolidation among the sector's smaller players, Jing Ulrich, the chairman of China equities at JP Morgan, forecasts. Other observers expect a rash of defaults. Quantifying the risk is tricky, although it is worth noting that on a ranking of Altman Z scores - a measure of the probability of a corporate bankruptcy, based on factors including liquidity, profitability, operating efficiency and asset turnover - compiled by Paul Schulte at Nomura, both Soho China and Guangzhou R&F score low enough to rank in the 'ugly' category. If mainland developers do fail to refinance their debts next year and default as a result, the pain will be felt especially keenly by offshore lenders, including the Hong Kong hedge fund industry. According to Scott Bache, a Hong Kong partner at legal firm Clifford Chance, hedge funds enticed by the high yields on offer have lent heavily in Hong Kong, both to listed and unlisted developers, to fund mainland projects. If those developers now default on their debts, offshore creditors are likely to find they have little or no legal rights over onshore assets. That could inflict further punishing losses on some funds, possibly leading to the disposal of more assets at fire-sale prices. The situation is not equally grim for everyone, however. Developers with strong balance sheets, like China Overseas Land & Investment, stand to benefit from scooping up assets on the cheap, while cash-rich investors in distressed debt are already rubbing their hands at the opportunities in prospect for 2009.