HONG KONG -- With Hong Kong surging to a double-digit growth rate and tech and Internet shares losing their shine, some international investors may be tempted to return to a formerly dominant sector: Hong Kong real estate.

That would probably be a mistake. Since 1997, real estate prices in this crowded territory have plunged. In addition, Hong Kong's authorities are looking increasingly desperate as they search for ways to support the property market. That panic is not a good sign for shares of the big developers that have dominated this property market.

The actions taken by the government, the biggest landlord in Hong Kong, include withdrawing thousands of units from the market. That move is an attempt to put a floor under prices. But analysts are nearly unanimous in their opinion that prices will fall more this year as real interest rates remain punishingly high.

The drop in property prices, which was written about by

TSC

in

late March, has negatively affected the stock prices of many of the island's big developers. One of the few exceptions has been

Amoy Properties

(AMOPY)

, a quintessential value play, that has risen 22% since March. However, Amoy Properties is still not being aggressively recommended by analysts despite a continued deep discount to book value.

The most trumpeted property stock in the territory is magnate Li Ka-shing's

Cheung Kong

(CHEUY)

, which has taken a beating of late because it was dropped from

Morgan Stanley Capital International's

index. Analysts like the stock because Li himself has recently bought more shares. And history has shown in the long run, the investor usually profits by mimicking this tycoon's purchases. "We believe that we should be buying together with Li Ka-shing," said

Merrill Lynch

in a recent report. Merrill has done underwriting business for Cheung Kong.

Still, mutual funds with positions in Cheung Kong or other Hong Kong real estate companies have largely dumped them, and those that haven't may be behind the curve. The low-cost, high-performance

(MAPTX) - Get Report

Matthews Pacific Tiger Fund used to own another giant developer,

Sun Hung Kai Properties

, among its top-10 holdings, but no longer does.

An Uncertain Outlook

In its global real estate report this month,

Salomon Smith Barney

said of Hong Kong that "the more interest rates rise, the weaker the recovery of the residential property market in 2000 will be." Michael Green, analyst at

Donaldson Lufkin & Jenrette

, figures residential housing prices will fall 20% this year, instead of the 10% he previously forecasted.

Top office rents have bucked the trend in Hong Kong and are up 15% to 20% from a year ago, according to real estate agents

Jones Lang LaSalle

. The bad news for office property investors is that one-third of all new office occupancy has been by the technology companies that are now finding it so hard to raise money on the capital markets, let alone make a profit.

Despite deep deflation, interest rates are rising in Hong Kong because the territory has a currency board arrangement that pegs the Hong Kong dollar to the greenback. Interest rates in Hong Kong nearly always move in lock step with those in the U.S. This connection means interest rates here continue to rise as property values fall. The government decided to act after the mainland-controlled

Bank of China

complained the economy was on the verge of collapse because so many middle-class homeowners now owned apartments worth less than the mortgages taken out to buy them.

If it seems surprising to those who think of Hong Kong as a bastion of free market economics that the government should even care about how expensive land prices are, think again. Half of Hong Kong's population lives in public housing. And with the government owning nearly all property in the territory, Hong Kong's authorities are anything but hands-off when it comes to land prices.

Here's what the authorities did to try to boost up the sagging real estate sector: The government said it would withdraw 16,000 public housing apartments from the sales market. Investors, who were probably right, were underwhelmed. The withdrawn apartments "cannot be sold anyway" for shoddy construction, according to a report by

SG Securities

.

The additional and potentially more serious problem for the government is not its failure to support real estate prices, but its apparently weakening resolve to let asset prices continue to fall as a necessity of having a fixed exchange rate.

A Troubled Marriage With the Dollar

SG Securities suggests that interest rates in Hong Kong could rise not only because of what the

Federal Reserve

does in Washington, but because of actions in Argentina. Aside from Hong Kong, Argentina is the only other major market with a currency board arrangement, in which every unit of local currency must legally be backed by a fixed number of U.S. dollars.

SG Securities said last week that although it is confident that Argentina would withstand speculative pressure to devalue its currency in the face of slumping growth, "Hong Kong will be caught in the crossfire as currency board arrangements worldwide are opportunistically and gratuitously attacked."

Of course, real interest rates would come down right away and Argentina would fade into irrelevance if Hong Kong devalued its currency. Asset prices in local currency terms would stop falling and might even rise, and Hong Kong would be instantly more price-competitive against its regional archrival, Singapore. As apartments once again started to increase in price, people might rediscover shopping again. The downside for foreign investors under this scenario is that a cheaper Hong Kong dollar would make all Hong Kong stocks less valuable in U.S. dollar terms.

Individual investors need to ask themselves how much longer Hong Kong's authorities will sit by and listen to the Bank of China complain about falling land prices before the currency link is abandoned.