HONG KONG -- With real estate prices and rents down about 50% from their 1997 highs, and with economic growth rebounding, a new investor to Hong Kong might think this would be the time to buy some of city's depressed-looking real estate stocks. After all, real estate used to be the city's premiere sector before telecom and Internet companies captured investors' hearts.

But this has not been the case, in large part because of Hong Kong's fixed exchange rate. The Hong Kong dollar is one of the few currencies in the world still linked to the U.S. dollar. As a result, the island's interest rates move in lock step with those of U.S., which wouldn't be such a problem if the Hong Kong economy and the American economy weren't in such very different places now.

Though Hong Kong's GDP growth is up and its stock market has boomed, it is still mired in deflation. Consumer prices have tumbled steadily since January of last year and are still falling at an annual rate of 5%. Yet this has been happening as interest rates march inexorably higher. Last Friday, Hong Kong's banks jacked up the prime lending rate by a quarter of a percentage point, to 9%. With deflation of 5%, that makes for 14% real interest rates. Ugly.

At such levels, "I can't see property going anywhere," says Adam Osborn, a real estate analyst at

Dresdner Kleinwort Benson

.

It is the polar opposite of what happened in Hong Kong's go-go years in the mid-1990s. Back then the U.S. economy was slowing, and rates were falling as a result. Though Hong Kong's economy was too hot, there was nothing to cool the wall of investment money coming down from mainland China.

It got so bad that real interest rates turned negative, as inflation was higher than what you could earn in the bank. The only reasonable thing for local residents to invest in was real estate, and so prices of apartments soared as did the stocks of the companies that built and sold them.

Clearly Hong Kong's economy could stand to come off the dollar peg. A devaluation of the Hong Kong dollar would boost import prices and cure the plague of deflation pretty quickly, but authorities remain determined to hold the peg no matter what happens. So, rates go up, and prices keep falling. The exception is the price of money, which in real terms keeps rising as prices fall and rates rise.

Moreover, with the conviction in the market that the government is prepared to step up land sales if necessary -- to prevent a repeat of the rocketing housing prices of 1994 and 1997, the market sentiment is that "unless you're really desperate, you don't have to buy," says Sylvia Wong, analyst at

Vickers Ballas

. Though Hong Kong is supposed to be the world's freest economy, the government actually owns some 99% of the land, and "sells" it for long leases when it feels like it.

So it is a gloomy scene for investors, and some of the local real estate stocks are priced for it. But amid this out-of-favor sector, several analysts have identified one grossly oversold company, and another that masquerades as a real estate company, but is really much more.

For pure value investors,

Amoy Properties

(AMOPY)

seems highly compelling. A renter of retail and office space, it trades at half its book value of HK$8.79 a share, and at seven times estimated earnings for this year. It has cut its famously large dividend, but has raised its payout ratio by 10 cents, and still carries a dividend yield of 6.7% on its Hong Kong shares.

"In valuation terms, Amoy is back to 1998 Russian crisis levels," says Osborn, who notes that "

the company seems a very safe and steady business," because the business generates income and cash, and has no net debt.

"Amoy's balance sheet is the strongest among major property investors," according to a recent research note issued by

TST Recommends

Tai Fook Securities

, which also has an outperform rating on the stock. "It has zero net debt position. It should be able to leverage on its balance sheet by taking on one to two more development projects" totaling as much as 2.7 million square feet, the report added.

The other stock that looks attractive -- Wong calls it "the only screaming buy" among the property stocks -- is

Cheung Kong

(CHEUY)

. What makes Cheung Kong so appealing is that it is the closest you can get to the personal portfolio of Hong Kong's supreme deal maker, Li Ka-shing.

Controlled by the Li family, Cheung Kong owns half of its much bigger subsidiary,

Hutchison Whampoa

(HUWHY)

. In fact, the Hutchison stake was responsible for 96% of Cheung Kong's earnings. Hutchison recently declared a massive special dividend after selling its

Orange

phone subsidiary to

Mannesmann

(MNNSY)

last year.

Vodafone's

(VOD) - Get Report

subsequent acquisition of Mannesmann gave Hutchison a 5% stake in Vodafone (the stake now stands at 3.5% after the sale).

Selena Sia, an analyst at

SG Securities

, says that stripping the Hutchison holdings out of Cheung Kong's book value, you come close to getting Cheung Kong's real estate holdings for free. Depressed market or not, that doesn't sound half bad.