Asian property investment could dip because of rising borrowing costs and investor risk aversion stemming from the U.S. subprime crisis, but the region is still a better bet than struggling U.S. and European markets.

European and U.S. commercial property markets, which had been energized by a spate of leveraged buyouts by private equity firms, are now expected to suffer because of turmoil in credit markets sparked by U.S. mortgage defaults.

With exposure to U.S. mortgage-linked collateralized debt obligations (CDOs) causing havoc in financial markets, credit for property deals, including commercial mortgage-backed securities, is drying up in the West.

Asia's property industry -- where complex securisations are an anomaly -- has lesser worries, such as a narrowing gap between bond and property yields that puts pressure on returns, and a rising yen that could make Japan expensive.

Convincing nervous investors to buy into thriving but notoriously volatile Asian property markets, from Hong Kong and Singapore to India, could also be tough.

Robert Lie, Asia head at ING Real Estate, said investors in Asia could no longer rely on a simple formula of cheap borrowing and rising capital values.

The job's getting a bit more difficult, Lie said. It doesn't mean you shouldn't invest in property, but you should rely more on rental increases and less on capital markets.

Lie suggested that private equity property funds would have to change tactics, having flourished in recent years by snapping up non-performing loans in the wake of Asia's financial crisis and riding a wave of asset inflation.

That period is over, Lie said, adding that ING Real Estate was having little trouble raising two funds for Asia, totaling about $1.35 billion.

FUNDS KEEP COMING

In the short term, deals in Asia are likely to keep flowing because a raft of new global funds raised in recent months are keen to put that money to work in assets such as Japanese commercial buildings and housing in China and India, where investment returns can surpass 30 percent.

Blackstone Group (BX.N: Quote, Profile, Research), whose $39 billion February purchase of U.S. landlord Equity Office Property Trust was a signature deal for leveraged buyouts, is opening a real estate office in Tokyo, sources told Reuters this week.

The private equity firm has been raising a $10 billion global property fund, while U.S. banks Morgan Stanley (MS.N: Quote, Profile, Research) and Goldman Sachs (GS.N: Quote, Profile, Research) have raised similar funds worth around $8 billion each, sources have said.

LaSalle Investment Management, a unit of Jones Lang LaSalle (JLL.N: Quote, Profile, Research), told Reuters on Tuesday it planned to funnel $15 billion of funds into Asian property over the next three to five years.

Direct investment in Asia-Pacific property hit $94 billion in 2006, up 43 percent from 2005, according to Jones Lang LaSalle.

That figure is likely to be surpassed this year, with investment totaling $55 billion in the first half, up an eighth from a year earlier, but that was still dwarfed by $327 billion invested in Europe and North America.

PLENTIFUL CREDIT

Because of growing risk aversion among investors, one property fund executive at a global bank told Reuters that raising equity from western investors was very favorable, but now it's just favorable.

Although interest rates have been rising across the region this year, no credit crunch has emerged.

You haven't seen evidence that money is harder to come by so far in Asia, although I'm not saying that won't change, said Matt Nacard, Asia property analyst at Macquarie Securities.

In the U.S. it's a totally different story.

The Japanese 10-year government bond yield jumped about 40 basis points from a trough in April to a 1.95 percent peak in mid-July because of global credit tightening.

But the yield has since dropped to 1.67 percent on expectations that Japan's central bank will hold off on raising interest rates in order to keep money markets flowing.

Tokyo office yields have fallen to around 3 percent from about 5 percent three years ago, but unlike major office markets in the United States and Europe, still offer a positive spread over bond yields.

For Nobuaki Kawai, senior consultant at STB Research Institute, the possibility of a sharp rise in the yen is the main risk to inward investment in Japanese property.

That would actually have a big impact since the cheap yen has enticed people to invest in Japanese real estate, he said.

The Japanese currency has strengthened about 5 percent to 117.3 yen to the U.S. dollar since mid-June, partly on expectations that investors will stop borrowing in the low interest rate currency to buy higher yielding assets elsewhere.

Macquarie's Nacard said the main threat to Asian property markets came from the possibility that the U.S. subprime crisis could lead to a major U.S. and global economic slowdown. Otherwise, Asia was a relatively healthy investment option.

I think if anything, the marginal dollar today is less likely to invest in U.S. real estate investment trusts and more in Asia, he said.

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