Investors in Asia's biggest property market, Japan, will need to be more selective and work harder on refurbishing buildings to make good returns as the cost of borrowing increases, fund managers say.

In the last few years, investors have thrived in Japan by borrowing at rock bottom rates and buying buildings cheaply - at yields of as much as 7 or 8 percent - as the property market emerged from a decade of economic stagnation.

But now fierce competition for assets between fledgling real estate investment trusts (REITs) and private equity funds has driven down Tokyo office yields to around 4 percent.

At the same time, expectations the Bank of Japan will start raising interest rates has lifted 10-year government bonds nearly half of a percentage point this year to 1.9 percent.

I think real estate has got to start doing more of the work - that means guys like us, Jack Chandler, chief executive of LaSalle Investment Management, told a conference in Singapore on Tuesday.

In the past, colleagues would accuse you of getting excess return for the risk you were taking, but that has changed.

LaSalle has raised around $2 billion of equity for investment in Asian property, Chandler said, with a little more than half for Japan.

Japan has an estimated $700 billion worth of buildings that would interest foreign investors, around two thirds of what is available in Asia.

Chandler said that when LaSalle began investing in Japan in 2000, buying an office block in central Tokyo with an empty floor seemed risky.

But with REITs improving information flows by supplying data on values and rents, the market had matured to the extent that LaSalle was now buying land and developing, he said.

GOVERNMENT SALES

Jon Tanaka, director of the real estate opportunities group at RREEF, said investors needed to get more inventive.

RREEF, the property asset management arm of Deutsche Bank, is looking to increase the 3 billion euros it has invested in Asia by launching funds aimed at Asian investors.

What people are looking for is assets with the potential to add value, decrease expenses, re-tenanting and opportunities to raise rents, Tanaka said.

Susie Tong, Asia manager for the commercial initiatives group at GE Commercial Finance, said her firm had invested around $7 billion in Asian property, mostly in offices and housing in Japan, but wanted to move into logistics, hotels and shopping centers.

She was confident a booming property market would outweigh rising interest rates.

Prime Tokyo offices are almost full, with rents rising 4.6 percent in the first three months of 2006 from the last quarter of 2005, according to consultants CB Richard Ellis.

We're expecting rental growth and capital value returns, and management turnaround opportunities should also help erode the effect of higher interest rates, Tong said.

Finding property sellers in central Tokyo has become difficult. But Yuichiro Kawaguchi, professor at Waseda University in Tokyo, said the government would start offloading $500 billion worth of buildings in the heart of the city to swell its coffers.

He said most of the buildings were offices and apartments for civil servants, and the first auction would be next month.

I think some of the Japanese developers will bid, Kawaguchi said. But he said he advised the government also to use its buildings to launch REITs to spur the market.

Japan Deutsche Bank