By Lewis Jackson

SYDNEY (Reuters) - An Australian real estate investment trust (REIT) has limited how much investors can withdraw from one of its largest office funds citing "challenging property conditions", in the latest sign of trouble for the embattled commercial property sector.

Investors in the unlisted A$2.5 billion ($1.72 billion) Charter Hall Direct PFA Fund received only a quarter of what they requested during a once-every-five-year window to withdraw their money late last year, according to a July update on the Charter Hall Group website.

Australia's fourth-largest REIT had marketed several properties to fund the remaining 75% of cash withdrawals requested, but "sales had proved challenging" and further redemptions may be delayed until mid-2024, the website said.

The delay in redemptions exposes the bind facing REITs with unlisted funds like Charter Hall: they need cash to pay out nervous investors and fund new projects but are reluctant to sell properties or tap equity markets in the middle of a commercial real estate downturn.

Charter Hall did not immediately respond to a Reuters request for comment.

On its website Charter Hall said the fund would "only sell assets for prices that reflect fair value and given the lower sales volumes in the office investment markets, sales have proved challenging".

Another REIT and Australia's largest office landlord Dexus last month sold a premium downtown Sydney office block for a 17% discount on a valuation made six months earlier.

Charter Hall joins the likes of BlackRock and KKR in curbing withdrawals from unlisted property funds as investors try to exit the commercial property sector which is facing its steepest valuation declines in more than a decade.

Emptied during COVID-19, the shift to home working has made office blocks slow to refill. Meanwhile, higher interest rates have slashed property values just as debt gets more expensive to service.

The one-two punch has crushed shares of listed REITs. The Australian and U.S. REIT benchmark indexes are down roughly a fifth since highs at the end of 2021. Meanwhile the broader Australian index is off 2% over the same period.

But unlisted fund valuations have declined more slowly, creating an incentive for investors to pull money out while a chunky premium over listed equivalents remains, according to fund managers with investments in REITs.

In June, BlackRock again limited redemptions from its Real Estate Income Trust (BREIT) for the eighth month in a row.

($1 = 1.4510 Australian dollars)

(Reporting by Lewis Jackson; Editing by Byron Kaye and Jacqueline Wong)